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Commercial Landlords' Guide to Navigating a Tenant in Bankruptcy Commercial Landlords' Guide to Navigating a Tenant in Bankruptcy

Commercial Landlords' Guide to Navigating a Tenant in Bankruptcy

Ice Miller's bankruptcy and creditors' rights attorneys have extensive experience representing landlords in tenant insolvencies nationwide and in cross-border cases and have been carefully monitoring the rapidly changing developments of the coronavirus (COVID-19) pandemic and its affect on landlords. It is our goal to provide the most up-to-date information available, along with advice on best practices and strategies to minimize loss and maximize long-term financial stability.

Below is a roadmap to guide landlords when navigating a tenant in bankruptcy. It is not intended to address each and every circumstance a landlord may encounter. If you have any specific questions or concerns, Ice Miller's bankruptcy and creditors' rights attorneys are available to assist.
  1. Strategic documenting of rent concessions is paramount and can provide landlords with significant protections in future tenant bankruptcy.
    Tenants have been relying on force majeure clauses, the defenses of impossibility and frustration of purpose and other equivalents to extract rent concessions from landlords. Landlords should consider negotiating a workable solution to minimize the economic pain in the form of a forbearance agreement and other similar written agreement. Forbearance agreements may structure late or future rent payments and rights in a way that may avoid further litigation and significant legal costs, include additional collateral protections for landlords (i.e., guarantees, letters of credit, etc.), increased rent on a go-forward basis, and other particularized protections for a landlord should the tenant ultimately file for bankruptcy
  2. The automatic stay and its affect on landlord rights.
    When a tenant files bankruptcy, most efforts to collect debts from the tenant are "automatically stayed" by section 362 of the Bankruptcy Code, including the payment of past due pre-bankruptcy rent obligations under the lease, or the setoff of security deposits (other than most letters of credit or certain third-party guaranties). While there are some exceptions to the automatic stay triggered by the bankruptcy filing, the stay is very broad, and violations of the stay could subject a landlord to sanctions. There are exceptions to the automatic stay. For example, the automatic stay typically does not affect a landlord’s rights to seek recovery from a non-debtor guarantor or draw down on a letter of credit issued to secure the tenant's obligations due under the lease. It is important to know how the automatic stay impacts a landlord's rights under a particular lease, and in what circumstances a landlord can seek relief from the automatic stay to enforce rights against the tenant debtor.
  3. The differences between chapter 7 and chapter 11.
    A chapter 7 bankruptcy is a structured liquidation. A trustee is appointed to step into the shoes of the debtor and sell all of the debtor’s assets in order to pay creditors. A chapter 11, on the other hand, is a reorganization. While it sometimes leads to liquidation, a debtor in chapter 11 typically endeavors to restructure its debts for continued operation of the business, or sell its business as a going concern. In either case, the Bankruptcy Code affords landlords rights and protections
  4. Assumption, assignment and rejection, and their impact on landlord's rights under the lease.
    In bankruptcy, the debtor or trustee may assume, assume and assign, or reject an unexpired lease of non-residential real property (applicable state law will determine whether the lease has expired). First, an unexpired lease of non-residential real property may be assumed, in which case the lease will remain in force, lease defaults must be cured, and the obligation to pay rent continues. Second, a debtor or trustee may choose to assume and assign the lease to a third party, even if the lease prohibits such a transfer. The debtor or trustee may only assume and assign if lease defaults are cured and the landlord is provided adequate assurance of assignee’s future performance under the terms of the lease. And if the leased premises is in a shopping center, the landlord may be entitled to additional protections. Third, an unexpired lease of non-residential real property can be rejected. Rejection of the lease is considered a breach of the lease as of the date the tenant debtor filed for bankruptcy, and entitles the landlord to file a claim for and seek payment of "rejection damages," which are capped under the Bankruptcy Code at the greater of one year or 15 percent (not to exceed three years) of the remaining term of the lease. A chapter 11 debtor may have up to 210 days from the bankruptcy filing to assume, assume and assign, or reject an unexpired lease of non-residential real property (unless the landlord agrees to a further extension); whereas a chapter 7 debtor typically has 60 days from the bankruptcy filing, unless such deadline is extended by the Court.
  5. Tenants are required to pay rent after filing for bankruptcy.
    Generally, a tenant must pay rent timely from the date of bankruptcy filing until that lease is assumed, assumed and assigned or rejected, and a landlord’s claim for such rent, if not paid, may take priority over other pre-bankruptcy claims. Courts differ, depending on the jurisdiction, on how to treat rent that comes due between the date a bankruptcy case is filed and the end of that month (commonly referred to as “stub rent”). Some courts require stub rent to be paid pro rata for the month it was incurred, while others consider the entire obligation a prepetition debt that need not be paid with post-petition rent payment. Landlords should also note that, during the COVID-19 crisis, some courts have suspended the requirement that tenants timely pay post-petition rent.
  6. Remedies a landlord may exercise if its debtor tenant fails to pay rent after the bankruptcy case is filed.
    A landlord may seek judicial intervention to compel payment of post-petition rent or force the tenant to assume or reject the lease if the tenant debtor fails to pay rent. A landlord may also seek relief from the automatic stay to exercise its rights under the lease. In either case, the landlord should not take actions without court approval, as doing so could violate the automatic stay and result in sanctions.
  7. Landlord's rights with respect to a security deposit, guaranty, or letter of credit after its tenant files bankruptcy.
    A landlord’s right to offset its damages depends largely on the type of security. Generally, a landlord may not setoff a security deposit against past due rent without first seeking relief from the automatic stay from the bankruptcy court. Typically, a landlord may, however, exercise its rights under a letter of credit or against a non-debtor guarantor for unpaid obligations under the lease without first seeking bankruptcy court approval.
  8. Claims a landlord may assert against debtor tenant for non-payment of rent and other damages.
    Rent due after a bankruptcy case is filed until the premises is surrendered is often entitled to “administrative priority” and paid before other pre-bankruptcy claims. Unpaid rent due before tenant files for bankruptcy, or lease rejection damages (see 3 above), are generally treated as unsecured claims, entitled to a distribution when, and if, money is available to pay unsecured creditors. If the subject lease is secured by an interest in tenant’s assets or property (by the terms of the lease or applicable state law), a landlord may assert a secured claim. And if a landlord was granted a security deposit under the lease, the landlord may assert a right to setoff, which is treated like a secured claim. Secured and unsecured claims may be asserted by filing a proof of claim in the bankruptcy case. Administrative claims may be asserted or requested by the filing of a proof of claim or a formal request for payment, depending on the jurisdiction and case. It is crucial that all claims are asserted properly and filed timely.
  9. Debtor or trustee claw back of pre-bankruptcy rent payments.
    Payments of rent received from a tenant before it filed bankruptcy could, under certain circumstances, be considered a “preference” subject to claw back by or disgorgement to a debtor or trustee. Preferences are payments received on account of an antecedent debt made within the 90 days prior to the bankruptcy filing, while the tenant debtor is insolvent, enabling the landlord to receive more than it would otherwise in a liquidation. Typically, if rent is paid when due or within the month that it is due, a landlord may not have preference liability. But if the tenant paid back rent within the 90 day preference period, those payments may be at risk. Fortunately, there are several defenses that may be available under the Bankruptcy Code, including the ordinary course of business defense, the contemporaneous exchange defense, or the subsequent new value defense, which can eliminate or minimize the risk of avoidance.
  10. Landlord concerns when its tenant seeks to conduct a going out of business sale.
    It is important that any going out of business procedures be read very carefully, as debtors oftentimes try to get court approval to ignore lease provisions or local laws governing such sales. Also, pay close attention if the tenant is seeking to sell FF&E or other property located at the premises. A landlord may only have a short period to contest the tenant’s claim as to who owns the property being sold (i.e. tenant or landlord). A landlord has remedies if it opposes going out of business sales at their premises, including the terms of the lease, local or municipal laws governing such sales, and zoning laws that may prohibit or restrict the contemplated going out of business sale.
  11. Benefits of a landlord serving on the Official Committee of Unsecured Creditors in a bankruptcy case.
    In chapter 11 bankruptcy cases, the United States Trustee’s Office, a part of the U.S. Department of Justice, is required to solicit creditors to serve on an official committee of unsecured creditors (the "UCC"). Landlords are typically eligible to serve on the UCC if the tenant debtor contemplates rejecting the lease, or has defaulted pre-bankruptcy under the lease. The UCC plays a central role in the chapter 11 process, and the fees and expenses of its attorneys and financial advisors must be paid from the bankruptcy estate. Sitting on the UCC can grant a landlord a strong voice, especially when it stands united with other similarly situated creditors. At the same time, the UCC and its members have certain fiduciary duties to all similarly situated unsecured creditors of the tenant debtor that landlords should consider carefully. If a landlord is interested in serving on the UCC, landlord should be prepared to promptly respond to the United States Trustee's inquiry (usually by completing a questionnaire ) with information regarding the nature of its claims against the debtor, as the UCC is typically appointed soon after the bankruptcy case is filed.
  12. The importance of monitoring the tenant's bankruptcy case.
    It is important to review all filings in the bankruptcy case carefully, as landlords' rights may be affected. For example, when a debtor obtains post-petition financing, the debtor may seek to grant its post-petition lender a “superpriority” lien on assets, which could include the granting of a lien on the lease. Doing so could potentially allow the post-petition lender the right to step into the tenant’s shoes under the lease without the procedural protections afforded by the lease assumption process discussed above. Landlords with questions regarding their rights or any documents they receive should strongly consider discussing them with a bankruptcy attorney as soon as possible.
Ice Miller’s Bankruptcy and Restructuring practice group represents clients in a broad array of industries, including commercial landlords, and can help evaluate what options might be available. Please contact Alyson Fiedler, Louis DeLucia, Dan Swetnam, John Cannizzaro, or any other member of the practice group with questions. 

This publication is intended for general informational purposes only and does not and is not intended to constitute legal advice.  The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstance.
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