Landlord and Tenant Issues in Bankruptcy
I. COMMON TERMINOLOGY
For individuals not familiar with bankruptcy, the Bankruptcy Code and bankruptcy practitioners utilize terms that are common to those familiar with the Code but that may be foreign to attorneys who do not regularly practice bankruptcy. The Bankruptcy Code begins by defining certain terms that appear throughout the Code. These terms are listed under 11 U.S.C. §101. However, that list is certainly not exhaustive as to the common and recurring terms that are used by bankruptcy practitioners. The terms commonly used in reference to landlord tenant issues in bankruptcy are provided below.
- Automatic Stay.
- 11 U.S.C. §362 automatically imposes a stay against any party from taking any action to collect a debt that could have been commenced prior to the bankruptcy case filing or attempting to exercise control over property of the debtor or property of the bankruptcy estate (defined below). Although this concept seems easy, §362 contains over one hundred paragraphs and sub-paragraphs providing detailed rules and exceptions to those rules regarding application of the automatic stay. Unless a creditor can identify a specific exception to the general rule, the creditor should avoid taking any action that could potentially violate the automatic stay. The automatic stay remains in place until the Bankruptcy Court grants relief from the stay upon a motion of a party-in-interest, the case is closed, the case is dismissed, when property ceases to be defined as property of the estate, or the date upon which a discharge is granted or denied.
- Co-Debtor Stay.
- In Chapter 13 cases, the automatic stay is extended to non-filing co-debtors to prevent the commencement or continuation of a civil action to collect all or part of a consumer debt from any individual that is jointly liable on the debt with the debtor. 11 U.S.C. §1301. Because only individuals can file for bankruptcy protection under Chapter 13, this provision does affect cases filed by corporations. Additionally, it only applies to consumer, non-commercial leases, and contracts, not to any non-consumer obligations.
- Bankruptcy Estate.
- Upon the filing of a bankruptcy petition, an artificial entity known as the “Bankruptcy Estate” is created. In Chapter 7, Chapter 12 and Chapter 13 cases, a bankruptcy trustee is automatically appointed to administer the Bankruptcy Estate. In Chapter 11 cases, the debtor is designated as a “Debtor-In-Possession,” and is granted the rights and duties of a bankruptcy trustee unless and until the Bankruptcy Court appoints a third-party trustee.
- Property of the Estate.
- 11 U.S.C. §541 defines the scope of property that is deemed to be property of the bankruptcy estate upon the case filing. Generally, any property or any interest in property (whether legal or equitable) that a debtor owns on the petition date becomes property of the bankruptcy estate under 11 U.S.C. §541. However, as with most rules under the Bankruptcy Code, there are numerous exceptions to the rule. Those exceptions should be reviewed in relation to the specific facts of each case. The debtor’s leasehold interest in property generally becomes property of the bankruptcy estate. However, any interest that a debtor has as a lessee under a lease of non-residential real property that has terminated by operation of expiration of the stated lease term before the petition date is excepted from the definition of property of the estate. Therefore, if a tenant is a “hold over” tenant following expiration of a lease, he maintains no leasehold interest in the property, and therefore there is no leasehold interest for the bankruptcy estate.
- A claim is defined a right to payment, whether or not such right is reduced to judgment, or the right to an equitable remedy to breach of performance if the breach gives to rise to a right to payment. 11 U.S.C. §101(5).
- Proof of Claim.
- Although a creditor may hold a claim against a debtor as defined by §101, often the creditor will not receive any payment on that claim (assuming such funds are available for distribution) unless it files a proof of claim as required by 11 U.S.C. §501. All creditors need to review the particular rules associated with filing Proofs of Claim, any deadlines for filing those claims, and any requirements regarding the sufficiency of the information included with that claim. Creditors should carefully review the requirements for valid proofs of claim provided by Federal Rules of Bankruptcy Procedure 3001-3008.
II. LANDLORD ISSUES WHEN A TENANT FILES BANKRUPTCY
- A. Landlord receives notice of bankruptcy filing; What to do?
- Often when landlords receive bankruptcy case notices, they incorrectly assume that they will be stuck with a non-paying tenant for an extended period of time with no remedy. It is true that the filing of any bankruptcy case imposes an automatic stay against certain collection activities to exercise control over property of the debtor or property of the bankruptcy estate under 11 U.S.C. §362. However, landlords, particularly landlords of commercial property, are given significant rights under the Bankruptcy Code to protect their interests in the leased property. Upon receipt of a bankruptcy case notice, a landlord should perform a checklist to determine the following information:
- the identity of the debtor and of the actual tenant;
- whether the lease is a commercial lease or a consumer lease;
- whether there were any pre-petition defaults in payments under the lease;
- whether there are any non-monetary defaults under the lease;
- whether there are any monetary or non-monetary defaults under the lease arising post-petition;
- whether there exists co-obligors under the lease or guarantors under the lease; and
- whether the lease was terminated under its terms or state law prior to the petition filing.
The information listed above is necessary to fully determine the landlord’s rights upon receipt of a bankruptcy notice. The materials that follow will address the most common issues faced by landlords in bankruptcy.
- B. Importance of determining who is the debtor?
- One of the first issues a landlord needs to address upon receipt of a bankruptcy notice is determining the actual party that has filed the bankruptcy petition. Often, individuals will file a bankruptcy case, but list a company or trade name as “d/b/a.” Similarly, corporations may file bankruptcy, but list the trade names of subsidiaries who are not bankruptcy debtors. The landlord needs to carefully identify the party that has filed bankruptcy and determine whether there exists a matching identity between that party and the tenant of the lease. For commercial leases, a bankruptcy petition filed by a guarantor, parent company or subsidiary of the actual tenant does not trigger the automatic stay provisions to prevent exercising state-law remedies against the non-debtor tenant. Generally, the only instance in which a non-party is protected by the automatic stay imposed by the bankruptcy filing of another arises entity is in a Chapter 13 case filed by an individual that is subject to a consumer lease, rather than a lease of commercial space.
- C. What remedies are available to the landlord?
- When a tenant files for bankruptcy protection, the landlord has several remedies that are often non-exclusive. The potential remedies available to a landlord depend upon multiple factors, such as whether or not the lease expired or was terminated prior to the petition date, whether the debtor cures any defaults under the lease, whether the debtor remains in possession of the property after the petition date, and whether the debtor defaults under the lease post-petition. Some of the available remedies are discussed below.
- 1. RIGHT TO PAYMENT.
- Pre-Petition Claims. The pre-petition claim of a landlord consists of all sums due under the lease as of the petition date such as unpaid rent and charges, CAM reconciliations, etc. To receive payment of these pre-petition amounts due, the landlord should file a proof of claim with the Bankruptcy Court and serve a copy of the proof of claim upon the debtor’s attorney and any standing trustee.
- Post-Petition Claims. Landlords have two types of post-petition claims potentially available to them; claims arising under 11 U.S.C. §365(d)(3) and claims arising under 11 U.S.C. §503(b).
- 11 U.S.C. §365(d)(3) Claims. A landlord’s claims arising under §365(d)(3) encompasses amounts due for post-petition rent and charges incurred from the petition date through the date that the debtor assumes or rejects the lease. The debtor is required to make these post-petition, pre-rejection payments without a Court order as they become due according to the terms of the lease. In the event the debtor does not make timely payments post-petition, the landlord can file a motion for relief from the automatic stay seeking to enforce its state-law remedies in the property. The landlord could also seek an order from the Court compelling the debtor to make timely payments, and to grant the landlord an administrative priority claim for any post-petition rents that come due.
- 11 U.S.C. §503(b) Claims. A landlord may also be entitled to an administrative priority claim under 11 U.S.C. §503(b). This claim is based upon the value provided by the landlord to the Bankruptcy Estate. To be entitled to a claim for payment under §503(b), the debtor’s possession and/or use of the subject premise must provide value to the estate. Additionally, the amount that the landlord is entitled to claim under §503(b) is the fair market value of the premise used by the debtor, not necessarily the rental value specified in the lease. For instance, if a tenant leases retail space in a center for $30.00/square foot, but only uses it as a warehouse to store inventory and equipment, then the administrative priority value could be for the warehouse rental rate ($10.00/square foot) and not the retail rate. To claim an administrative claim under §503(b), a creditor must file a motion and application to the Court.
- Lease Termination Damages. 11 U.S.C. §502(b)(6) allows a landlord’s claims for “damages resulting from the termination” of a lease to the extent the claim exceeds the rent reserved by the lease, without acceleration, for the greater of one (1) year, or 15%, not to exceed three (3) years, of the remaining term of the lease, following the earlier of the date of the filing of the petition and the date on which the lessor repossessed or the lessee surrendered the property, plus any unpaid rent due under such lease, without acceleration, on the earlier of such dates.
A claim for lease termination damages is separate from the pre-petition rent claim, but may be included in the same proof of claim. Although the claim can include lost rent and other charges and costs incurred under the lease, it is capped at the greater of one (1) year of rent or 15% of the remaining term not to exceed three (3) years. If the space is re-let, then the claim may be reduced to the actual damages to the landlord, subject to the cap noted above.
III. DEBTOR’S RIGHTS AND RESPONSIBILITIES RELATIVE TO A LEASE
Upon the filing of a petition, the debtor usually obtains the benefit of the automatic stay to preserve the status quo to determine whether it is in the debtor’s best interest to remain in a given location, cure the defaults under the lease, and assume responsibility for future obligations under the lease. As an alternative, the debtor can decide to reject the lease, thereby extinguishing some or all of the debtor’s liability and responsibilities under the lease.
- A. Assumption of Lease
- A debtor (or a Trustee) may assume a lease by electing to continue in the lease according to the terms provided and remain in possession of the property being leased. In cases where the debtor assumes a lease, the debtor must either cure the default prior to assuming the lease or provide adequate assurance that the debtor will promptly cure the default. 11 U.S.C. §365(b)(1)(A). Often, the debtor will be required to cure all defaults under the lease or cure any obligations under the lease prior to assuming the lease.
- One major exception to the requirement of curing any default under a lease prior to assumption relates to non-monetary obligations under the lease. In some instances, it is impossible for the debtor to cure a non-monetary obligation such as one prohibiting the insolvency of the debtor, a decline in financial condition of the debtor, or the filing of a bankruptcy petition. The inability to cure those non-monetary defaults will not prevent a debtor from assuming the lease.
- The decision to assume a lease is not one made lightly by a debtor or Trustee. By assuming the lease, the debtor remains responsible for all future obligations under the lease. Therefore, in the event of a subsequent default, the landlord would potentially maintain a substantial claim for the remaining obligations under the lease. Contrarily, if the Debtor rejects the lease and it is terminated, the amount of the landlord’s claim is limited as discussed above.
- B. Lease Rejection
- As an alternative to assuming all obligations under a lease, a debtor may elect to reject the lease to eliminate the burden of future obligations. A rejection of the lease is treated as a breach of the lease, giving the landlord a right to damages. However, those damages are limited to those specified under the Code. See, 11. U.S.C. §502(b)(6).
- A debtor can reject a lease by formal notice and motion to the Court. However, a lease can also be deemed rejected by inaction of the debtor. In a case under Chapter 7 where the lease is residential real property, the Code deems that the residential real property lease is automatically rejected sixty days after the petition date if the debtor does not move to assume the lease. Under Chapter 13, a debtor may decide whether to assume or reject the lease up until the time of confirmation of a plan of reorganization.
- In cases involving the lease of non-residential real property, the debtor must assume the lease on the earlier of 120 days after the petition date or upon entry of an order confirming the plan. 11 U.S.C. §365(d)(4). This deadline can be extended for ninety (90) days upon Motion of the Debtor. Any further extensions of time must be approved by the landlord. In the event the debtor does not assume the lease as provided by §365, it is deemed rejected, and there is no provision in the bankruptcy code for subsequently reinstating the lease.
- Even after the lease is rejected, the landlord cannot automatically recover possession of the premise immediately. Unless the order rejecting the lease provides otherwise, the landlord should obtain relief from the automatic stay prior to taking any action to oust the Debtor and take possession of the leased space. Upon obtaining relief from the automatic stay, the landlord can initiate state law eviction proceedings.
IV. TENANT’S REMEDIES IN THE EVENT OF LANDLORD BANKRUPTCY
When a landlord files a bankruptcy petition, the landlord maintains the same rights to assume or reject the lease under §365 as discussed above. In the event the landlord rejects the lease, the lessee may treat the lease as terminated under its terms and have no further obligations under the lease. Alternatively, the lessee can elect to retain its rights under the lease and offset any rent obligation owed to the lessee to the amount of damages that were the result of the landlord’s breach. 11 U.S.C. §365(h)(1)(A). In the event the tenant’s damages exceed the amount of rent payable prior to the date the tenant is required to relinquish possession of the property, then the tenant should file a proof of claim in the case that will be handled as a general unsecured claim.
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