This Article discusses the issues a landlord confronts when its commercial tenant files for bankruptcy protection. It also considers pre- and post-bankruptcy options available to a landlord to mitigate the impact of a tenant’s bankruptcy filing.
Section 365 of the Bankruptcy Code allows commercial tenants, as debtors, to take actions on their leases that greatly impact landlords. Subject to court approval and certain limitations, a debtor-tenant can use its reasonable business judgment to reject burdensome and unfavorable leases and assume leases that are beneficial to the debtor-tenant’s bankruptcy estate (11 U.S.C. § 365).
Purpose of Section 365 of the Bankruptcy Code
Section 365 of the Bankruptcy Code governs assuming, assuming and assigning, and rejecting commercial leases. These provisions serve to:
Further the federal bankruptcy goal of rehabilitating troubled companies while balancing the interests of all parties.
Maximize the value of the debtor-tenant’s estate (which includes the tenant’s interest in unexpired leases).
Provide some protection to non-debtor landlords.
In weighing the competing interests of the parties, Congress attempted to strike a balance, but the result is a system that favors the interests of the debtor-tenant (and its creditors) and leaves the landlord at a legal and practical disadvantage.
The Bankruptcy Code gives a debtor-tenant time to evaluate carefully its unexpired leases and extract the maximum value by any one of the following methods:
Assuming the lease if it has a below-market rental rate, thereby locking the landlord into an undesirable lease.
Assuming and then assigning a valuable lease that would not otherwise be a part of the debtor’s reorganization plan to a third party to monetize the value of the lease.
rejecting the lease if it provides for an above-market rental rate; or
using the threat of rejection to negotiate better lease terms with the landlord.
Debtor-tenants are only afforded this protection if:
- The lease is unexpired.
- The lease is a true lease.
The Automatic Stay
Once a tenant files a petition in bankruptcy, a stay is triggered that automatically stops substantially all acts and proceedings against the tenant-debtor and its property. Commonly referred to as the automatic stay, which only applies to prepetition events. The debtor-tenant must perform all obligations arising after the date of its bankruptcy filing. The automatic stay does not bar action against the debtor-tenant for defaults after its petition is filed, or postpetition.
Practical Strategies for Landlords
The Bankruptcy Code generally favors the interests of debtor-tenants (and their creditors) over landlords (see Purpose of Section 365 of the Bankruptcy Code). A landlord can, however, take steps to potentially avoid, or at least mitigate against, the impact of a tenant filing for bankruptcy, including:
- Considering the potential for bankruptcy by the tenant before entering into a lease with the tenant.
- Carefully drafting the lease.
- Scrutinizing tenant’s financial information before signing a lease and incorporating added protections as needed.
At a minimum, a landlord can increase its leverage over the debtor-tenant or an assignee if bankruptcy is filed and improve its chances of a higher monetary recovery or other commercially-reasonable outcome.
ESQ.title law firm has over 20 years’ experience as advisors to foreign national and domestic real estate investors, commercial real estate landlords, commercial tenants, real estate owners, developers, real estate investment companies, ultra-affluent high net worth individuals, and small business owners. If you have any questions on whether a particular a commercial real estate transaction is right for you, need assistance in leasing or in analyzing due diligence on a particular opportunity, contact us at 305-501-2836 or visit us at www.JordanLawyers.law for immediate assistance. Our offices are conveniently located in Miami, Florida (Coral Gables), and service clients throughout the State of Florida.