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Oh, What a Tangled Web the Bankruptcy Code Weaves

Bankruptcy. Tenants' use of this simple word strikes fear in hearts of landlords. What should landlords do when tenants threaten bankruptcy? To untangle the dreaded bankruptcy web, landlords should consider the following:

Should I Terminate The Lease Prior To Bankruptcy?

Maybe. A tenant threatening bankruptcy is usually behind on rent. Consequently, you may have grounds under your lease to terminate the lease prior to bankruptcy. Before you terminate, ask:

  • Is the tenant filing for Chapter 11 reorganization or Chapter 7 liquidation?
  • Can the tenant make rental payments during the bankruptcy proceeding?
  • Can the property be rented to a third party on short notice?

If the tenant is headed for a Chapter 7 liquidation and has insufficient assets to cover future rents, terminate the lease before the bankruptcy filing. If, on the other hand, the debtor's prospects for reorganization are strong, future rental payments are likely, and there is no third party waiting to rent the premises, you might be wise to keep the lease in place. Regardless, write a provision into your lease providing that upon default the lease terminates automatically upon notification by the landlord.

Can I Terminate The Lease After Bankruptcy?

No. Even though most lease agreements contain boiler plate language providing that the lease is in default upon the filing of bankruptcy, the landlord cannot terminate the lease without a court order.

The Bankruptcy Code provides that if a lease of real property is not assumed or rejected within a certain period of time, the lease is deemed rejected and the trustee and/or debtor is required to surrender immediately the property to the lessor. The time period varies with the type of bankruptcy and the type of real property.

Landlords should not sit back and wait until the lease is assumed or rejected, especially if rental payments are not being received. The landlord should file a motion requiring the trustee and/or debtor to assume or reject the lease and to require rent payments.

How Can My Lease Be Assumed?

For a trustee and/or debtor to assume a lease in either Chapter 7 or 11, he/she must:

  • cure all pre-petition defaults;
  • compensate the landlord for any actual loss from such default; and
  • provide adequate assurance of future performance.

If all three conditions are not satisfied, the lease cannot be assumed.

Can My Lease Be Assigned To A Third Party?

Yes, unless the lease was terminated prior to bankruptcy. The Bankruptcy Code overrides any lease provisions which prohibit or restrict assignment of rights. To assign a lease, the lease first must be assumed. All "four corners" of the lease must be assigned, not just the advantageous provisions. Further, this prevents a new tenant from extracting rent concessions.

What If I Have A Shopping Center Lease?

Shopping center leases involve different considerations concerning adequate assurance of future performance.

  • First, the financial condition and operating performance of a proposed assignee and its guarantors -- the new source of rent -- must be similar to that of the debtor and its guarantors.
  • Second, any percentage rent due under such lease must not decline substantially.
  • Third, any assumption or assignment of such lease is subject to all provisions in the lease including those governing radius, location, or exclusivity, and must not breach provisions in other leases relating to the shopping center.
  • Fourth, the assumption or assignment of such lease must not disrupt the tenant mix.

What If My Lease Is Rejected?

File damage claims in three parts:

  1. a pre-petition claim for unpaid rent and CAM which will be treated as a general unsecured claim;
  2. a post-petition claim for unpaid rent and CAM which will be treated as a priority claim; and
  3. a claim for damages resulting from breach of the lease which also will be treated as an unsecured claim.

The damage claim amount is capped by the Bankruptcy Code. To assert a claim, the landlord must file a proof of claim with supporting documentation.

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