Tips to Minimize Landlord’s Exposure When a Commercial Tenant Files Bankruptcy

Landlords often have clues that a tenant is going to be filing for bankruptcy, rental payments are consistently late several months in a row and the tenant falls more than a month behind on the rent. But, it can still be shocking when a landlord receives a legal notice in the mail, instead of a rent check.

Because bankruptcy can add significant expenses and increase the time it takes to remove a delinquent tenant, landlords should not allow tenants to fall far behind on rental payments. Below are some tips on how to address the issues raised by a bankrupt tenant:

• Perform due diligence on the proposed tenant’s finances, regardless of whether it is a large corporation
• Obtain an appropriate deposit from the tenant, regardless of whether it is a large corporation or a single-owner limited liability company
• Consider reducing the term of the lease based on the tenant’s square footage vs. the size of the commercial property, meaning no extended leases that can be easily rejected in a bankruptcy and not subject to payment of the liquidated damages stated in the lease
• Include a clause that protects the landlord in the event of late or slow rent payments
• Include a clause to address any future bankruptcy although often times these so-called ipso facto clauses are rejected by bankruptcy courts

What Happens When You Get Notice of a Tenant’s Bankruptcy?

But, even landlords who are vigilant about selecting reliable tenants and enforcing lease provisions may find themselves on the receiving end of a bankruptcy notice.

Most of the time, commercial property owners will receive notice about a tenant’s bankruptcy filing from a letter sent by the Bankruptcy Court. This “notice to creditors” gives the court’s address, the case number, and several important dates in the case.

The notice also signals that something called the “automatic stay” is in place. When any type of bankruptcy is filed the court automatically issues an order to all the creditors that they are not to pursue any collection actions. This includes eviction proceedings and sending collection letters for past due rent. If a creditor violates the automatic stay, it can be held in contempt of the Bankruptcy Court.

Because bankruptcy and creditor’s rights issues can be complicated and technical, the next step is to consult with a creditor’s right attorney, often also a bankruptcy practitioner. If the landlord and tenant are in the middle of eviction proceedings, the court handling the eviction must be advised of the bankruptcy. The failure to notify the court can have severe consequences for the landlord.

Businesses often file a Chapter 11 bankruptcy to restructure their debt. This means that the tenant will want to continue to operate and will work out a plan with the supervision of Bankruptcy Court that will include payment of any back rent. Not all creditors will receive all of the rent owed, but if the tenant plans on continuing to rent the same property, the landlord stands a better chance of eventually recovering back rent.

Protecting Your Commercial Landlord Rights

Even if eviction proceedings have not started, landlords can seek to collect back rent by getting relief from the automatic stay. Typically, Bankruptcy courts will not allow a tenant to stay in possession of the space if it is not current on rent or does not have a plan to make future rent payments and pay past due rent.

While bankruptcy is designed to give debtors an opportunity to get a fresh start or restructure debt, there are many protections in place for creditors. Landlords with tenants still in possession of the property have some of the strongest rights of any creditors and are often some of the first creditors to get paid from the bankruptcy.

However, to enforce their rights, landlords must meet all the Bankruptcy Court deadlines for filings and attend, or have their representative attend, key hearings dealing with the lease. If the landlord does not seek to actively protect their rights, the Court is not likely to do it for them.

The filing of the bankruptcy may not mean the end of the landlord–tenant relationship. The landlord may have the tenant for months or years afterwards. If a commercial landlord receives a bankruptcy notice they must take action right away to seek professional guidance and to protect their rights.

A tenant bankruptcy can present several challenges to a landlord but as with all legal matters, the challenges can be met by consulting with competent counsel.

Carmen Contreras-Martinez is counsel at Saul Ewing Arnstein & Lehr. She concentrates her practice in commercial litigation, representing clients in federal and state courts in diverse matters including commercial contract disputes, partnership and shareholder disputes, and general commercial disputes.