Commercial Leases and Bankruptcy: A Roadmap for Landlords by Thomas J. Nehilla & John M. Coles |
You are a commercial landlord and one of your commercial tenants runs into financial difficulty, stops paying rent, and notifies you that it has filed for bankruptcy. What do you do now? Do you know what things you should be concerned about? Are you aware of your rights under the law? Many commercial landlords have found themselves in precisely this situation in recent years. With the number of commercial bankruptcies at an all-time high, it remains very likely that most commercial landlords will have to deal with a bankrupt tenant at one time or another. This article addresses some of the major issues that a commercial landlord needs to consider and provides a roadmap for them to follow when faced with a commercial tenant bankruptcy. Section 365 of the Bankruptcy Code (“Section 365”) provides the statutory framework for dealing with unexpired real property leases in bankruptcy. The provisions of Section 365, as interpreted by the courts, serve as a helpful roadmap to commercial landlords when faced with a tenant bankruptcy. Section 365 gives a bankrupt tenant the right to assume, assume and assign or reject an unexpired lease of real property and provides the legal considerations that follow from this basic choice. Before getting to the question of assumption or rejection, however, the first issue that a commercial landlord should consider is whether the lease at issue remained in force when the debtor/tenant filed its bankruptcy petition. Section 365 provides that a lease that has expired by its terms or was properly terminated prior to the debtor/tenant's filing its bankruptcy petition is not an asset of the bankruptcy estate, and therefore cannot be assumed or rejected by the debtor/tenant pursuant to Section 365. In short, a debtor/tenant whose lease has been properly terminated pre-petition has no further rights in that lease. The mere fact that a debtor/tenant is in default under a lease, however, does not mean that the debtor/tenant has lost its rights to assume or reject the lease for purposes of Section 365. The critical question is simply whether the lease has actually been terminated and the answer to that question, of course, will be determined on a case-by-case analysis of the relationship between the landlord and tenant and based on the terms of their lease. Provided that the lease has neither expired nor was properly terminated, the debtor/tenant immediately enjoys the protections of the automatic stay provisions of the Bankruptcy Code upon the debtor/tenant's filing its bankruptcy petition. These provisions prohibit any party, including a landlord, from taking any action to collect unpaid obligations, declare a debtor/tenant in default, or attempt to evict a debtor/tenant or retake possession of the leased premises. Once a tenant is in bankruptcy, all of these steps may be taken by a landlord only after seeking and receiving from the bankruptcy court appropriate relief from the automatic stay. Once it is clear that the lease remained in force when the debtor/tenant filed its bankruptcy petition, then the debtor/tenant must decide whether to assume or reject the unexpired lease. Section 365 gives a debtor/tenant 60 days in which to decide whether to assume or reject an unexpired lease of nonresidential real property. (It should be noted that tenants of residential real property likely have additional rights under Section 365 and applicable laws that are beyond the scope of this article.) If the debtor/tenant does not indicate its intentions to the bankruptcy court within that 60 day period, then Section 365 provides that the unexpired lease is deemed rejected. Section 365 allows a debtor/tenant to request an extension of the 60 day period for cause shown. In many larger bankruptcy cases, such extensions are routinely granted, which often results in landlords having to wait to learn of the ultimate disposition of an unexpired lease. Given the many time delays that can arise, it is often advantageous for a landlord to be attentive to the debtor/tenant's bankruptcy process and to remain in contact with the debtor/tenant to try to determine its intentions with respect to the lease. Legal counsel is often necessary to adequately represent a landlord before the bankruptcy court and to oppose any requests for extensions of time that a landlord believes may be frivolous or unnecessary and to monitor any other issues that may arise relative to the lease. If the debtor/tenant eventually decides to reject the lease or otherwise fails to act within the required time periods so that the lease is deemed to be rejected, then Section 365 requires the debtor/tenant to immediately surrender the leased premises to the landlord. If the debtor/tenant fails to do so, it will become necessary for the landlord to file appropriate motions with the bankruptcy court to recover the leased premises. As discussed above, unilateral actions by a landlord to evict a tenant in bankruptcy or recover the leased premises violate the automatic stay provisions of the Bankruptcy Code. Therefore, even if the lease is or is deemed rejected, the landlord may still need to file appropriate motions with the bankruptcy court to obtain relief from the automatic stay before proceeding with any other rights it may have under the lease. Following a debtor/tenant's rejection of an unexpired lease, a landlord may have the right to file a claim in the bankruptcy case for some of the debtor/tenant's unpaid obligations. In filing such a claim, the landlord will be a general unsecured creditor. The recovery on any such claims will be determined by a number of factors, including the amount of the dividend paid to general unsecured creditors in the case. It is advisable to retain legal counsel to assist with this rejection claims process. If the debtor/tenant decides that it wants to assume an unexpired lease, Section 365 provides several requirements that must be satisfied in order for the debtor to exercise that right. First, the debtor/tenant must cure any default that may have occurred under the lease, or provide “adequate assurance” that the default will be promptly cured. Second, the debtor/tenant must compensate or provide “adequate assurance” that the debtor/tenant will promptly compensate the landlord for any pecuniary loss to the landlord resulting from any default under the lease. Third, the debtor/tenant must provide “adequate assurance” of future performance under the lease. It should be noted that these requirements do not apply to a default which is a breach of a provision in the lease relating to (1) the insolvency or financial condition of the debtor/tenant; (2) the debtor/tenant's commencement of the bankruptcy case; (3) the appointment of a trustee or custodian of the debtor/tenant's property or estate; or (4) the satisfaction of any penalty rate or provision relating to a default arising from any failure by the debtor to perform nonmonetary obligations under the lease. Despite the Bankruptcy Code's use of the term “adequate assurance,” the Code does not define that term, and its meaning is left to be developed based upon the facts and circumstances of each case. At a minimum, the primary focus of “adequate assurance” concerns the debtor/tenant's ability to fulfill its financial obligations under the lease. In re: Martin Paint Stores, 199 B.R. 258 (Bankr. S.D. N. Y. 1996). Therefore, it may not be necessary for a debtor/tenant to actually cure the default in order to assume the lease; the debtor/tenant simply needs to provide evidence that it will be able to do so promptly. After assuming an unexpired lease, a debtor/tenant may, of course, continue to occupy and possess the leased premises. In the alternative, the Bankruptcy Code does give the debtor/tenant the right to assign its unexpired lease to a third party once the debtor/tenant has assumed the lease, provided, however, that the assignee can provide adequate assurance that it will be able to perform its obligations under the assigned lease. The Bankruptcy Code allows such an assignment, even if the lease agreement between the landlord and the assigning tenant specifically provides that such assignments are not permitted. If a debtor/tenant decides to assume an unexpired lease, then the debtor/tenant must cure all existing defaults under that lease. To establish the amount of any monetary defaults, a landlord must often file a cure claim in the bankruptcy case identifying the amounts due and providing the supporting documentation to justify those amounts. Debtors/tenants may object to the amount of these cure claims, and often, particularly in bankruptcy cases with large corporate debtors, the process of resolving these cure claims can be long and arduous. As a result, it is important for a landlord filing a cure claim to have legal counsel to protect the landlord's rights and ensure that the landlord will be fully compensated. In addition to the debtor/tenant's obligation to cure all defaults prior to assuming a lease, Section 365 also requires that a debtor/tenant timely perform all of its obligations under the lease after it has filed its bankruptcy petition. In other words, tenants in bankruptcy must continue to pay rent and perform other lease obligations going forward if they intend to continue to possess the leased premises. Failure to do so gives landlords grounds for requesting and receiving relief from the automatic stay to evict a debtor/tenant and retake possession of the leased premises. Additionally, a debtor/tenant's failure to satisfy its post-petition obligations can constitute grounds for the bankruptcy court to refuse to extend the time period that a tenant has to assume or reject a lease. A landlord may have an administrative claim in the bankruptcy case for any unpaid post-petition obligations. As you can see, there are many complications that might arise when a commercial tenant files a bankruptcy petition. The best way for commercial landlords to protect themselves is to retain legal counsel early in the bankruptcy process and to remain involved in the proceeding as necessary. By doing so, commercial landlords can help ensure that they will have the best chance to receive their rent and other payments due under the lease, as well as to make sure that any leased property that a tenant does not wish to retain can be vacated quickly with an opportunity to be released to a new tenant as promptly as possible. This article is reprinted with permission from the January 2004 issue of Real Estate, a supplement to The Legal Intelligencer and the Pennsylvania Law Weekly. © 2004 ALM Properties Inc. Further Tom Nehilla is a partner in the law firm of Rhoads & Sinon LLP and is an experienced member of the firm’s real estate practice. He has represented and counseled many commercial landlords with negotiations of commercial leases. As such, he also has experience in representing landlords throughout the bankruptcy process, including when their tenant files for bankruptcy.
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