Don’t panic if your landlord files for bankruptcy

Listen to this article

As property values decline and vacancies increase, many commercial landlords and tenants are facing difficult times. General Growth Properties, owner of properties including Pioneer Place, filed for Chapter 11 bankruptcy protection in April. Eddie Bauer recently filed as well.
It seems as though there is a lot of information available to landlords when a tenant faces bankruptcy, but less for commercial tenants when a landlord faces bankruptcy. Tenants may have many questions if their landlord files for reorganization under Chapter 11 bankruptcy code.

Tenants that learn their landlord has filed for bankruptcy often ask: Is my space going to be boarded up when I come in tomorrow? Answer: No, and try not to panic. A landlord’s bankruptcy is not as daunting as it seems. After the filing, the tenant has some time to evaluate the situation because the landlord is given an automatic stay under the bankruptcy code. This keeps the creditors at bay, and also stops all legal actions, which include eviction or potential remedies under the lease.

During this period, the landlord will be assessing its assets, and a lease can be a valuable asset. Depending on the value of your lease, a landlord may either assume or reject it.

If your landlord decides to assume your lease, then the landlord is obligated to cure any defaults under the lease. The landlord will file a motion to assume the lease, stating what it believes needs to be cured; the tenant will have an opportunity to object if there are any defaults missing or dollar figures disputed.

A landlord must be able to provide adequate assurance of performance for any assumption. If assumption is allowed, the lease will continue in full force. The landlord will be obligated to continue to perform all covenants or “promises” made to you in the lease as if no bankruptcy had occurred.

Often a landlord may decide to assume the lease, in order to assign it to a third party. It is important to keep track of who your potential new landlord could be since you are given an opportunity to object.

In a recent proceeding in Delaware, some tenants were heavily involved with the third party assignment process. The bankruptcy court generally favors approving assignments, but will consider objections when there is a question of whether the new landlord can meet the lease obligations. If your lease is assumed and then assigned, make sure you keep track of where and when your rent should be paid.

If, however, the landlord rejects your lease, then your lease is terminated or canceled. Some tenants are often troubled when they learn that their landlord is no longer obligated to keep the “promises” made in the lease. But no matter how unsettling this may be, it is reality in the bankruptcy world.

The tenant has a claim for rejection damages as a result of early termination, or a tenant can choose to stay on the property for the remainder of the lease and offset or reduce rental payments by any amount of damages the tenant suffers as a result of the landlord’s failure to provide services under the lease, such as utilities or maintenance responsibilities. This option extends to the full remaining term of the lease and includes any options to extend.

Another option is that the landlord may try to sell the property, and the bankruptcy code allows the sale to be free and clear of any interests in the properties, subject to certain conditions. When the economy is doing well and property values and rents are increasing, the sale of the property could threaten existing leases.

Given the current market, a potential buyer may be interested in keeping all existing tenants because a leased building with happy tenants is valuable. Tenants should consider the negotiation leverage they may have given the current economy.

Tenants are also concerned about their security deposits. Unless the security deposit is traceable into a specific account, there is a claim only for damages in the amount of the security deposit.

In order to recover a security deposit, a tenant needs to file a proof of claim, which is usually mailed to a tenant. A return of a deposit is a general unsecured claim except to the extent of the priority amount limited to $2,425. Any amounts above the $2,425 are general unsecured claims.

The main concept to remember is that a tenant has rights and remedies in a landlord’s bankruptcy. In some instances, those remedies can come in the form of monetary compensation. Of course, actual payment depends on whether there is money to pay claims – we are talking about bankruptcy after all.

Jim Waggoner is a partner at Davis Wright Tremaine, where he specializes in credit recovery and bankruptcy law. Contact him at [email protected] or 503-241-2300.

Monique Hawthorne is an associate at Davis Wright Tremaine, where she specializes in real estate, land use and environmental law. She is also a LEED-accredited professional. Contact her at [email protected] or 503-241-2300.