Landlords can avoid frustration and pursue several forms of recourse under the bankruptcy code.
Personal bankruptcy filings are occurring at record levels and are, in turn, impacting residential property owners more than ever. Once a landlord’s worst enemy, the United States Bankruptcy Code (“Code”) now is showing signs of becoming a property owner’s friend. Although the Code is not perfect and may be interpreted and imposed differently throughout the country, it offers residential landlords certain protections.
Typically, individuals file bankruptcy under either Chapter 7 or 13 of the Code. Chapter 7 bankruptcies involve liquidation of a debtor’s non-exempt assets by a court appointed trustee, for distribution to creditors. Often Chapter 7 debtors have few or no assets for distribution. Chapter 13 bankruptcies (or individual reorganizations) are for individuals who qualify as having excess income after payment of necessary living expenses. The excess income funds a Chapter 13 plan which pays creditors over a minimum of 36 months, but cannot be longer than 60 months. A trustee is appointed in a Chapter 13 case principally to watch over the debtor and receive and distribute the payments to creditors. Upon completion of a bankruptcy under Chapter 7 or 13, the debtor is discharged of his dischargeable debts.
The benefits for a landlord found in the Code are best understood through the following scenario. Let’s assume a residential tenant files bankruptcy on Friday afternoon. The tenant is in the middle of a one-year lease with a renewal provision at the sole discretion of the landlord. From here on out, the tenant is the “debtor.”
All Chapters of the Code impose an “automatic stay” of all collection and enforcement proceedings. The stay prevents eviction proceedings or other action–either for possession or for money damages–without first receiving the bankruptcy court’s permission. Early in the process, the Code gives the debtor certain benefits, including the option to reject (terminate) or assume (live with) unexpired leases.
The Code provides, in Section 362(b)(22), that the automatic stay shall automatically cease 30 days following the bankruptcy filing date to permit landlords to continue any eviction, unlawful detainer action or similar proceeding against a debtor-tenant where the landlord has obtained a judgment for possession against the debtor-tenant prior to the bankruptcy filing.
The debtor-tenant can challenge the cessation of the automatic stay pursuant to 362(b)(22) by filing and serving a certification within 30 days of the bankruptcy filing date attesting that (1) certain circumstances exist that would allow the tenant to satisfy the monetary default giving rise to the judgment for possession and (2) that the debtor or their adult dependant has deposited any rents coming due in the 30-day period with the bankruptcy court clerk. Additionallly, if the debtor certifies, within the 30-day period, that the entire monetary default has been satisfied, then the automatic stay will stay in place and prevent the landlord from enforcing the pre-petition judgment for possession. See, 11 U.S.C. Section 362(l).
Similarly, Section 362(b)(23) of the Code provides that the automatic stay does not apply to eviction actions based on endangerment of the property or the illegal use of controlled substances on the property. In this case, the landlord must file a certification with the Court stating that the eviction action has been filed or that, within 30 days prior to the petition date, the debtor has endangered the property or used illegal drugs on the property. Relief from stay will be granted to the landlord within 15 days of the filing of the certification unless the debtor timely files a response to the certification and then proves a subsequent hearing that the situation that gave rise to the eviction complaint has been remedied. See, 11 U.S.C. Section 362(m).
Upon filing the petition (the original bankruptcy filing), the Code requires the debtor or the trustee in Chapter 7 cases to timely perform all obligations of the lease from that date until the lease is assumed or rejected. If the debtor or trustee fails in that duty, the landlord may seek relief from the automatic stay and proceed with its remedies, which include an action for possession of the premises. In many Chapter 7 cases this Code provision is overlooked if the trustee rejects the lease or the lease is automatically rejected under the time specified in the Code.
In a Chapter 7 case, the Code provides that a lease of residential real property is automatically rejected if the trustee does not assume or reject the lease within 60 days after the bankruptcy is filed. Thus, even if the debtor has not defaulted under the lease before filing bankruptcy–the Code does not recognize defaults that are breaches of covenants relating to either insolvency, financial condition, the filing of a bankruptcy proceeding, or the appointment of a trustee or custodian in the case of real property leases –60 days after bankruptcy the landlord can consider the lease rejected.
If the lease is rejected, the lease automatically is deemed to have been breached as of the day before the bankruptcy filing and the landlord is entitled to repossess the premises in accordance with state law. As a result, any damages that the landlord might suffer are treated as pre-petition general unsecured claims. The code limits “rejection damages” to either 15 percent of the balance of the rent reserved in the lease or the rent reserved for one year from the filing date or the date the premises were surrendered, whichever is earlier. In addition, the claim can include any pre-petition rent due at the time of the filing.
As a result of the 60-day time period, a landlord knows with certainty when they can treat the lease as rejected and begin to repossess the leased premises. If it is necessary, a landlord can file a motion to compel the assumption or rejection of a lease before the end of the 60-day time period. Such a motion generally can be heard by the court within 30 days, but can be heard on an expedited basis if there is a pressing need for a ruling (e.g. new tenant).
With bankruptcy court permission, the 60-day time period can be extended. This occurs infrequently and generally only when the trustee, in exercising his business judgment, believes the lease can be assumed and assigned for value. Assuming and assigning a lease is addressed below. However, assuming and assigning a lease only makes business sense if the lease is a below-market lease and proceeds result from the assignment, which proceeds can be used to pay unsecured creditors in the bankruptcy.
In a Chapter 13 bankruptcy the landlord must be more vigilant because the debtor may assume or reject an unexpired lease of residential property at any time before the confirmation of a Chapter 13 plan. The court, however, at the request of a party to the lease, may order another specified period of time to assume or reject. Debtors often put off assuming or rejecting a lease until the Chapter 13 plan confirmation. The date for confirmation of a debtor’s plan varies from court to court. In jurisdictions where the scheduled confirmation date is far off, it is prudent for the landlord to request an earlier deadline, especially where the debtor is unable to timely make post-petition payments.
A landlord should closely scrutinize the Chapter 13 plan because it will likely affect the landlord’s rights. Assumption of the lease is something that would usually be included in the Plan. An assumed lease becomes a debtor’s post-petition obligation, making any claim from a subsequent default an expense of administration in the Chapter 13 proceeding. That claim then becomes a high priority in the distribution of funds in the event the Chapter 13 case is converted to Chapter 7.
Assuming a lease requires the debtor to prove various elements. In order to assume a lease a debtor must provide adequate assurances that it (or another tenant, if it intends to sublease) will promptly cure any defaults, compensate the landlord for any financial loss resulting from a default and provide adequate assurance of future performance.
The requirement of adequate assurance protects the landlord if the debtor wants to either assume the lease, or assume and assign it. The requirements provide defenses for the landlord against the attempted assumption. If the debtor cannot provide evidence that it can meet these requirements, then the lease cannot be assumed.
An obvious indicator of the debtor’s ability to provide adequate assurance is whether the debtor can cure the defaults by immediate payment of all past due rent and expenses incurred by the landlord. Debtors who cannot immediately cure, may propose to cure defaults by paying pre-bankruptcy rent as a general unsecured claim. Their inability to pay in full may be used as a defense by an objecting landlord.
But a landlord whose lease is being assumed should object to any treatment of his cure claim as a general unsecured claim. The Code requires a prompt cure when the cure cannot be immediate. Many courts construe this to mean the debtor is allowed a reasonable period of time to cure the defaults. In these instances, a landlord should request that his cure claim and his future rent claim be separately classified above all other creditors and that the cure occur over as short a time as possible. A landlord should further request that the Chapter 13 trustee institute a wage attachment so that the monthly default amount and current rent is forwarded to the trustee and never reaches the debtor’s hands. This generally satisfies the assurance of future performance, although a wage attachment will not apply in the case of self-employed individuals.
The strategy a landlord employs when a residential tenant files bankruptcy varies depending upon which Chapter the case is filed under and the facts of each case. Chapter 13 cases tend to present a landlord with more issues because the debtor will often want to assume the lease. It is advisable that a landlord consult with an experienced bankruptcy attorney before taking any action with respect to a bankrupt tenant.
Contrary to common belief, things can happen quickly in a bankruptcy case. When the landlord learns of the bankruptcy of its tenant, it must act promptly to protect its rights as landlord. Sitting on those rights may prejudice the landlord forever.