Landlord Bankruptcy Rights 101: The Rules of the Game
Part two of the Trade Creditor’s Corner series. To read part one, please visit here.
With the recent rising tide in retail tenant bankruptcy filings and more on the horizon in 2018, landlords will be among the most heavily impacted. Learning the rules of the game is smart and may save the landlord money. What are the key fundamentals a landlord of a nonresidential real property lease should focus on when a tenant bankruptcy looms?
- Plan Ahead. Get Security.
If the tenant is in default and you want to control a lease’s short term marketing and disposition, carefully review the right to terminate the lease. Exercise it if you can before any bankruptcy is filed. Negotiation of lease modifications or forbearance, on default, before bankruptcy creates opportunities to bolster landlord remedies by, for example, shortening the time to terminate or requiring credit enhancements to the lease and acquiring recourse against third parties and non-tenant assets through third party guaranties and letters of credit. Access to security deposits ,which typically consist of posting a tenant’s cash with the landlord, may be restricted in a bankruptcy case due to the automatic stay. The automatic stay goes into effect on the filing of the bankruptcy case and halts all actions to collect against the debtor or the debtor’s property.
- The Tenant Must Pay to Stay.
Under the Bankruptcy Code, a tenant generally must pay its post-petition rent timely, with certain limited exceptions. You should consult a bankruptcy professional about the payment rules for the month in which the bankruptcy is filed which vary by state. If rent is not otherwise paid timely for the post-petition period, the landlord can seek relief from the automatic stay to recover the premises or file a motion to compel payment. Landlords need to carefully monitor monthly payments during bankruptcy since administrative rent is generally required to be paid in full and therefore is one of a landlord’s most valuable bankruptcy claims.
- The Tenant has a deadline to decide whether to stay or go unless Landlord consents to more time.
Currently the Bankruptcy Code gives a debtor tenant an initial period of 120 days from the filing date to file a motion to choose one of three options regarding a lease. A debtor tenant may assume or adopt a lease provided it can cure defaults promptly and provide “adequate assurance of future performance,” which generally means the tenant has the ability to pay rent. A debtor tenant may reject or repudiate the lease and be excused from future performance. Lease rejection damages will be treated as a prepetition breach claim and capped, as discussed below. Lastly, a debtor tenant could choose to assume and assign the lease to a qualifying third party. Because of the synergistic nature of shopping centers, shopping center leases are given special protections on assumption and assignment.
The initial period to decide on lease disposition may be extended for another 90 days by the court for “cause.” “Cause” is not defined in the Bankruptcy Code but, in the absence of lease default, is a relatively low hurdle for a debtor tenant to overcome. Any further extensions of time to assume or reject past the 210th day mark must be with the prior written consent of the landlord, or the lease is deemed rejected. Landlords should be wary of the different ways more sophisticated debtor tenants and their professionals try to obtain a “ prior written” consent – for example, by presenting a rent check that, once endorsed, a debtor deems to be a written consent to a further extension. Once again, the cautious landlord should consult counsel to make sure it is not inadvertently giving up valuable rights and to see if it can negotiate for better treatment in exchange for a consent.
Anti-assignment provisions in leases are generally unenforceable in bankruptcy. The Bankruptcy Code also prevents the landlord from calling defaults based on the financial condition of the debtor or the tenant filing bankruptcy.
- Bankruptcy Lease Claims: Know your Priorities. Post-bankruptcy rent obligations should be paid in full; pre-bankruptcy rent claims will be capped.
Generally, claims that arise or accrue during the bankruptcy case are given administrative priority status and paid, in full. There is disagreement among the courts in different states as to whether rent that accrued, for example, during the first five days of the month in a case that is filed on the sixth day of the month should be treated as a pre-petition versus post-petition claim. Generally, so long as the tenant is in possession and operating during the post-petition period, the landlord should evaluate pursuing payment of all components of rent, as defined under the lease, during this period as an administrative claim entitled to payment in full.
Prospects for recovery on unpaid pre-petition rent absent an assignment of the lease and on rejection damage claims are nominal to nil in today’s retail cases. Furthermore, rejection claims are capped under a formula calculated as the rent reserved without acceleration for the greater of one year or 15%, not to exceed three years, of the remaining term of the lease, following the earlier of the filing date or turn over.
In the reality of today’s retail world, a landlord must understand its rights, protect its entitlement to every administrative dollar, and vigilantly monitor the case to make sure its rights are adequately protected against encroachment by other creditors.
The secured lender generally has the most comprehensive rights of all. The next installment of the series will discuss the critical role of the secured lender in today’s bankruptcy world and its rights vis-à-vis the other creditors in the case.
If you have any questions about this topic or any other bankruptcy matter, please contact Joyce at[email protected]