How Landlord or Tenant Bankruptcy Impacts a Commercial Lease
When a commercial landlord or tenant files for Chapter 11 bankruptcy, certain provisions in the bankruptcy code dictate how the commercial lease will be handled. Below is a breakdown of the rights and responsibilities of non-bankrupt parties to a lease in the wake of a bankruptcy declaration.
Tenant Responsibilities After a Landlord Files for Bankruptcy
When a commercial landlord files for bankruptcy, tenants must continue to make timely payments of rent, common area maintenance (CAM) charges, and other fees as dictated by their lease. Fortunately, tenants typically don’t have to worry about their security deposit; in most commercial leases, the tenant remains the owner of the security deposit funds, which, therefore, do not become part of the bankruptcy estate. The security deposit will still be paid back to the tenant at the end of the lease (less any deductions for property damage).
Tenant Rights if the Landlord Assumes and/or Assigns the Lease
Commercial landlords who declare bankruptcy generally have the right to assume, assume and assign, or reject any existing commercial leases within a specific timeframe. If the bankrupt landlord opts to assume the tenant’s lease, the landlord must cure any defaults under the agreement and provide the tenant with adequate assurance of its ability to fulfill all obligations for the remainder of the lease term. Landlords may also assume and assign the lease to a third party. Under this arrangement, all arrears must be cured, and the assignee must provide adequate assurance of its ability to fulfill the landlord’s obligations to the tenant for the remainder of the lease term under the current terms.
Tenant Rights if the Landlord Rejects the Lease
If the landlord chooses to reject the lease or fails to assume the lease in the allotted timeframe, the tenant generally has two options. One option is to treat the lease as terminated and vacate the property. Alternatively, the tenant can stay on the premises for the duration of the lease term and continue to pay the same rent, but without the receipt of landlord services. The tenant can reduce its rent payment to offset any damages incurred as a result of the landlord’s failure to fulfill obligations under the lease, such as the cost of any utilities or maintenance that were the landlord’s responsibilities under the lease.
Landlord Rights if a Tenant Files for Bankruptcy
Similarly, when a tenant files for bankruptcy, it has the right to assume, assume and assign, or reject its commercial lease within a specified timeframe. Tenants cannot modify the lease terms without the landlord’s consent.
Prior to assumption, tenants must cure all outstanding defaults, such as unpaid rent or CAM charges, and provide adequate assurance that they can continue to fulfill their future lease obligations. A tenant may look to assume the lease and assign it to a third party, perhaps as part of a sale of some or all of its assets to the third party. If the tenant wishes to assume and assign the lease, all outstanding debts or defaults must first be cured, and the assignee will need to provide the landlord with adequate assurance that it can perform all future lease requirements.
Assumption of a debtor’s lease requires bankruptcy court approval, with notice to the landlord, who will have the opportunity to object. It is critical for a commercial landlord to use comprehensive language in its leases to protect its rights when a tenant seeks relief under the bankruptcy code and to be highly engaged from the outset of the tenant’s bankruptcy to ensure that its rights are adequately protected.
Landlord Rights if the Tenant Rejects the Lease
If a tenant rejects the lease, it is treated as if it was terminated immediately before bankruptcy was filed, and the tenant must relinquish possession of the premises. The landlord may have a claim for damages against the tenant for failing to pay rent and other charges before the bankruptcy filing, as well as rent and other charges if the tenant continued to occupy the property for a period after the bankruptcy filing. Landlords should keep in the mind that the tenant’s security deposit is part of the tenant’s bankruptcy estate, and the landlord cannot use these funds to cover other debts; a claim for security deposit funds must be entered through the bankruptcy case. If the tenant provided the landlord with a guarantee from a third party at the start of the lease, the landlord may have claims against the guarantor that are not affected by the tenant’s bankruptcy proceedings.
Consult with an Attorney
If you are a commercial tenant or landlord, and your respective landlord or tenant has declared bankruptcy, speak to an experienced attorney as soon as possible to ensure the protection of your rights throughout the bankruptcy proceedings and afterward.
Conor McMullan, a senior associate at FLB Law in Westport, Conn., brings a wealth of experience from his background as a bankruptcy attorney to his real estate practice at FLB Law. He has represented municipalities, Chapter 11 debtors and creditors in bankruptcy proceedings and a broad spectrum of clients across the commercial real estate sector in various litigation and transactional issues. Contact Conor at mcmullan@flb.law or 203.635.2200. For more information about FLB Law, click here.