What Tenants Need to Know If the Landlord Files Bankruptcy
Originally published on June 11, 2020, and updated on July 7, 2021
Listen to Harold Israel Discussing on WBBM What Happens When a Landlord Files For Bankruptcy
While media attention of the COVID-19 pandemic has focused on commercial tenants, many commercial landlords are also experiencing distress as a result of missed rent payments. There are a few general concepts that are helpful to understand as a tenant in the event your landlord files bankruptcy.
- Continue Paying Rent. A landlord’s bankruptcy does not affect its tenants’ obligations to continue paying rent. Therefore, a commercial tenant must continue paying rent to its landlord during the pendency of the bankruptcy. Similarly, to the extent a landlord has obligations under the lease, the landlord must continue performing those obligations.
- The Automatic Stay and Tenant Claims. An “automatic stay” immediately comes into effect upon the filing of bankruptcy, which, among other things, prohibits the collection of all prepetition debt. Ordinarily, a landlord will not owe a tenant money. If, however, a landlord owes a tenant money at the time it filed bankruptcy, a tenant must stop all collection efforts and will have a claim in the landlord’s bankruptcy for these amounts. In many cases, a landlord may hold a tenant’s security deposit. This security deposit legally belongs to the tenant and does not become the landlord’s bankruptcy estate property. However, unless the landlord agrees otherwise, the tenant will need to obtain a bankruptcy court order requiring the landlord to return the security deposit.
- Assumption. A landlord may choose to assume, assign, or reject leases, depending on its goals and the terms of each lease. In the event a lease is assumed, the landlord is obligated to continue performing under the terms of the lease for the remainder of the lease’s term. In addition, the landlord must provide “adequate assurance” to the tenant that it will be able to continue performing its obligations under the lease. A landlord may also assume and assign its lease to a third party, oftentimes as part of a sale of the underlying real estate. When assuming and assigning the lease, the landlord must provide “adequate assurance” that the new landlord will be able to perform its obligations under the lease.
- Rejection. A landlord may also reject a lease, in which case the landlord is no longer obligated to continue performing under the lease. In most cases, if a landlord rejects a lease, a tenant is entitled to either: (a) move out and treat the rejection as a breach of the lease (which will allow the tenant to file a claim for the amounts owed) or (b) remain in the premises for the rest of the term of the lease. If a tenant remains in place, the landlord is no longer required to perform any of its obligations under the lease; however, the tenant may “setoff” or credit any damages arising under the lease for the landlord’s non-performance against rent owed.
- Sales of Real Property. A landlord in bankruptcy may determine that its best course of action is to sell its property “free and clear” of all liens, claims, and encumbrances, which is one of the biggest advantages of a bankruptcy sale. Despite the general rule that a tenant may stay in place after rejection of its lease, courts are divided as to whether a sale of real property in bankruptcy can extinguish tenants’ rights. Some courts allow tenants to remain in place, while other courts allow the sale “free and clear” of all interests, including a tenant’s lease. Thus, it is imperative to consult your attorney to determine what rights you may have in the event of a landlord bankruptcy.