What are my rights as a commercial landlord when my tenant files for bankruptcy?

If you’re a commercial landlord whose tenant has just declared bankruptcy or is threatening to, you no doubt have more questions than answers. Here are the things you need to know now, and a few habits to help keep your losses - and your cash - under control.

Below, the situation is broken down stage-by-stage, from the earliest warning signs to the final court appearance. No two cases are alike, however, and no list will capture all of the variations.

Written Forbearance Agreement

The most important thing you can do as a commercial landlord is document any relief in writing before a bankruptcy. Doing so protects you should the tenant later file. You’ll be able to show the court exactly what happened if the tenant does decide to go bankrupt.

Many tenants have asked for rent deferrals, citing all manner of force majeure, impossibility and frustration of purpose defenses. Landlords who agree to the request will do best by negotiating a written forbearance agreement. It can restructure late and future rent, and can head off litigation and legal fees. Landlords can consider asking for future rent increases, guaranties, letters of credit, or other collateral to buttress the lease. They also can include provisions on what happens if the tenant later goes into bankruptcy.

The Tenant Files for Bankruptcy

When a commercial tenant files a petition for bankruptcy relief, Section 362 of the Bankruptcy Code is triggered. That provision puts in place an automatic stay, which halts most efforts to collect the unpaid rent and to use the security deposits. The stay is wide reaching, and sanctions can be imposed for violations of it. But most letters of credit fall outside the stay. Some third-party guaranties are likewise. For example, if you have a letter of credit in place and the tenant files for bankruptcy, that does not mean that you cannot seek the letter to cover your losses. In the same way, it probably does not stop you from going after a guarantor, if the guarantor has not filed as well. That’s why it’s helpful to know how the stay works in your own commercial lease. So, prior to sending a demand letter, or locking a door, or drawing down on a deposit, a commercial landlord is going to need to evaluate whether or not the automatic stay is going to apply to the action the landlord wants to take. It’s also possible, in some circumstances, to ask the court to lift the stay.

There are two main chapters under the Bankruptcy Code. Chapter 7 is liquidation. In that chapter, a trustee sells the tenant’s property and uses it to pay the claims. In a chapter 11, the tenant usually reorganizes its affairs or sells the business as a going concern. It also can liquidate. In either chapter, you have rights as a landlord. The chapter matters for two reasons. First, it can dictate what will happen to the lease. Secondly, the chapter affects the rights you have as a landlord.

In a bankruptcy, the trustee (or debtor) can assume, assume and assign, or reject an unexpired commercial lease. State law determines when the lease expires. If it’s assumed, the defaults are cured, the rent is paid and the lease remains in force. Under the Code, an unexpired commercial lease can be assigned, even if the lease itself bars it, so long as all the defaults are cured and there is adequate assurance of the assignee’s future performance. Special protections may apply to shopping centers. Rejection means a breach of the lease as of the date the bankruptcy petition is filed. You have a claim for damages based on the rejection. That claim is capped at the greater of one year’s rent, or 15% of the rent for the balance of the lease, up to a maximum of three years.

The tenant has a limited time in which to decide. If it has a Chapter 11, it has up to 210 days, but that can be extended only with the landlord’s consent. In a Chapter 7, the tenant usually has 60 days unless the bankruptcy court extends it. The deadline will give you some certainty. In a Chapter 11, your consent to extend this deadline is a powerful bargaining chip.

Until the lease is assumed, assigned or rejected, the tenant generally has to keep paying the rent on time. The unpaid, post-petition rent may have priority over prepetition claims. The rent that accrues between the date of the bankruptcy petition and the end of the month is called stub rent. Some courts prorate it, while others treat the entire amount as prepetition. Stub rent is important because the prorated share is postpetition rent, and must be paid. Otherwise, it is lumped with the prepetition debt. With COVID, some courts have suspended the timely rent obligation.

There may also be situations in which a landlord wants to force a bankruptcy tenant to pay the post-petition rent, or wants to force a decision on whether to assume, assign or reject. But again, the court has to approve. You can’t just go on autopilot and continue doing what you were doing before the bankruptcy petition, or you can get sanctioned.

So before you act, see what kind of security you’re dealing with. Some you can reach without the court, but some you can’t. A cash deposit may require a relief from stay first. Security given by a letter of credit or guarantor that is not part of the bankruptcy filing can probably be reached without the court.

Your place in the line is determined by the kind of claim you have. The unpaid rent accrued after the tenant files for bankruptcy until it makes a final abandonment of the space is called “post-petition” rent. It often has a priority, and is paid before general unsecured claims. The unpaid rent accrued before the tenant filed, and any damages from a rejected lease generally have no priority and are paid if funds are left. Commercial landlords who have a claim under a right of setoff, or an interest in the tenant’s property, may have a secured claim. This includes the right to use the security deposit. But they have to file a proof of claim, and they have to do it on time. For administrative claims, depending on your court and case, you will have to file something, either a proof of claim or a formal request for payment, in order to be paid. And make sure it is timely and properly filed.

A debtor’s payment on an old debt, made when the debtor is insolvent, within 90 days before the bankruptcy, gives the creditor a “preference.” What this means is that the creditor gets more than it would in a liquidation. In the case of timely rent paid, a landlord should be safe. There’s a chance of this affecting you if you took a catch-up payment after the fact, in the 90 days before the bankruptcy. For example, if you let the tenant “catch up” on rent it owed in the 90 days, and the tenant later filed for bankruptcy, you may be at risk for the amount you accepted in the 90 days. Fortunately, there are defenses, like the ordinary course, contemporaneous exchange and new value defenses.

If your tenant is running a going-out-of-business sale, pay attention to the procedures for the sale. The rules for the sale can be complicated, so be sure to read every page of the procedures. These rules can try to override the lease and local law, but there are protections that a commercial landlord can look to, such as lease and local law, plus zoning laws. At a going-out-of-business-sale, disputes can arise over the ownership of FF&E. There may be a short window of opportunity. Sometimes, the trustee sells equipment or furniture which are actually fixtures, belongs to the landlord and should not be in the auction. Or things could get sold that are otherwise part of the realty and should not be sold at all. Read the sale motion closely, and object right away if you see things that are yours.

Under chapter 11 the U.S. Trustee (Justice Department) will ask creditors if they want to serve on an unsecured creditors’ committee. Landlords usually qualify if the lease was rejected or there was a default before the petition filed. The committee’s lawyers and advisors are paid by the estate. Getting on the committee also means you have a greater ability to be heard, as part of the committee, which is representing a group of creditors, not individual creditor interests, which sometimes have divergent agendas. Of course, with the committee, members also have a powerful fiduciary responsibility to similar creditors. It means you’re speaking for more than just yourself. The committee is usually appointed soon, so fill out the questionnaire and don’t wait.

The Filings Can Quietly Change Your Rights

Be sure you check all the filings in the case. The filings can quietly change your rights, so do not assume the notices are routine. If someone is a chapter 11 financing lender, they may get a superpriority lien covering the lease. They could step into the lease without the normal assumption protections. This is a reason to call a bankruptcy lawyer quickly.