Part I – A Bankruptcy Primer
It is an often too frequent scenario for a commercial landlord: a landlord will be served with a notice that a tenant has filed for bankruptcy. The landlord will quickly refer to the tenant’s lease and find that the lease is unclear as to a landlord’s remedies upon a tenant bankruptcy, to the extent the lease addresses bankruptcy at all. The landlord must then confront an often mystifying and confusing bankruptcy process to protect its interests, including pursuing claims against the bankrupt tenant.
In this series of two posts, we will provide a summary of the typical issues that arise for a commercial landlord in a tenant bankruptcy. This first part provides an introduction on the issues a landlord faces upon a tenant’s bankruptcy. We will cover in the second part a landlord’s right to recover for damages caused by a tenant rejecting (i.e., breaching) its lease following a bankruptcy.
- Types of Bankruptcy Proceedings
Chapters 7 and 11 of the Bankruptcy Code are available for bankrupt companies. A Chapter 7 is a liquidation case where a trustee is appointed by the Court to liquidate whatever assets might be available to pay creditors, but the bankrupt tenant no longer operates its business. A tenant filing a Chapter 11 bankruptcy case seeks to reorganize its business through a reorganization plan that is voted on by its creditors and must be approved by the bankruptcy court. The Chapter 11 debtor generally remains in possession of its assets and continues to operate its business during the Chapter 11 proceeding. Most of the issues we discuss below arise in a Chapter 11 case.
- Automatic Stay
The Bankruptcy Code provides that an “automatic stay” goes into effect immediately upon the tenant’s bankruptcy filing. The automatic stay bars creditors, like landlords, from seeking to collect amounts owed prior to the bankruptcy filing or to pursue state law eviction proceedings (or other efforts to take possession of the leased premises). If a landlord takes action against a tenant in violation of the automatic stay, the landlord can be liable to the tenant for damages (including punitive damages) and attorney’s fees. The automatic stay applies even where the lease provides that a tenant bankruptcy is a default of the lease. The Bankruptcy Code does except from the automatic stay landlord remedies to take possession of a leased property where the lease terminated prior to the bankruptcy filing.
- Assumption or Rejection of the Lease
A bankrupt tenant, in a Chapter 11 case, has the right to either assume or reject any unexpired commercial leases. If the tenant “rejects” the lease, the tenant is abandoning and terminating its rights. The tenant must, upon rejection, vacate the premises and turnover possession to the landlord. A landlord can then file a proof of claim in the bankruptcy case for damages arising from the rejection (or really, breach) of the lease. Landlord bankruptcy claims will be discussed in more detail in our next post.
To assume a lease, a tenant must cure all defaults under the lease (with a few exceptions), including any rents owing prior to the bankruptcy case, and provide the landlord with “adequate assurance of future performance.” What qualifies as “adequate,” if challenged by the landlord, would be decided by the bankruptcy court. A debtor must assume the lease as written and cannot, for example, reject provisions it might find onerous.
A debtor, upon assuming a lease, even has the right to assign the lease to a third party. This often occurs in connection with a bankruptcy sale of the debtor’s business or if the lease is under-market and has value to potential tenants. The Bankruptcy Code makes clear that a lease can be assigned to a new tenant even if the lease itself prohibits such an assignment. But to assign the lease, the assignee tenant must provide the same “adequate assurance of future performance” to the landlord and the bankruptcy court. If a shopping center lease is at issue, “adequate assurance of future performance” requires that the proposed use by the new tenant would not breach any use or exclusivity provision (or otherwise disrupt the tenant mix at the center).
A debtor in a Chapter 11 case has 120 days from the bankruptcy filing to assume or reject commercial leases and can only extend for an additional 90 days without the landlord’s consent to the extension.
Should you be interested in discussing any of the issues in this article, or otherwise how best to draft and enforce commercial leases with a view toward bankruptcy concerns, please contact Andrew J. Abrams at 312.938.4070 or [email protected] Boodell & Domanskis, LLC’s creditors’ rights and real estate attorneys can provide counsel on how best to protect a landlord’s interests when drafting a lease and, if necessary, enforce your lease rights in any tenant bankruptcy proceeding.
Click to read Your Tenant Filed Bankruptcy: What Should A Landlord Do? (Part II) in its entirety.