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Commercial Tenant Bankruptcies from a Landlord Perspective
Author: Will G. Bassham
If you are a commercial landlord and your tenant files for bankruptcy, you’ll need to take steps in the context of the bankruptcy to protect your interests. The steps you take will largely depend on the tenant’s decision whether to “assume” or “reject” your lease under Section 365 of the Bankruptcy Code. An assumption means that the tenant retains the leased premises and keeps the lease in place as a post-petition liability. It may also mean an assignment of the lease by the tenant to a third party (even if your lease terms prohibit such assignment). A rejection will mean termination of the lease, a surrender of the premises by the tenant, and a possible claim by the landlord for lease “rejection damages” (more on this below). Both scenarios (assumption and rejection) require the approval of the Bankruptcy Court.
When dealing with a tenant bankruptcy, the commercial landlord will want to keep the following points in mind:
(1) Rent Prior to Assumption/Rejection – Following a bankruptcy filing, the Bankruptcy Code requires the tenant to comply with its obligations under the lease prior to assumption or rejection. 11 U.S.C. § 365(d)(3). It is not uncommon, however, for tenants to fail to pay (or delay in paying) all amounts owed post-petition. The vigilant landlord will have its legal counsel ensure prompt compliance with Section 365(d)(3) prior to the tenant’s decision on assumption/rejection.
(2) In Case of Lease Assumption – If the bankrupt tenant elects to assume the lease, the landlord should ensure that all delinquent amounts under the lease are paid current at the time of assumption. As part of the assumption process, the tenant may give the landlord notice of the ‘cure amount’ that it proposes to pay in order to bring its lease current. If the tenant’s cure amount is incorrect, the landlord will have to timely object. Failure to do so can result in the Court entering an order approving tenant’s stated cure amount, thus barring later objection. Practically speaking, this sort of issue can often be resolved without filing a formal objection in the bankruptcy – but the deadline may come rather quickly in some cases, and landlord counsel will need access to rent records so that he/she can press the issue with the tenant’s counsel and come to agreement on the correct amount owed.
(3) In Case of Lease Rejection – If the tenant rejects the lease, the landlord may assert a lease “rejection damages” claim in the bankruptcy. This claim will be treated as a general unsecured claim in the bankruptcy, sharing pro rata with the other unsecured creditors of the bankruptcy estate. The amount of the claim that may be asserted is capped by the Bankruptcy Code. Under Section 502(b)(6), a landlord may assert a claim for the rent that would otherwise become due under the lease following rejection, but such amount is capped at the greater of (i) one year’s rent or (ii) 15% of the remaining term of the lease (not to exceed three years’ worth). The proper calculation of a lease rejection damages claim under Section 502(b)(6) can differ depending on where the bankruptcy is filed. For example, courts disagree over whether the 15% standard is meant strictly as a measurement of time (lease years/months remaining in the term) or the rental amounts owed. Depending on the term remaining and the rental escalations under the lease, the method used by the Court can have a significant impact on the amount of the claim.
In summary, a landlord facing a commercial tenant bankruptcy must actively monitor the tenant bankruptcy in order to protect its rights. The tenant’s decision whether to assume or reject the lease will largely dictate how the landlord proceeds thereafter. For more information or assistance with tenant commercial bankruptcies, please contact me at 214-560-1705 or at email@example.com.