MY TENANT JUST FILED BANKRUPTCY, NOW WHAT?

From AIR:

MY TENANT JUST FILED BANKRUPTCY, NOW WHAT?

Top Ten Considerations for Commercial Landlords

The real estate-driven economy has been so good for so long that some landlords may have forgotten how bankruptcy laws impact their rights when a tenant files bankruptcy. Moreover, the bankruptcy amendments of 2005 have changed those rights, so the rules that landlords may remember have been altered since the last real estate slowdown.

First, a bankruptcy may prevent the eviction of a tenant.

When a tenant files bankruptcy under a commercial lease, the first thing a landlord usually wants to know is how to evict the tenant. Unfortunately, the bankruptcy filing prevents the landlord from doing so, at least in the short term. Commencing or proceeding with an eviction without previously asking the bankruptcy court for permission can result in damages being awarded against the landlord.

Second, the tenant must continue to pay rent to remain in possession.

For the privilege of staying in possession of the leased location, a tenant is obligated to pay all of the rent and other charges as they come due under the lease during the bankruptcy for as long as the tenant remains in possession of the premises. However, if there is unpaid rent or other charges that came due prior to the bankruptcy filing, the tenant does not have to pay past due amounts in order to remain in possession.

For example, in the recent Wickes Furniture bankruptcy case, Wickes timed the bankruptcy filing in order to maximize its cash flow by filing for bankruptcy two days after the rent on its various locations came due. Therefore, at least in terms of its immediate obligations, Wickes was able to avoid paying one month’s worth of rent on those specific locations.

Third, the tenant has up to seven months to decide.

After filing bankruptcy, the tenant has three options.

1. It can reject the lease,

2. keep the lease,

3. or assign the lease.

The tenant initially has 120 days to make its decision. The tenant can ask the bankruptcy court to extend that decision-making time period for up to 90 days, for a total of 210 days (or approximately seven months total from the date of the bankruptcy filing). After that 210-day period expires, the court has no power to grant further extensions unless the landlord agrees to an additional extension. During this decision-making time period, the tenant must remain current on its rent.

Fourth, if the lease is priced over market, it is likely that the tenant will reject the lease.

In order to reject the lease, a tenant has to notify the Bankruptcy Court and the landlord that it wishes to reject. It is almost impossible to force a tenant to keep a lease that the tenant views as unfavorable. Once the Court accepts the tenant’s decision, the tenant must surrender possession and is no longer required to pay rent. The unpaid rent then becomes an unsecured debt of the bankruptcy estate.

Fifth, the tenant may choose to stay.

If the tenant determines that the lease is important to its ongoing business, it may choose to keep the lease (referred to in bankruptcy parlance as “assuming” the lease), the tenant must ask the bankruptcy court for permission, and must meet previously unmet obligations or provide adequate assurance that it can promptly meet existing obligations.

In the Wickes Furniture case, in order for Wickes to keep a particular location, Wickes would have had to pay any past due rent. A tenant who wishes to keep the location must also pay any contractually required attorneys’ fees incurred by the landlord (except for attorneys’ fees incurred in bankruptcy court litigation), and must demonstrate to the court that the tenant has the ability to perform the lease obligations.

Sixth, the tenant may choose to assign the lease.

If a lease is under market, yet not critical to the tenant’s ongoing business, the tenant may choose to assign the lease to a new party. In order to do so, the original tenant must ask the bankruptcy court for permission, and must satisfy all lease obligations, including the payment of past due obligations. In some instances, the new tenant may be willing to satisfy the original tenant’s past due obligations.

Seventh, anti-assignment provisions in the lease are unenforceable.

Sometimes, the new tenant (assignee) may be willing to pay the original tenant for the opportunity to take over as tenant. The original tenant is entitled to whatever sums it can negotiate with the new tenant, regardless of any lease provisions which provide that the landlord is entitled to capture those sums or even if the lease provides limitations on assignment. The bankruptcy court will normally approve the assignment to a new tenant notwithstanding such lease provisions. However, the original tenant must demonstrate to the court how the assignment will allow it to perform under the lease obligations. Also, unlike under state law, the original tenant will no longer remain responsible for payments due under the lease after the assignment.

Eighth, shopping center landlords have stronger protections against unfavorable new tenants.

If the location is part of a shopping center, landlords have four additional protections:

(1) the new tenant must be at least as financially sound as the original tenant was at the time the lease was originally signed;

(2) the new tenant must show that percentage rent will not decline substantially;

(3) the assignment may not disrupt the tenant mix;

(4) the assignment may not violate any location, use, radius or exclusivity provision of the lease or of any other leases at the shopping center.

Ninth, landlords must be proactive with untimely tenants.

Prior to a bankruptcy filing, proactive landlords can enhance their chances of avoiding the bankruptcy problems discussed above through the timely filing of a proper unlawful detainer complaint. If a tenant fails to pay rent, the landlord should serve the tenant with a three-day notice to pay rent or quit and immediately file an unlawful detainer complaint. If the landlord is able to file the complaint before the tenant files for bankruptcy, the lease is deemed terminated as a matter of law, the tenant no longer has rights under the lease, and the landlord can evict the tenant without being subject to bankruptcy laws. Therefore, if the landlord suspects that a bankruptcy filing by a tenant may be imminent, acting promptly when rent is not paid timely may be the difference between obtaining immediate possession or being dragged into bankruptcy court.

Tenth, don’t wait to contact bankruptcy counsel.

It is important for landlords to understand that in bankruptcy proceedings, tenants obtain rights they would not otherwise have and landlords lose certain rights that they normally enjoy under state law. As a result, it is critical for a landlord to move quickly in the event of a bankruptcy (or even before bankruptcy if at all possible) to enforce its rights to receive current rent, to protect itself against an unwanted assumption or assignment or (if pre-bankruptcy) to evict the tenant.

Over the decade and a half that I have been representing commercial landlords, it has become clear that those landlords who act promptly by engaging bankruptcy counsel early on in the process are far better positioned to protect themselves in bankruptcy court than those who are slow to respond. Acting quickly can also minimize the legal expense resulting from bankruptcy proceedings.

About The Author:

Jeff Krieger is a bankruptcy attorney with the Los Angeles-based law firm Greenberg Glusker. He can be reached at jkrieger@ggfirm.com.