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Q&A for Landlords: Keys to Surviving Tenant Bankruptcies

Q&A for Landlords: Keys to Surviving Tenant Bankruptcies

How does a landlord best protect and shield itself from the economic turmoil of its tenants? The Coronavirus (COVID-19) has had pronounced impacts on the retail industry, and likely will continue to affect retail for some time to come. Many retail tenants, for the first time, are finding themselves unable to pay their rent. Landlords, in an attempt to protect their spaces from going dark, are considering forbearance or deferment agreements and rent abatements to keep their tenants afloat. But what if that isn’t enough?

Many retail chains and other tenants are seeking bankruptcy protection, and most experts are projecting a continued wave of bankruptcy filings. How should a landlord prepare for the potential bankruptcy filing by a tenant and protect itself once a bankruptcy occurs? The good news is that the Bankruptcy Code contains special provisions to protect landlords and their unique interests. The following answers to some commonly asked questions from our clients provide insight into how a landlord can successfully navigate the bankruptcy maze.

Q:  Is it true that a bankruptcy filing halts my eviction efforts?

A:  Yes, at least temporarily due to the automatic stay.

When a tenant files for bankruptcy, the automatic stay of § 362 of the Bankruptcy Code comes into effect and you must immediately stop any collection or eviction actions that you have against the tenant. This means, for example, that you cannot declare the tenant in default, terminate the lease, or obtain a judgment of eviction against the tenant once the tenant files for bankruptcy.  You must also stop all actions, including letters and other communications, to collect rent from the tenant. You may, however, seek “relief from stay” to resume the eviction action, which the Bankruptcy Court may grant “for cause,” including lack of adequate protection. Also, the automatic stay likely does not protect any guarantors that have not filed bankruptcy, as discussed below.


Q:  What happens to the unpaid rent due from before the case was filed?

A:  It depends.

The rent outstanding prior to the bankruptcy filing (also known as pre-petition rent) must be paid promptly if the tenant assumes the lease during the course of the bankruptcy case. If the tenant rejects the lease, then you have a rejection damages claim for that pre-petition rent, plus future rent obligations (subject to a cap, usually equal to one year’s rent). Typically, unsecured claims are paid only pennies on the dollar in a bankruptcy case, which is why it is imperative for landlords to move quickly to enforce their rights in bankruptcy cases and avoid additional unpaid rent.


Q:  Assume or Reject, what does that mean?  When can I get my bankrupt tenant out of the space?

A:  The Bankruptcy Code sets strict deadlines by which the tenant or trustee must decide whether to keep, or assume, the lease, or reject it.

The tenant in a Chapter 11 case involving a commercial lease has 120 days to decide to assume or reject the lease, subject to one 90-day extension, without the landlord’s consent. Any further extensions require the landlord’s consent.  The tenant uses this time to evaluate its leases.  In large multi-store retail cases, the tenant will typically hire an industry consultant to analyze each lease on a store by store basis.  Often, rejection motions are filed quickly concerning the locations that are not profitable so that the obligation to pay rent will stop.  Once rejected by Court order, the landlord can recover its space, and is left with the rejection damages claim, which is simply an unsecured claim in the case.

The more profitable leases will generally be assumed outright, but be prepared for the tenant (or its financial advisors) to reach out to renegotiate the lease.  The tenant might suggest it will assume the lease but only if concessions are provided such as reduced rent, or extending the term.  Often, this negotiation takes place with the deadline to assume or reject approaching quickly, so knowing your market and being ready to respond will be important to a successful negotiation.

For the tenant to assume the lease, it must do two things: (1) cure any defaults (other than certain non-monetary defaults); and (2) provide adequate assurance of future performance.  If you have a desirable prospective tenant, and don’t want the lease to be assumed by the tenant (or a buyer/assignee of the tenant as most Chapter 11 cases involve a sale), then make sure to consider and analyze whether an objection based upon a lack of adequate assurance of future performance is appropriate.  The Bankruptcy Code requires the existing tenant or prospective assignee to demonstrate its financial wherewithal to perform under the lease, which is an important protection for landlords.

Note that if the case is a Chapter 7 case, the Bankruptcy Trustee has 60 days to assume or reject the lease, which date can be extended. Chapter 7 Trustees typically reject leases quickly to avoid unnecessary administrative expenses, although sometimes Trustees will keep the space long enough to conduct an auction of the personal property.


Q:  Will the tenant pay rent while in bankruptcy?

A:  The tenant is required to pay post-petition rent, subject to a 60-day deferral period, for cause.

The tenant should pay rent that comes due after the filing of the case.  For example, if the tenant files Chapter 11 in the middle of the month, and rent comes due on the first of the month, the Bankruptcy Code requires the tenant to pay the rent when it becomes due the following month.  Courts differ on whether this “stub” rent must be paid prior to assumption, but in some jurisdictions the “stub” rent must be paid. You will likely need to file a motion to force the payment of the stub rent.

In light of the COVID-19 pandemic, tenants have sought relief in the Bankruptcy Court from the obligation to pay rent.  Certain Bankruptcy Courts have permitted some relief to tenants under the unprecedented circumstances, but typically post petition rent may only be deferred up to 60-days based upon a showing of “cause.” Even if rent is deferred, you may still be entitled to “adequate protection” to reimburse you for certain expenses, such as utilities, as in the bankruptcy case filed by Pier 1 earlier this year. Also, courts across the country are generally requiring a prompt cure of the deferred rent once a critical mass of the stores have reopened. Landlords should demand a budget by the tenant demonstrating when the deferred rent will be cured and reflecting the source of the funds, such as Debtor-in-Possession financing.


Q:  What if the tenant fails to pay the rent during the bankruptcy case?

A:  You may seek “relief from stay” or file a motion to compel payment of rent, among other things.

If the tenant fails to pay post-petition rent, consider seeking relief from stay, which if granted would allow an eviction action to resume or be initiated. You may also file a motion to compel payment of rent, in order to enforce your rights under the Bankruptcy Code. Note that, as part of the protections afforded landlords under the Bankruptcy Code, any missed post petition rent, prior to rejection, will qualify as a priority claim (paid ahead of general trade debt or unsecured claims), but you may have to take action to assert that claim.


Q:  Does the bankruptcy case affect my rights against a guarantor?

A:  Generally, no.

If the guarantor itself did not file bankruptcy, then you may still recover under the terms of the guaranty. Putting pressure on the guarantor may also help expedite the tenant’s treatment of your lease during the course of the bankruptcy case.


Q:  My lease puts the tenant in default it if declares Bankruptcy.  Will that help me here?

A:  Although it is common practice to include this language in a lease, these provisions are generally unenforceable in the Bankruptcy Court.    

You are generally not protected by any provision in your lease or in any forbearance, deferment, or abatement agreement that includes a provision that the agreement terminates or that the tenant is in default merely due to the filing of a bankruptcy.  Although this language is common and expected in many of these agreements, and can act as a deterrent to many tenants from filing, these provisions are not enforceable in the Bankruptcy Courts.


Q: Can the tenant assign the lease after it is assumed?

A:  Yes, even if the lease prohibits such assignments.  However, the Bankruptcy Court will protect the tenant mix in retail shopping centers.

Bankruptcy Courts do not require the landlord’s authorization for assignments, even if required by the lease.  As such, if the tenant elects to assume the lease, it could potentially later assign the lease to another tenant without the landlord’s consent.  In the retail context, an unauthorized assignment can be particularly challenging because the landlord has an interest in preserving the existing tenant mix and in protecting against any violations of exclusive or prohibited uses.  In recognition of this concern, the Bankruptcy Code has a special provision for shopping centers that preserves radius, use, and tenant mix restrictions, among other things. Landlords may also object based upon whether the prospective assignee has the financial ability to perform under the lease.


Q:  How do I plan ahead so I can get paid?

A:  Although you can’t protect against all scenarios, there are a few steps you can take now to ensure a better possibility of getting paid.

Make sure to obtain the tenant’s and guarantor’s financials before agreeing to forbear, defer, or abate rent.  Not only will this assist in evaluating the possibility that a tenant might file bankruptcy in the future, it can be very useful information in a bankruptcy case of either the tenant or a guarantor.

If possible, require the tenants to post a letter of credit.  Since letters of credit do not generally become part of the bankruptcy estate, the landlord can draw on them for rent payments without violating the automatic stay.  A letter of credit would put you in a much stronger position than the other landlords involved in the case.

Verify that your leases define the tenant’s monetary obligations as “Additional Rent” regardless of whether they are for CAM, Insurance, Tax or default fees or interest.  This may aid in those payments being classified as “rent reserved” for purposes of calculating post-petition rent.  You should also verify that your leases contain appropriate remedies for default, such as default fees, interest, and recovery of attorneys’ fees and costs.

When entering into any abatements, deferments or forbearance agreements, it is important to consider the impact that such incentives could have on your ability to be paid in the event that the tenant were to later declare Bankruptcy.  Discuss the timing and the potential impact with your counsel when entering into these agreements.

Consider collecting back-rent directly from the guarantor.  If there is no guarantor on the lease, you may condition any rent deferment or abatement on the condition that a new guarantor be added to the lease.  If possible, terminate the lease prior to the bankruptcy filing.  If the lease is terminated, the lease generally cannot be assumed.

Obtain a higher security deposit.   The security deposit will make the landlord a secured creditor and will put the landlord in a position of higher priority, to the extent of the deposit.

Analyze the market values of the lease versus the existing lease terms.  In the current environment, if a replacement tenant is unlikely, and the space may be dark for a lengthy time, you want to be armed with all information to negotiate modified lease terms for assumption.


Q: What is your best advice in having a successful outcome when facing a bankruptcy?

A:  Be proactive and do not simply wait until the tenant makes its move. 

In these national retail cases, tenants are moving very quickly in rejecting leases, with the first wave of rejections within days of the bankruptcy filing. We had a situation where a landlord client contacted us after receipt of the rejection notice and advised that it was willing to extend concessions in order to retain the tenant. We ultimately had our client removed from the rejection list, but in some instances, these rejection motions are heard on an emergency basis, so prompt action is key. Therefore, it is imperative for landlords to have a firm understanding of the leasing market and be prepared to stand firm as to the full “cure” amount or to make concessions if the alternative is an empty space for a prolonged period of time. If you know your location is desirable and that your lease is a market rate, you can hold your ground and you are under no obligation to make any concessions. In some jurisdictions, your attorney’s fees can even be added to your “cure amount.”

In order to minimize lost rent, landlords also need to move swiftly in filing motions to compel payment of rent or to seek relief from stay in the event of the non-payment of future rent. As part of an “agreed upon order,” landlords can request provisions that allow expedited relief in the event of a future default.

Overall, landlords should know that the Bankruptcy Code offers them protections and safeguards, but that they may need to be assertive and proactive in order to obtain the full benefit of those provisions.


Ryan E. Davis

Heather S. Moraes

Bradley M. Saxton

Heather S. Moraes, Esquire
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Ryan Davis, Esquire
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Bradley M. Saxton, Esquire
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