There has been no shortage of significant bankruptcy filings in 2020 as a result of the ongoing pandemic. Large companies such as J.C. Penney, Brooks Brothers, Lucky Brand, GNC, subsidiaries of Regus, and others, have all filed for bankruptcy protection, citing the coronavirus for sharply reduced sales at their brick and mortar stores.
These filings and others have had strong implications for commercial landlords across the country. Accordingly, this article provides a much needed “Top 5” tip list for commercial landlords to consider when their tenant files for bankruptcy.
Tip No. 1 – Respect the Automatic Stay Under Section 362(a) of the Bankruptcy Code
Once a debtor files for bankruptcy, the automatic stay of Section 362(a) of the Bankruptcy Code immediately takes effect. This is a very powerful tool that protects a debtor during the pendency of a bankruptcy proceeding. In a voluntary bankruptcy petition, the stay automatically becomes effective, without the need for a hearing or court approval.
As such, a commercial landlord should not take any action to violate the automatic stay. This would include filing a lawsuit against the debtor, taking action to continue a pending lawsuit against the debtor, making demands to collect unpaid rent, etc. If, for example, a landlord filed an eviction action prior to the bankruptcy filing, then it must seek and obtain an order lifting the automatic stay before it can take any further action in the litigation. Failure to adhere to the protections of the automatic stay may subject a landlord to sanctions and punitive damages.
Tip No. 2 – Recognize that a Debtor Must Timely Pay Post-Petition Rent While Occupying the Leased Property
While a debtor continues to occupy a leased property during the pendency of a bankruptcy action, the debtor must comply with all of its obligations under the lease. This includes timely paying rent owing to the landlord that is due after the filing of the bankruptcy action.
If the debtor does not timely pay its rent while continuing to occupy the premises after the bankruptcy filing, then the landlord may file a motion for an administrative claim with the bankruptcy court. An administrative claim is afforded the highest priority under the Bankruptcy Code, and such claims are paid before general unsecured creditors.
Tip No. 3 – Timely File a Proof of Claim With the Bankruptcy Court for All Amounts Owing to the Landlord
It is very important that a landlord file a proof of claim with the bankruptcy court. Often times, in the months leading to a bankruptcy filing, the tenant-debtor will fall behind in its rental payments. Shortly after the bankruptcy petition is filed, a debtor is required to file schedules of assets and liabilities with the bankruptcy court, which lists all debts owed by the debtor before the filing of the bankruptcy petition. If the amounts owed to the landlord are not listed, or the amount listed is incorrect, then a proof of claim must be timely filed by the landlord.
In each bankruptcy case, a “general bar date” is set to file a proof of claim, with notice being provided to all creditors. A proof of claim for pre-petition debts owed by the debtor must be filed before the bar date in accordance with the instructions provided in the notice. Failure to do so may result in the claim being struck by the court.
Tip No. 4 – Be on the Lookout for the Debtor to Assume, Assign or Reject the Lease
During the pendency of a bankruptcy action, a debtor has the choice to either assume the lease, assign the lease to a third-party, or reject the lease. These actions trigger important deadlines of which any landlord should be keenly aware. If a debtor assumes or assigns the lease, then it is responsible to pay all “cure costs” associated with the lease. This includes all back-owed rent (including pre-petition rent), and in many jurisdictions, other amounts owed under the contract, including interest, late fees, and potentially attorney fees, if provided for under the lease. When a debtor moves to assume or assign a lease, it must also provide notice of the proposed cure cost. If the cure cost is not correct, then a landlord must timely file an objection to the cure amount with the bankruptcy court.
By contrast, if the debtor seeks to reject the lease, then the landlord must file a claim with the court for all “rejection damages” owed by the debtor for terminating the lease. This would include all rent owed to the landlord for the remainder of the lease, which may be subject to caps set forth in the Bankruptcy Code. Often times, the rejection notice will provide a landlord with a short turnaround time to file a rejection claim, usually 30 days. These types of damages are generally treated as unsecured claims.
Tip No. 5 – Take Steps to Protect the Landlord
There are several ways in which a landlord may better protect itself before a debtor files for bankruptcy. These steps include obtaining a personal guaranty of the lease, requiring a letter of credit, and a security deposit. A personal guaranty from additional individuals or entities is one way to maximize recovery. Provided that a lease guarantor is not in bankruptcy, nothing in the Bankruptcy Code prevents a landlord from taking action against a guarantor to a debtor-tenants’ lease.
A letter of credit is also a useful tool, which permits a landlord to draw down on the proceeds of the letter of credit in the event of default. A letter of credit often times is not considered property of the bankruptcy estate. There is a split of authority as to whether a lost profit damage claim of a landlord for the remainder of the lease term is capped under the Bankruptcy Code.
Finally, a security deposit is always recommended. While generally considered property of the debtor’s estate, a landlord may be permitted to exercise its rights of set-off of its claim against the security deposit. This may place the landlord in a superior recovery position than general unsecured creditors.
Bonus Tip – Retain Experienced Bankruptcy Counsel
There is no substitute for retaining experienced and local bankruptcy counsel to protect a landlord’s rights during the pendency of a bankruptcy case. As demonstrated above, there are many notices, orders, and accompanying deadlines set forth in bankruptcy filings that must be followed, and can easily be missed by a non-attorney not familiar with the Bankruptcy Code or the local rules of the particular jurisdiction in which the bankruptcy action is filed. Retaining experienced counsel at the onset of the bankruptcy case can help commercial landlords avoid common pitfalls and maximize their recovery against their debtor-tenant.
Carl D. Neff is a bankruptcy partner with the law firm of FisherBroyles, LLP, and practices in Delaware. You can reach Carl at (302) 482-4244 or at Carl.Neff@FisherBroyles.com.