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.