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You are the owner (or part owner) of a commercial development that’s doing very well. Your space is 100% leased and your tenants seem to be thriving. Rent collection problems are rare. You like your tenant mix. The property is well-managed. Life is good.

The unexpected happens. You receive a notice that a tenant has filed a Chapter 11 bankruptcy petition. You’ve heard of Chapter 11 — it’s not liquidation and not necessarily going out of business. It has something to do about “reorganizing” the business, doesn’t it?

What are your rights as a landlord of commercial space when a tenant has filed a Chapter 11 bankruptcy petition? This article sets out a few of the issues you will need to consider.

  • Seek the advice of an experienced Chapter 11 practitioner.  The filing of a Chapter 11 petition implicates a number of complex provisions of the United States Bankruptcy Code and the Federal Rules of Bankruptcy Procedure.
  • A default does not occur merely by virtue of the bankruptcy filing.  Many commercial leases have a provision that if the tenant files a bankruptcy petition (or if an involuntary petition is filed against it), the tenant is in default of the terms of the lease. Generally, such provisions are of no force or effect.
  • Certain steps ordinarily allowed under the lease require permission.  The bankruptcy automatic stay prohibits certain actions without permission of the bankruptcy court. For example, a landlord may not file a lawsuit to collect past-due rent or exercise self-help remedies (such as changing the locks or discontinuing utility service). Obtaining permission involves filing a motion for relief from the bankruptcy automatic stay, another subject entirely.
  • Understand the implications of an “executory contract.”  If the lease is in full force and effect as of the date of the filing of the bankruptcy petition, it is deemed an “executory contract” under the bankruptcy laws. This designation      presents several options for the debtor/tenant. Generally, a decision must be made no more than 120 days after the bankruptcy filing. During that period, the tenant must keep its post-petition rental obligations current.  Options include:
    • “Rejecting” the lease.  The tenant files a motion for permission to reject the lease as it is of little value or importance to the tenant’s reorganization efforts. A court generally will not interfere with the debtor’s business judgment if the rejection is made for valid business reasons. The landlord will have a claim against the bankruptcy estate for the amounts owed under the lease, as well as damages arising from the tenant’s rejection of the lease (these damages are capped under bankruptcy laws).
    • “Assuming” the lease.  The tenant files a motion or permission to assume the lease if the lease is one that is important to the tenant’s reorganization efforts. Again, the debtor’s business judgment usually carries the day, even if the landlord opposes the assumption of the lease.However, some important landlord protections apply in this scenario. The tenant must:
      • Remain current under the lease post-bankruptcy
      • Generally “cure” any default under the lease, including monetary defaults, or at least provide the landlord with assurance that the default will be cured
      • Compensate the landlord for any actual monetary losses resulting from the tenant’s default under the lease
    • “Assuming and assigning” the lease. The tenant files a motion for permission to assume the lease and assign the tenant’s performance obligations thereunder to another party — a substitute tenant. The rules of “assuming” the lease apply, but the court is asked to approve the substitution of a new tenant.This result may seem harsh, but the bankruptcy laws provide you important protections. For example, the financial condition of the lease assignee and the assignee’s ability to perform under the lease must be demonstrated. The lease assignee is subject to all the lease provisions related to use of the space and tenant mix if the property is a shopping center. Other protections exist, so you should consult your legal advisor.
  • Inaction may be your worst option. Bankruptcy laws provide significant protections to you as a landlord, only a few of which are outlined in this article. Never sit silently while decisions which could affect the future of your commercial property are made. Become part of the process, or you may find yourself with unexpected and unwanted results which could affect the long-term value of your commercial investment.