Answered by Sean Williams and Harold Israel
The COVID-19 pandemic and related commercial establishment closures have led many commercial landlords to revisit what happens if a tenant files for bankruptcy. What happens, and your legal options, are going to depend, in part, on the type of tenant (individual or company) and the type of bankruptcy (no-asset Chapter 7 or a Chapter 11 reorganization). There are, however, a few general concepts that are helpful to understand in the event of a commercial tenant bankruptcy.
- Filing Bankruptcy Does Not Terminate a Lease. As a preliminary matter, many leases have a provision terminating a lease, or otherwise creating defaults, if a tenant files for bankruptcy. Such clauses are unenforceable as a matter of law in bankruptcy and will not have any effect on a tenant’s bankruptcy.
- The Automatic Stay. An “automatic stay” immediately comes into effect upon the filing of a bankruptcy which, among other things, prohibits the collection of all prepetition debt.
- Pre v. Post-Petition Debt. When a bankruptcy is filed, a bright line is drawn by the court between debt that arose prior to the filing and debt that arises after the filing. Rent owed prepetition cannot be paid during the pendency of the bankruptcy case except if the lease is assumed by the tenant, discussed below. Rent due after the filing of a bankruptcy must be “timely” paid and is entitled to administrative priority (i.e. paid ahead of all other prepetition general unsecured claims). Failure to make post-petition rent payments may be cause for dismissal of the debtor’s bankruptcy case.
Recently, due to the COVID-19 pandemic, some bankruptcy courts have allowed retail debtors to delay their rental payments for a period of time while in bankruptcy, effectively pausing the bankruptcy case.While this is a recent development, we anticipate that tenants who rely on in-person sales may seek similar rent relief.
- Assumption. One of the most powerful tools available to a tenant in bankruptcy is the ability to assume, assign, or reject leases, depending on the value and favorability of the terms of any lease. Assumption refers to a tenant’s agreement to continue to be bound by the lease. If a tenant assumes a lease, the tenant must generally make a “cure” payment (i.e. pay all prepetition amounts due under the lease) as a condition of the assumption. In the event that the tenant doesn’t immediately make a cure payment upon assumption, the tenant must provide “adequate assurance,” or proof, that such payments will be made.
A tenant may also assume and assign its lease to a third party.Here, the tenant must still “cure” any prepetition default prior to assumption and assignment and must provide “adequate assurance” that the assignee of the lease will be able to perform under the lease.Generally, even if a lease contains broad anti-assignment and/or use clauses (i.e. prohibiting the premises from being used for a specific purpose), those clauses are also unenforceable in bankruptcy (except with respect to “shopping centers,” but only to the extent that assignment is contrary to any radius, location, use, exclusivity, or tenant balance provisions in the lease).
- Rejection. Rejection refers to a termination of the tenant’s obligations under a lease. If a tenant rejects a lease, the debtor is no longer obligated to perform under the terms of the lease. Moreover, the rejection is treated as occurring immediately before the bankruptcy filing, meaning that all prepetition amounts due under the lease and damages for breach of the lease, are treated as general unsecured claims.
There may be other payment options available to a commercial landlord in the event of a tenant bankruptcy, for example, whether the lease is guaranteed by a non-bankrupt entity or individual or collateral has been pledged to secure the tenant’s obligations. It will be a case by case, lease by lease, analysis.
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