Tuesday, May 3, 2016

What Happens When a Commercial Tenant Files for Bankruptcy?

In many cases, commercial tenants resort to filing for bankruptcy when they cannot pay the rental arrearage owed to the landlord and/or are struggling to pay the monthly rent as it becomes due. In some cases, the bankruptcy is filed after the landlord has commenced an eviction action under state law. The purpose of this article is to briefly summarize the landlord’s rights when this happens.

As soon as the bankruptcy case is filed, the landlord is prevented from taking any further action to recover possession of the premises or to collect the past due rent. This statutory injunction is commonly referred to as the “Automatic Stay”. The landlord must be careful not to make even casual collection attempts during the Automatic Stay, or the Bankruptcy Court may hold the landlord in contempt. 

In the bankruptcy case, the tenant has the right to reject, assume or assign the commercial lease within 120 days from the bankruptcy filing, which period can be extended by the Court for another 90 days. As a result, commercial tenants usually have 210 days to decide what to do about the lease. More often than not, the lease will be rejected because the tenant cannot afford to pay the arrearage or the monthly rent going forward. When this happens, the landlord becomes a general unsecured creditor of the bankruptcy estate, and can obtain relief from the Bankruptcy Court to proceed to recover possession of the leased space. 

In some cases, however, the tenant will want to keep the lease in place (i.e. assume the lease), or assign the lease to a third party. If the tenant elects to assume the lease, then the tenant must cure any arrearage that existed before the bankruptcy filing (i.e. “pre-petition” rent), and timely pay all rent that becomes due after the bankruptcy filing (i.e. “post-petition” rent).  If the tenant elects to assign the lease, then the tenant will be required to demonstrate to the Bankruptcy Court that the assignee is capable of performing the tenant’s obligations under the lease, and the assignee will be required to cure any arrearage and pay the rent going forward. 

Many commercial tenants file bankruptcy under the false assumption that they will be able to remain in the leased space and negotiate a better deal with the landlord going forward. Fortunately for landlords, the Bankruptcy Code does not give commercial tenants this ability (although, in some cases, the landlord may want to consider renegotiating the lease in order to keep the space occupied). Unfortunately for landlords, the filing of the bankruptcy petition usually delays the eviction of the tenant by at least two months, depending on state law and how quickly the bankruptcy estate makes a decision regarding the rejection/assumption of the lease. 

The Automatic Stay usually does not prevent the landlord from recovering possession of the leased space if the lease was terminated prior to the bankruptcy filing since there is no lease to assume, reject of assign. Accordingly, a landlord that strongly suspects an imminent bankruptcy filing should respond proactively when a tenant fails to pay rent or communicates its dire financial position to the landlord. If the landlord, in accordance with state law and the lease, is able to terminate the lease and recover possession prior to the bankruptcy filing, the landlord will improve its chances of re-letting the space without undue delay.   

This article is a very basic outline of some of the rights and obligations of tenants and landlords in bankruptcy. However, there are many nuances and complications in this area of law (e.g. rights of assignment, landlord’s administrative expenses preference, shopping center leases, and security deposits) that are beyond the scope of this article. It is essential that tenants and landlords retain experienced legal counsel to guide them through the bankruptcy process.

Ejectment - Evicting a Tenant that Claims Ownership

Most states have an expedited process to evict a residential tenant that breaches the terms of his/her lease or has no right to occupy the premises. In Virginia, this process is accomplished through an action known as an Unlawful Detainer. Typically, a landlord that wants to evict a tenant will file a Summons for Unlawful Detainer in the General District Court and, because Unlawful Detainer actions are entitled to priority on the Court’s docket, a landlord can usually get an order for possession in 30-45 days.  

A considerable problem arises when the tenant claims some type of ownership interest in the property. In Virginia, the General District Courts are considered to be “Courts Not of Record” with no authority to adjudicate title to property. Thus, the General District Courts are deprived of jurisdiction if the tenant claims to be occupying the property, not by virtue of a lease, but rather by virtue of the tenant’s ownership interest.

What is a landlord to do when a tenant no longer claims to be a tenant, but instead claims to be the owner of the property? Enter the common law ejectment action. A July, 1895 article in the Virginia Law Register by Thomas Kirkpatrick points out that an action for ejectment is over 400 years old. The Virginia Code retains the cause of action (which was litigated when the Tudor dynasty was on the English throne!) but offers no guidance as to the elements that the plaintiff must prove to prevail. One must look to the common law to determine the elements:

  1. The Plaintiff must have a subsisting interest in the property, the right to a judicial declaration of ownership and the right to recover possession; 
  2. The Defendant must be actually occupying the premises and claim an ownership interest that is adversely affected by the Plaintiff’s claim of sole and exclusive ownership; and 
  3. The Plaintiff must be dispossessed by the Defendant’s continued occupancy of the Premises.

How, you may be asking, could a tenant not named on the deed possibly claim an ownership interest the property? The first way is often the fault of the landlord: there is a mistake in the lease that creates some type of ownership interest over and above the customary occupancy interest. This scenario is easily avoided by having an experience landlord attorney prepare a proper lease. The second scenario tends to arise when the owner of the property dies and multiple parties claim ownership. Take, for example, the following case that was actually litigated by the attorneys at Gross & Romanick, P.C.:

The owner of a piece of property died intestate. His only statutory heir was his mother. However, at the time of his death, he had a long-time, live-in girlfriend. The mother tried to evict the girlfriend after probating her son’s estate, but the girlfriend claimed she was the deceased’s common law wife entitled to a statutory share of the estate (including ownership in the property). In most circumstances, this case would be easily resolved because Virginia does not recognize common law marriages. However, the girlfriend claimed that the common law marriage existed under Pennsylvania law where she and the son had lived for a period of time before coming to Virginia. Luckily for the mother, the time that the son and girlfriend had lived in Pennsylvania was too short to meet Pennsylvania’s common law marriage definition. Gross & Romanick ultimately convinced a Circuit Court judge to declare title in and award possession to the mother.  

Obviously, there is some nuance to the case that we are glossing over in this short article. This case demonstrates the importance of having a knowledgeable landlord/tenant attorney assist with any eviction proceeding, as shrewd tenants often come up with creative legal arguments to extend occupancy.

Fair Debt Collection Practices Act (FDCPA) Bites Rent Collector

In a recent case before the U.S. District Court for the Eastern District of Virginia, a trio of residential tenants alleged that a collection agency representing their landlord violated the Fair Debt Collection Practices Act (FDCPA) by sending them a letter containing a demand for payment of back rent and interest allegedly owed to the landlord. See Galdamez, et. al. v. I.Q. Data International, Inc.  The tenants specifically alleged that since their lease and the Virginia Residential Landlord Tenant Act (VRLTA) did not permit the landlord to recover pre-judgment interest, the collection agency’s demand for $19.33 in interest ran afoul of the FDCPA. The tenants in the case had already vacated the property and no lawsuit had been commenced by the landlord to recover back rent. 

The collection agency filed a motion to dismiss the lawsuit, arguing that Virginia Code § 55-227 permits a landlord to claim interest in “any action for rent”. Judge Brinkema denied the motion and ruled in favor of the tenants, finding that the VLRTA does not contain any reference to pre-judgment interest, and that Virginia Code § 55-227 was not applicable since the VRLTA governed the case. Thus, the case will go forward to determine how much the collection agency will be sanctioned for demanding pre-judgment interest in an otherwise proper demand letter. Undoubtedly, it will be a stiff penalty for a seemingly minor oversight. 

Each violation of the FDCPA can result in statutory damages up to $1,000 per violation plus reasonable attorney’s fees. In addition, the debtor can claim damages for physical distress, emotional distress, lost wages if the debtor’s job was disrupted, and recovery of funds from a wage garnishment. The court can also impose injunctive relief, such as ordering the debt collector to cease from further communication with the debtor and the debtor’s family.