Bankruptcy affords debtors the opportunity for a fresh start. Sometimes though, debtors are subject to ongoing agreements with continuing performance obligations for both parties, which do not automatically end by virtue of the bankruptcy filing. One of the most prevalent of these “executory contracts” is a commercial lease. Upon filing the bankruptcy, the tenant has a fixed amount of time to determine whether it will continue to perform under the lease – it is important to understand your tenant’s options and deadlines for addressing the commercial lease in bankruptcy, what your options are to protect and enforce your rights, and what claims you may be able to assert within the bankruptcy.
1) Be mindful of the automatic stay!
Upon the filing of a Petition and commencement of a bankruptcy, there is an “automatic stay” on all efforts by creditors to collect or enforce their rights against a debtor. This stay prohibits creditors from: (i) commencing any judicial or other similar action against the debtor; (ii) exercising control over or obtaining possession of property of the debtor’s estate; and (iii) creating, perfecting, or enforcing any lien against property of the debtor’s estate or the debtor. Violations of the automatic stay may result in strict and sometimes severe sanctions against the offending creditor, depending on severity.
Even if not subject to the automatic stay, before pursuing remedies such as eviction or repossession of the property, it is prudent to either seek relief from the automatic stay or clarification from the bankruptcy court to confirm that automatic stay does not apply.
2) Is the lease an “executory contract”?
Only executory contracts can be assumed, assigned, or rejected by the debtor. These options are not available for non-executory contracts.
Did the lease expire before the Petition Date? Contracts that end or expire before the bankruptcy cannot be revived solely by virtue of the bankruptcy process, are not executory, and are outside the scope of the automatic stay. The Bankruptcy Code specifically prohibits the assumption of nonresidential real property leases terminated before bankruptcy.
Was the lease terminated before the Petition Date? Review the default and termination provisions of the lease. The ability to terminate the contract before bankruptcy allows for maximum flexibility for the landlord. To the extent the lease has provisions for automatic or self-executing defaults and terminations, require little to no action to enforce, or minimal notice requirements, and were properly complied with, the lease may be deemed terminated pre-bankruptcy.
Even if technically not subject to the automatic stay, because of the serious penalties and breadth of the automatic stay, a landlord should seek bankruptcy court approval before enforcing its rights under the lease and applicable state law.
3) Understand the Debtor’s / tenant’s options for addressing the commercial lease in bankruptcy, and the respective implications.
A commercial tenant in bankruptcy has 120 days to decide whether to reject, assume, or assign a lease. This deadline, however, may be extended with approval of the bankruptcy court, or upon the debtor receiving the landlord’s written consent. If a commercial tenant fails to make a decision before the 120-day period expires, absent an extension, the lease is automatically deemed rejected. In the event the tenant seeks an order extending the period to assume or reject, the tenant must demonstrate “cause” as to why the 120-day period should be extended. In the current pandemic, courts may be more likely to find sufficient cause and provide more flexibility to debtor-tenants.
What happens if your tenant “assumes” the lease?
Assumption is a bankruptcy term for the decision by a debtor to continue to perform an executory contract or lease. If the debtor chooses to “assume,” they must satisfy the following three requirements:
· Cure. The debtor must cure defaults, including all non-monetary defaults, or provide adequate assurance that the default will be cured promptly. There are some instances where a Debtor will have “incurable” breaches of the lease, which may make the lease un-assumable.
· Compensate. The debtor must compensate, or provide adequate assurance that it will promptly compensate, the landlord for any actual monetary loss caused by the default. This may include interest on defaulted amounts, attorneys’ fees and expenses, if provided for in the agreement or by law.
· Assure. The debtor must provide adequate assurance of future performance under the lease if the Debtor was in default.
If the Debtor assumes the lease, the landlord will also have an “administrative claim” for all obligations under the contract, regardless of whether they arose before or after bankruptcy. This claim is entitled to a higher priority in the distribution of assets of the estate than other priority claims and general unsecured claims.
What happens if your tenant “rejects” the lease?
If the tenant rejects the lease, the landlord of non-residential real property is entitled to immediate surrender of the premises and certain damages will be treated as general unsecured claims in the bankruptcy case. Damages are limited and calculated based on the amount of time and rent remaining due under the lease.
Rejection can also give rise to an administrative claim for any benefits received by the debtor during the gap period occurring after the bankruptcy filing but before rejection.
4) What can you do if there is reason not to wait for the tenant’s decision on assumption or rejection of the lease?
Compel a decision. File a motion requesting the court set a shortened deadline by which the debtor must assume or reject the contract. However, these requests are rarely granted unless the landlord demonstrates significant risk of harm caused by the delay in the tenant’s decision on treating the lease. This is also difficult to do if the debtor is not in default and is current on its payment obligations.
Seek adequate protection, including post-Petition rent. If the court will not compel the debtor to make a decision sooner than allowed, then alternatively request adequate protection during the interim period, which can take the form of post-Petition rent payments or other protective measures.
Seek relief from automatic stay. Request relief from the automatic stay to exercise termination rights under the contract.
File an administrative claim. File an administrative claim for the reasonable value of any benefits received by the debtor during the interim period after the bankruptcy filing and before the tenant’s decision on treatment of the lease. Depending on the language of the lease, this may include the landlord’s attorney’s fees to receive post-petition rent.
Examine the debtor. Examine the debtor and compel production of relevant documents to determine the debtor’s ability to perform the contract.
In any event, it is important to keep the lines of communication open with your tenant (or their attorney) to reach the most effective resolution for all parties. The issues that arise when addressing commercial leases and executory contracts in bankruptcy are quite nuanced. It is highly advisable to consult with a bankruptcy attorney if confronted with these issues to optimize your chances of a successful outcome.
This article is for information purposes only and is not offered, nor should be construed, as legal advice.
If you have any questions about the issues addressed in this article or for additional COVID-19 related business information, please do not hesitate to reach out to Michael P. Dunn, Joshua C. Kligler, or Yosef B. Shwedel to discuss further.