Landlord’s Rights When Its Tenant Files A Bankruptcy Petition

By: Joel Shafferman

Landlords often find themselves as involuntary parties to bankruptcy cases filed by a tenant. Affected landlords should be comforted in knowing that the bankruptcy laws give them protections not available to other creditors.  

Bankruptcy Basics

Most debtors file bankruptcy cases under either Chapter 7, Chapter 13, and Chapter 11 of the Bankruptcy Code. Chapter 7 contemplates a trustee liquidation of assets. Chapter 11 is generally used by commercial enterprises that want to continue operating and repay creditors or by selling their assets in an orderly manner.  

The Automatic Stay

With rare exceptions, the filing of a bankruptcy case automatically stays any pending eviction or collection proceedings commenced by a landlord. The automatic stay prohibits all creditors (including landlords) from commencing or continuing any proceeding against the tenant which could have been commenced prior to the bankruptcy filing. 

The automatic stay is effective immediately upon the bankruptcy filing and applies even the landlord is unaware of the bankruptcy case. If any landlord violates the automatic stay, the debtor may be able to recover damages, including attorneys’ fees.  If the violation is willful, the debtor may even be awarded punitive damages. Therefore, any landlord must not exercise “self-help” to obtain possession of the premises. 

Obtaining Relief from the Automatic Stay

If a tenant who has filed a bankruptcy petition is not paying current rent, the landlord can file a motion with the bankruptcy court seeking to modify the automatic stay to permit it to continue its pre-bankruptcy plenary or summary proceedings.  Even if the tenant is paying rent after the bankruptcy filing, if the landlord can establish that a warrant of eviction was issued prior to the debtor’s bankruptcy filing, the landlord may be able to obtain an order granting it modification of the automatic stay.  

Debtor Must Compy With Terms of Lease During Bankruptcy Case

During the pendency of a bankruptcy case, the tenant must comply with all of the terms of its lease. If the tenant does not pay its post-bankruptcy rent and/or additional rent, the Bankruptcy Code gives the landlord’s “administrative expense” status, which is a higher priority of claim than other creditors which the exception of secured claims. If a tenant is not paying its post-petition rent the landlord should as the bankruptcy court for immediate payment and modification of the automatic stay. 

Debtor’s Choices of How to Treat its Lease During Chapter 11 Case

Once a debtor commences a  bankruptcy case, the debtor in a Chapter 11 case, or the trustee in a Chapter 7 or Chapter 13 case, has the following three options with respect to a lease: (1) assume the lease and continue performing all obligations; (2) assume and assign the lease to a third party (this is generally done as part of a sale of the debtor’s other assets in a Chapter 7 or Chapter 11 case); or (3) reject the lease and surrender possession of the property. 

A commercial tenant in a Chapter 11 case, the debtor has 120 days from the of its bankruptcy filing to decide whether to assume or reject the lease.  The tenant also has the legal right to seek a 90-day extension of this 120-election period.  The court will likely deny a tenant’s request for an extension if the tenant has failed to timely perform its lease obligations. Thereafter, the court cannot grant any further extensions without the landlord’s consent. If the tenant does not assume or reject the lease within this time, the lease will be deemed rejected. If this happens, the landlord should ask the Bankruptcy Court to confirm that the lease has been rejected to risk violating the automatic stay when it seeks to regain possession.

Debtor’s Assumption of the Lease

If a lease is valuable, the tenant in a Chapter 11 case will often ask the bankruptcy court to allow it to assume its lease. However, the tenant cannot assume a lease unless it promptly cures all monetary defaults and complies with all lease terms.   Additionally, the tenant must provide the landlord with “adequate assurance” that it will be able to perform under the lease going forward. This requires a tenant to prove to the court that it has the wherewithal to pay future rent.  Of course, the landlord can oppose the tenant’s request to assume its lease and the bankruptcy court will determine the outcome.

Debtor’s Assumption and Assignment of the Lease

Currently, many businesses use Chapter 11 to effectuate an orderly liquidation of their assets. In such cases, the debtors will seek to assume and assign their profitable commercial leases to third parties. This strategy is also employed by Chapter 7 trustees who are tasked with liquidating a business.  Subject to certain exceptions, the tenant or trustee will be able to assume and assign a lease to a third-party even if the lease contains an anti-assignment provision.  Upon the assignment of a lease the landlord’s claim be timely paid, and the proposed assignee must provide adequate assurance that it will be able to comply with the terms of the lease.  If the landlord opposes the proposed transaction, it can file an objection and the bankruptcy court will decide the outcome.

Debtor’s Rejection of the Lease and Landlord’s Filing Proof of Claim

A debtor or trustee can use its bankruptcy case to reject a burdensome lease which is one of the reasons many businesses file bankruptcy cases.  A tenant’s rejection of a lease gives rise to two distinct landlord claims: (1) a claim for pre-petition unpaid rent and (2) a claim for rejection damages.  The Bankruptcy Code imposes a limit (i.e. a cap) on the rejection damage claim, thus restricting the amount of future damages a landlord may recover because of the debtor’s termination of a lease. The landlord’s claim for the loss of future rent is limited to the greater of one year’s rent or 15% of the remaining term of the lease, which claim cannot exceed three year’s rent.