Tenant Files Chapter 11 Bankruptcy – What Should You Do?

The prospect of a landlord encountering a tenant filing Chapter 11 bankruptcy can be daunting. This legal guide will give a basic overview of the rights and remedies available to landlords facing this scenario.

1. Tenant’s Basic Rights

The moment a tenant files Chapter 11 bankruptcy, many provisions of the existing lease are no longer enforceable. A provision stating that if the tenant files bankruptcy, the lease is breached and the tenant can be evicted is forbidden. Any provision “accelerating” the lease or making its performance more difficult due to bankruptcy filing are also considered unlawful. Even if the landlord is lucky enough to have terminated the lease prior to the filing of bankruptcy, they cannot continue any pending unlawful detainer actions without permission of the bankruptcy court.

2. Tenant’s Election–Assumption or Rejection of the Lease

In a Chapter 11 bankruptcy filing, unexpired leases become property of the bankruptcy estate. This allows the debtor to decide whether to assume the lease, or reject the lease. If assumed, the lease remains in effect. If rejected, the tenant is automatically deemed in breach of the agreement which allows the landlord to terminate the lease. The debtor must make their election within 120 days of the bankruptcy filing, although a 90 day extension may be granted upon request. If no election is made within the allotted time period, the lease is deemed rejected.

3. If the Tenant Assumes the lease…

…the tenant must promptly remedy all outstanding defaults owed to landlord. The promptness of the “cure” of these defaults depends on judicial discretion, but is typically an immediate one. The tenant’s election to assume the lease will have the effect of continuing the lease in full and any subsequent defaults are given administrative priority over all interests outside of secured creditors and will not be subject to a statutory cap on damages.

4. If the Tenant Rejects the lease…

…the tenant is in breach of the lease as of the date the lease is rejected, which could be retroactive to the date of bankruptcy filing. Upon rejection, the landlord no longer has the ability to reinstate the lease, but is entitled to 3 possible remedies: (1) Administrative Claims, (2) Rent Past Due Prior to Bankruptcy, or (3) Breach of Lease Damages. For the first 60 days of occupancy following filing, the landlord has an administrative claim for rent ahead of general unsecured creditors. However, any landlord claim for unpaid rent past due prior to bankruptcy filing is an unsecured claim with the same priority as unsecured creditors. Finally, the landlord may be entitled to all future rent that would be due under the lease following rejection. Unfortunately, the Bankruptcy Code caps a landlord’s damages to the greater of one year’s rent or 15% of the rent due for the balance of the lease.

5. If the Tenant Fails to Vacate

If tenant does not vacate after rejection or post-assumption, and the tenant does not pay rent, the landlord is able to seek a stay of proceedings from the bankruptcy court which can then allow the landlord to pursue an unlawful detainer action to regain possession of the leased premises.

6. Conclusion

Though the prospect of a looming tenant bankruptcy can be frustrating, it is important to know the rules. You should plan ahead by negotiating with delinquent tenants, and be aware of the debtor’s rights during bankruptcy proceedings. Doing so can allow landlords the possibility of minimizing losses and properly analyze the probabilities with respect to collecting rents in the future.

If you need assistance with any area of Business Law, contact the experts at Brown & Charbonneau, LLP for a consultation: 714-505-3000