The retail sector has experienced a wave of bankruptcy filings over the last year. Brick-and-mortar businesses in financial distress include big-name brands like Big Lots, Party City, The Container Store, and Vitamin Shoppe. When large retailers seek bankruptcy protection, they are not the only businesses impacted. Landlords can be particularly hard hit.
While commercial landlords can't stop their tenants from filing for bankruptcy, they can take steps to minimize the potential financial and legal fallout. This article discusses a few strategies that commercial landlords can employ when a retail tenant seeks bankruptcy protection.
Understand the Bankruptcy Process
In a Chapter 7 business bankruptcy, all business assets are liquidated by the bankruptcy trustee and used to pay as many creditors as possible. In most cases, the business is closed typically at the outset at the end of the proceedings. For a Chapter 11 business bankruptcy, the debtor is allowed to restructure as a means to pay down debt. The debtor's reorganization plan, which must be approved by the court, may involve modifying the payment terms for existing debts, restructuring financial obligations, and/or selling assets to pay debts. The business remains operational throughout the bankruptcy process under the supervision of the debtor itself as of a bankruptcy trustee.
In either type of bankruptcy, once a debtor files for bankruptcy, the automatic stay set forth in Section 362(a) of the Bankruptcy Code takes effect. The stay is intended to provide a period of time in which all judgments and collection activities are suspended. Foreclosures and repossessions of property are also suspended during this time. Creditors may not pursue any debt or claim that arose before the bankruptcy petition was filed. Under the automatic stay, a commercial landlord can't file or pursue eviction proceedings against the debtor. They also cannot make efforts to collect unpaid rent without first obtaining an order from the court. The court must grant relief from the automatic stay before any such actions can proceed.
Consider the Status of the Lease
The lease may state that a tenant's bankruptcy is considered
a breach or otherwise triggers a default.
However, such provisions are generally unenforceable. In contrast,
a lease properly terminated before a bankruptcy filing is not
subject to the bankruptcy process. Additionally, when the lease is
terminated pre-petition, the tenant has no right to continue the
lease after filing.
Evaluate Alternative Payment Options
While commercial landlords can't take legal action against the debtor during bankruptcy, alternative payment sources may be available. Court authorization is required to collect unpaid rent during the pendency of the bankruptcy. If the tenant has defaulted on the lease, landlords can look to letters of credit for payment. They can also pursue personal guarantors, as these are not protected by the automatic stay.
File a Claim for Pre-Petition and Post-Petition Rent
Retailers are obligated to continue to pay rent during the bankruptcy process. This applies as long as they continue to occupy the leased premises. If they fail to do so, landlords are entitled to file a motion for an administrative claim with the bankruptcy court. The Bankruptcy Code gives administrative claims top priority. They are paid prior to those of general unsecured creditors.
Rent that was owed prior to bankruptcy is considered an "unsecured" claim. When filing for bankruptcy, debtors are required to file a schedule of their liabilities.
This includes unsecured claims like outstanding rent. Generally, any creditor whose claim is not scheduled or is scheduled as disputed, contingent, or unliquidated must file a proof of claim. This is required to be treated as a creditor for purposes of voting on the plan and distribution under it.
Accordingly, landlords must determine whether their claim is accurately listed on the debtor's schedules. If not, they must file a proof of claim with the bankruptcy court. Failure to do so may prevent a landlord from voting upon the debtor's plan of reorganization. It may also prevent them from participating in any distribution under that plan. While you may not obtain full payment of pre-petition debts (i.e. back rent), any recovery is generally better than nothing. It's important to preserve your rights.
Be Ready for Tenant to Assume or Reject the Lease
During a bankruptcy proceeding, the tenant has the option to assume the obligations under the lease or reject them. The deadline in a Chapter 7 case is 60 days, although it may be extended by the court.
In a Chapter 11 bankruptcy, the debtor must decide within 120 days of filing bankruptcy or the date of an order confirming a plan of reorganization – whichever is earlier. The court may grant a 90-day extension if the debtor can show good cause to do so. However, any additional extensions require court approval and the lessor's written consent. Absent an extension of the deadline by the court, the failure to make an election results in the lease being deemed rejected.
If the debtor decides to assume the lease and remain in possession, they must meet certain conditions. The debtor must cure all defaults under the lease, including unpaid pre-petition and post-petition rent. They must also pay any related fees and costs due under the lease. In addition, the debtor must provide "adequate assurance of future performance." If the debtor rejects the lease, it must vacate the property and is no longer obligated to pay rent. However, landlords may still pursue unpaid rent as an unsecured creditor.
Protect Your Rights Before Bankruptcy
Landlords can take steps to avoid the legal headaches associated with a tenant bankruptcy. One option is to conduct a thorough review of any prospective tenant's financial condition. Because a terminated lease is not subject to bankruptcy proceedings, timely and proactive enforcement of a lease can help. Acting quickly in response to unpaid rent may also avoid the consequences of bankruptcy.
Work With an Experienced Bankruptcy Attorney
Finally, it is imperative to work with experienced counsel who can help you navigate the bankruptcy process and protect your legal rights. At Scarinci Hollenbeck, our Bankruptcy & Creditors' Rights Group is widely respected for its vast experience and excellent client service. Our bankruptcy attorneys guide clients through the turmoil surrounding financially troubled and bankrupt companies, providing comprehensive representation in both transactions and litigation involving distressed and insolvent entities.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
