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What Commercial Landlords Need to Know if a Tenant Files a Chapter 11 Bankruptcy (And What They Should Consider Before the Filing)

Due to the COVID 19 virus and related rules and guidelines regarding social distancing, many commercial tenants will have difficulty making payments on commercial leases and otherwise complying with their lease obligations.  This may cause a substantial number of commercial tenants to file for Chapter 11 bankruptcy.  To prepare for this potential, commercial landlords should be aware of the following:

  1. Automatic Stay.  Once the Chapter 11 bankruptcy is filed, a bankruptcy stay immediately goes into effect prohibiting the landlord from commencing eviction actions, continuing an unfinished eviction action, attempting to collect past-due rent, or using a security deposit to offset amounts owed to the landlord by the tenant.  If a landlord wishes to pursue these actions, it must first request relief from the automatic stay.
    However, the filing of a bankruptcy case does not prohibit the landlord from taking possession of a commercial property leased by the tenant if the term of the lease expired before the filing of the bankruptcy case or later expires during the bankruptcy case.
  2. Time to Assume or Reject Lease.  The Bankruptcy Code provides that an unexpired commercial lease will be deemed rejected and the tenant shall immediately surrender the property unless the tenant assumes or rejects the lease by the earlier of a) the confirmation of a Chapter 11 Plan, or b) 120 days after the date the bankruptcy case was filed.  If a Plan has not been confirmed, the 120-day period may be extended for a period of 90 days upon request of the tenant (which is usually granted).  Therefore, Chapter 11 tenants generally have 210 days to decide whether to assume or reject an unexpired commercial lease, unless a Chapter 11 Plan is confirmed before the expiration of this period.

    Note that commercial tenants who file Subchapter V Chapter 11 petitions in bankruptcy for small businesses are required to file a Plan within 90 days of the bankruptcy filing, so the decision of whether to assume or reject a lease will typically be made by the time the Plan is filed.

  3. Scope of Assumption or Rejection.  Assumption or rejection of a commercial lease in bankruptcy requires assumption or rejection of the entire lease; a tenant cannot assume or reject parts of a lease.
  4. Assumption of the Lease.  If a tenant assumes a commercial lease in a Chapter 11 bankruptcy, the tenant must cure all defaults or provide adequate assurance that all defaults will be “promptly cured.” It further must provide adequate assurance of future performance under the lease.
  5. Assignment of Leases.  Once a tenant assumes a lease, it may then assign the lease to a third party, but it must provide adequate assurance of future performance by the assignee.  The Bankruptcy Code sets forth specific requirements that must be met in order to establish adequate assurance for the assignment of a shopping center lease.
  6. Tenant’s Obligations During Bankruptcy.  During the pendency of a Chapter 11 bankruptcy case, the tenant must perform all obligations under an unexpired commercial lease which arise from and after the date of the Ch. 11 filing. The landlord may request relief from the automatic stay to pursue its remedies under the lease if these obligations are not performed after the bankruptcy is filed. 
  7. Landlord’s Claim in Bankruptcy.  If the bankruptcy court approves a tenant’s assumption of the lease and the tenant cures all defaults under the lease and continues to comply with the lease, the landlord will hold no claim against the tenant. If, however, the bankruptcy court approves the rejection of a lease by a tenant, the rejection is treated as if the lease was breached the day the bankruptcy was filed.  In this event, the landlord will have an unsecured, non-priority claim for amounts due and owing by the tenant before the Chapter 11 filing, and for future damages under the lease, but these future damages are capped by the Bankruptcy Code.  Typically, these unsecured, non-priority claims do not receive substantial payments through a Chapter 11 Plan.
    Landlords are entitled to an administrative priority expense if the tenant fails to comply with its lease obligation to pay rent after the bankruptcy is filed.  But the landlord must demonstrate that the bankruptcy estate benefitted from the use of the property. Landlords must be sure to monitor deadlines for filing claims in a Chapter 11 bankruptcy case.
  8. Stub Rent.  Under current Nebraska bankruptcy law, a landlord may be entitled to an administrative priority expense for “stub rent” which generally is rent for the period of time between the date of the filing of the bankruptcy to the date of the first lease payment which becomes due after the bankruptcy filing.
  9. Potential Preferential Payments.  In a Chapter 11 bankruptcy, payments made by the tenant on pre-existing debts within 90-days before the filing of bankruptcy may be voided as preferential transfers.  Accordingly, lease payments on past due rent during the 90-day period prior to the bankruptcy filing may constitute voidable preferential transfers resulting in an obligation of the landlord to repay such amounts.  If it appears that a landlord has reason to believe that its commercial tenant may be filing bankruptcy, proper planning and precautions are necessary to protect the landlord’s interest.  Lease payments timely made during the 90-day period before bankruptcy do not constitute preferential transfers.

    Certain exceptions may apply to defeat preferential transfer claims, including an exception for payments made in the ordinary course of business or for payments made in exchange for “new value” provided by the landlord, such as when the landlord allows the tenant to remain in possession of the leased property.

    If a Chapter 11 tenant assumes a commercial lease in bankruptcy, there is no cause of action for preferential payments.  

Issues for Commercial Landlords to Consider Before a Tenant Files for Bankruptcy

  1. Lease Termination.  Of course, if a commercial lease expires or is terminated before the Chapter 11 tenant files for bankruptcy, there is no commercial lease to assume or reject.  Accordingly, if the landlord has grounds to terminate a commercial lease and does not want the tenant to have the option to assume, assign or reject the lease for a period of 210 days after the tenant files for Chapter 11 bankruptcy, the landlord may wish to proceed to terminate the lease pursuant to the lease terms before the tenant files.  
  2. Protective Measures.  Landlords should also consider taking protective measures before tenants declare bankruptcy.  Specifically, Landlords should consider:

    – Applying the security deposit to unpaid obligations as allowed by the lease;
    – Requiring an increase in the security deposit;
    – Requiring a Letter of Credit;
    – Requiring a surety bond; or
    – Requiring personal or third-party guaranties.

    While there is some risk that an increase of a security deposit may be challenged as a preferential transfer if it occurs during the 90 day period before the tenant’s bankruptcy, a landlord may be able to defeat such a claim if the landlord provided “new value” to the tenant as noted above.  It would be advisable to consult with legal counsel before taking this action.

  3. Obtaining Important Property Information.  If a landlord believes a tenant may file for bankruptcy, the landlord may want to utilize its rights under the lease to obtain information about the property.  Specifically, a landlord may pursue rights under the lease to inspect the leased premises to assure the property is being properly maintained or to obtain important information from the tenant such as security codes and information regarding insurance, HVAC and utilities.  By doing so, the landlord may avoid damages caused by such things as frozen or burst pipes if a tenant abandons the property or fails to maintain the premises.   

If you have any questions about the treatment of commercial leases in a Chapter 11 bankruptcy case, please contact Rick Myers or Sam King at 402.492.9200 or via email.

Sun May 17, 3:28pm

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