Tenant Files Bankruptcy?

Bay Area Council, Housing Bill, SB 1069,San Francisco, Bay Area

By Tracy Green

You receive a phone call telling you that one of your tenants just filed a bankruptcy. What should you do? The discussion below provides a general overview to assist landlords.


1. What is the Status of the Lease?

A Chapter 11 debtor can: (i) assume the lease and continue to perform; (ii) assume and assign the lease to a third party; (iii) or reject the lease and surrender the premises. The debtor has 120 days to assume or reject the lease, and can request one 90-day extension, or obtain consent for further extensions. The Code requires the debtor to satisfy all terms under the lease until the tenant rejects or assumes and assigns the lease to a third-party. Claims that arise after the case is commenced are administrative claims and have a higher priority than the pre-petition claims. Rent that is due after the commencement of the case while the debtor is occupying the premises is an “administrative claim.”

If a tenant files a Chapter 7 (liquidation) case, the business is generally shut down and a trustee is automatically appointed. Chapter 7 trustees are only interested in selling the lease if it has value. Otherwise, the trustee will maintain the leased premises for as long as is necessary to liquidate the assets. The trustee may try to conduct an auction, and landlords should make sure that the trustee has sufficient funds to pay rent and insurance, and agrees to remove all items not sold at auction.

If the debtor fails to timely assume the lease, the lease is deemed rejected, and the courts do not have jurisdiction to resurrect it. It is critical that landlords monitor pleadings for requests for extensions of time to assume or reject a sale of the lease. Some courts allow debtors to file sale motions which attach exhibits of the leases to be assumed with the defaults listed at zero, and a landlord’s legal rights can be permanently impacted if no objection is filed.

2. Assumption.

Leases can be assumed by the debtor even if the terms of the lease expressly prohibit assumption. However, before a lease can be “assumed”, the debtor must cure all defaults, and provide the landlord with adequate assurance that the debtor (or its assignee) will be able to perform under the lease going forward. This can be done via a motion or plan. If the debtor assumes the lease, and later the case rejects the lease, damages are limited to two years of administrative rent.

3. Rejected Leases.

The debtor can reject a lease by way of a motion or by operation of law where the debtor does not timely assume the lease. If the lease is rejected, the landlord will be entitled to “rejection damages,” also known as the Cap Claim. The landlord’s rejection claim for rent is capped at the greater of (1) one lease year or (2) fifteen percent, not to exceed three years, of the remaining lease term. Also, if the tenant damaged the property, the landlord could have a pre-petition (or post-petition claim) for damages. Tort damages are not part of the Cap Claim. Although a landlord’s claim is limited by the Cap amount, the landlord can pursue guarantors for the full amount of the damages under the lease.
The landlord may have a “stub rent” claim, which is the post-petition rent for the period between the date of the filing and the start of the next month. Also, if the lease provides for attorney’s fees, the landlord may be entitled to attorney’s fees.

4. Security Deposits

Security deposits that were not applied before the filing of a bankruptcy case are considered property of the bankruptcy estate. Landlords should not setoff claims they have against a debtor’s deposit without relief from stay. The security deposit is applied to the landlord’s general unsecured claim, the Cap Claim. The dominant trend is to treat letters of credit like security deposits, applying them against the Cap Claim. However, in one case a landlord that did not file a proof of claim and drew down on the full amount of a letter of credit that exceeded the amount of the Cap Claim, was entitled to keep all of the funds. That court noted that the Cap Claim arises under Bankruptcy Code section 502(b), which limits the amount of a claim. The Court reasoned if the landlord did not file a proof of claim, the limits of the claims process could not apply. Since letters of credit expire on specific dates, landlords relying on them as security deposits should look to see if the letter will expire during the case, and decide if action is needed to renew it.

5. Conclusion

Landlords have multiple types of claims which must be timely asserted. Landlords should pay very close attention to deadlines, and monitor the debtors case until the landlords claim has been liquidated.

Tracy Green is a partner in Oakland-based law firm Wendel, Rosen, Black & Dean LLP’s Insolvency & Restructuring Practice. She can be reached at 510.834.6600 or tgreen /at/ wendel.com.

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