Effect of Tenant Bankruptcy on Leases

During this economic downturn, many companies are filing bankruptcy. As a result, both landlords and tenants must address the impact of a tenant bankruptcy on an existing lease.

How Can a Landlord Protect Itself?

If a tenant is in default and the landlord believes a bankruptcy is on the horizon, the landlord must decide whether to act quickly to evict the tenant and terminate the lease, before the bankruptcy petition is filed. During the bankruptcy, all litigation and collection efforts outside of the bankruptcy must stop, and the fate of the lease is almost entirely in the tenant's hands, as outlined below.

What Are a Tenant's Options In Bankruptcy?

Once the tenant files bankruptcy, it will have up to 120 days (which may be extended to 210 days "for cause") to decide what to do with the lease. Essentially, there are five options:

1. Reject the Lease. The tenant may reject (i.e., breach and surrender) the lease. After a rejection of the lease, the landlord has three claims. The first is for rent arrearages prior to the bankruptcy, which is an unsecured claim. The second is for rent for the period between the bankruptcy filing and the date the tenant surrenders the premises, which claim has administrative priority in the bankruptcy. The third type of claim is for rent for the balance of the lease, but this claim is subject to a cap (usually one year's rent) and is also unsecured.
2. Assume and Continue to Occupy. The tenant may "assume" (i.e., affirm and continue) the lease, but must cure all defaults at the time of assumption.
3. Assume and Assign. The tenant may assume and then assign the lease to a third party, thus terminating the tenant's liability under the lease. The bankruptcy code allows courts to disregard anti-assignment clauses in leases, although the code provides certain landlord protections for shopping center leases.
4. Renegotiate and Assume. The tenant may use the threat of rejecting the lease as a means to renegotiate the lease with the landlord.  If the landlord agrees to make concessions, the tenant then assumes the lease "as amended."
5. Assume then Reject. The tenant may assume the lease, but then reject it during the pendency of the bankruptcy. In this situation, the landlord has an administrative priority claim for two years of rent, in addition to the other claims discussed in option 1 above.

The Bankruptcy & Troubled Loans practice group has substantial experience in the areas of commercial leasing, real estate foreclosures, credit workouts, receiverships and bankruptcy. For more information on this Client Alert or for help evaluating your current situation, contact any of the attorneys in the Bankruptcy & Troubled Loans practice group (for a listing, click here ).

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