June 18, 2014

The “ABCs” of Commercial Leases in Bankruptcy


You are a landlord of office, industrial or retail space and you just received notice that one of your tenants has filed bankruptcy. There are several issues that may or may not arise depending on the nature of your tenant's enterprise and the type of bankruptcy case (reorganization or liquidation) that was filed. Much also depends on whether or not the tenant (or his bankruptcy trustee) chooses to assert the various rights granted to the tenant by the bankruptcy code. In nearly every case, however, there are three very important themes:

"A" stands for "Assumption or rejection" of your lease;

"B" stands for "Breach" which may call for immediate action; and

"C" stands for your "Claim" and how you go about collecting it.

Before we jump into a discussion of the landlord's rights and remedies under each theme, it is important to briefly explain the difference between a reorganization case and a liquidation case. Most commercial tenants end up filing under chapter 11 for their reorganization cases because the business is an entity — a corporation, a limited liability company, or a partnership. Where the debtor is an individual or couple, and the debts do not exceed certain limits set by Congress, the debtor(s) may reorganize under chapter 13. Under either chapter, in every reorganization case, it is the debtor that the landlord must negotiate with or assert rights and remedies against. In liquidation cases under chapter 7, the landlord must deal with the tenant's bankruptcy trustee who is charged with maximizing the tenant's assets for the benefit of all general creditors of the tenant. Based on the value of the leasehold, the trustee will decide whether to assert the tenant's rights against the landlord granted by the bankruptcy code.

A. Assumption or Rejection. The first and foremost question the landlord faces in every case is "will the bankrupt tenant remain in the property?" Of course, the landlord may want the tenant out, which is, in part, a function of the breach issues discussed in the next section. There are five basic scenarios:

  1. The lease has expired by its terms or by operation of law due to an uncured defaultbefore the tenant filed the bankruptcy case. Here, the lease is terminated and none of the tenant's bankruptcy rights come in to play. The landlord may evict the tenant after obtaining relief from the automatic stay by filing a motion in the bankruptcy court, or the landlord may choose to enter a new lease with the tenant on entirely new terms.
  2. The lease is current and the tenant wants to stay. If the tenant is reorganizing, all the tenant has to do is make the rent and associated payments, give the landlord "adequate assurance of future performance under the lease and obtain bankruptcy court approval to assume the lease within 60 days after the date the bankruptcy case was filed.
  3. The lease is in default and the tenant wants to stay. Again, assuming the tenant is reorganizing, all the tenant has to do is cure the default, make the payments, give the landlord adequate assurance of future performance under the lease and obtain bankruptcy court approval to assume the lease within 60 days after the date the bankruptcy case was filed.
  4. A chapter 7 bankruptcy trustee is involved. The trustee has exactly the same rights as the tenant under scenarios 2 and 3 above. In most cases, however, the trustee will not want to run the tenant's business for the long run. If the lease has value (it is a below market lease), the trustee, after filing a motion and giving the landlord an opportunity for a hearing, will assume the lease and assign it to a third party in exchange for a payment to the tenant's bankruptcy estate. The trustee must cure any defaults, the new tenant must (on behalf of the trustee) provide adequate assurances of future performance, and the trustee must accomplish the assumption and assignment within the 60 day period after the date the bankruptcy was filed. The landlord's objections, if any, to the new tenant's assurances of future performance will be heard by the bankruptcy court.

    Note that the magic 60 day period for assumption and assignment may be extended for cause if a motion to extend the period is filed by the tenant or the bankruptcy trustee before the original 60 day period expires. If the original 60 day period expires without a proper extension or an assumption approved by the bankruptcy court, the lease is deemed rejected and may not be resurrected by anyone (unless the landlord consents).

  5. Neither the tenant, nor the trustee in a liquidation case, wish to retain the leasehold. The property is either surrendered to the landlord immediately, or, because the trustee must first investigate the potential value of the lease, after the investigation period. In this case, the trustee must pay at least the administrative rent for each day the trustee fails to surrender the leasehold after the bankruptcy filing date.

B. Breach Issues. There are three separate breach issues that arise in both reorganization cases and liquidation cases:

  1. The mere filing of a bankruptcy petition by the tenant is not, as a matter of bankruptcy law, considered a default entitling the landlord to terminate (even though the lease contains a clause that says it is). Such a clause is called an "ipso facto clause," and such clauses are void under the Bankruptcy Code.
  2. By far the most important breach issue is whether or not the lease expired by its terms or by operation of law following the tenant's default before the filing of the bankruptcy case. The tenant may believe it still holds a valuable lease or leases, only to realize that the landlord holds all the cards. If this is the case, the bankruptcy court must grant the landlord's motion for relief from the stay and allow recovery of the premises.
  3. Where there is still a valid lease, but the lease is in default, remember that in order for the tenant or the bankruptcy trustee to assume the lease, all pre-bankruptcy defaults must be cured, including but not limited to payment defaults.

C. Claim and Collection Issues. Where the lease is in default at the time the bankruptcy is filed, every landlord has at least three types of claims:

  1. The pre-bankruptcy rent claim (pre-filing date lease payment default plus CAM charges, insurance premiums and the like, and any damages for nonmonetary defaults);
  2. The administrative rent claim (post-filing date lease payments, plus all other charges that come due between the bankruptcy filing date and the date the premises are given back to the landlord via surrender or court order; and
  3. The pre-bankruptcy full lease expectancy breach claim (chapter 7 cases and failed reorganization cases where the landlord files a proof of claim to share in the bankruptcy estate as a general creditor for the entire lease expectancy subject to two limitations: First, the duty to mitigate damages by reletting the premises; and second, the formula in the bankruptcy code that limits the expectancy claim to the rent reserved in the lease for "the greater of one year, or 15 percent, not to exceed three years of the remaining term of the lease . . . ."

The landlord has two discretionary collection tools and one automatic collection tool available in every bankruptcy case:

  1. Motion for relief from the automatic stay. Here, the landlord insists on immediate payment of administrative rent by either a reorganizing debtor or bankruptcy trustee. This motion is recommended in every case where the tenant is in default on the petition date. All such motions must be filed separately from any other motion.
  2. Motion for adequate protection (adequate assurances of performance of both the duty to pay administrative rent, maintain insurance, security and other operating concerns). This motion is less aggressive than a relief from the stay motion.
  3. Proof of Claim. The landlord's claim should be filed in every case where there is a loss. The written proof of claim must be filed within 90 days after the first date set for the meeting of creditors in the case. The proof of claim form is a standard form, and should include all three types of claims.

Note that a traditional collection tool outside of bankruptcy, the statutory landlord's lien on the tenant's personal property, is almost always useless after a bankruptcy case has been filed because these liens may be avoided by the filing of a lawsuit in bankruptcy court by the tenant or bankruptcy trustee.

For more information on this topic, please contact marketing@jordanramis.com or call (888) 598-7070.


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