Bankruptcy Basics: What Every Landlord Should Know
by James H. Billlingsley, Esq.
Most landlords will experience a tenant bankruptcy at some point. The Bankruptcy Code provides certain protections to the tenant during the bankruptcy. Landlords need to know some basic concepts to even begin to deal with the issues that arise when the tenant files bankruptcy.
The Automatic Stay
The instant a bankruptcy case is filed, a stay (much like an injunction) goes into effect automatically. Hence, the name, the “automatic stay.” The automatic stay generally prohibits landlords from evicting tenants, locking them out or otherwise excluding them from the premises, applying security deposits, and attempting to collect past due rent. Violating the automatic stay can subject the landlord to monetary damages and attorneys fees. If your tenant has filed bankruptcy, is damaging the premises, or is delinquent on paying rent, you should consult with a bankruptcy attorney about obtaining a court order terminating the automatic stay.
Commercial Tenants are Obligated to Pay Rent after Filing Bankruptcy
The Bankruptcy Code delays (and in some cases, excuses) the payment of unpaid rent by commercial tenants that accrued before the bankruptcy case was filed. But it requires commercial tenants to pay rent, and pay it on time, after the bankruptcy case is filed. In fact, the Bankruptcy Code requires commercial tenants to perform all of their obligations under the lease after the bankruptcy case is filed. If a commercial tenant fails to perform its obligations under the lease after filing bankruptcy, the landlord may have a basis for terminating the automatic stay. Residential tenancies are more complicated because the Bankruptcy Code isn’t entirely clear about a residential tenant’s obligations. Once again, it’s probably best to consult with a bankruptcy attorney about what you can and cannot do with a bankrupt tenant.
The Tenant Has the Right to Elect Whether to Keep the Lease
The Bankruptcy Code gives the tenant two choices. It can stay in the premises and continue to perform under the lease. This is known as “assuming” the lease. But assumption comes at a cost to the tenant. It must pay all accrued and unpaid rent (whether the rent accrued before bankruptcy or after) and cure all other defaults under the lease (except for defaults relating to filing bankruptcy). The tenant has a second option. It can vacate the premises and avoid any further obligations to the landlord. This is known as “rejecting” the lease.
Damage Claims in Bankruptcy are Capped
If a landlord sues a tenant in state court for breaching the lease, there is usually no limit on the amount of damages the landlord can recover. That’s not the case in bankruptcy. If the tenant rejects the lease, the landlord’s total claim is capped by the Bankruptcy Code. The formula to determine the cap is somewhat complicated. But a shorthand rule is this. If the lease has more than six years of term remaining, the landlord is entitled to 15% of the remaining rents. If the lease has less than six years of term remaining, the landlord is entitled to one year’s rents.
About the Author:
James H. Billingsley, a shareholder in Polsinelli Shughart's Dallas office, provides advice and counsel in a variety of commercial matters to clients in a broad range of industries. His practice concentrates in bankruptcy and business reorganization, distressed company issues, distressed acquisitions and dispositions, commercial insolvency litigation, and complex commercial litigation.
Mr. Billingsley has significant experience in distressed real estate issues, and he has worked extensively in the retail industry, representing landlords and other creditors in numerous retail bankruptcy cases.
Mr. Billingsley is a member of the State Bar of Texas, the American Bankruptcy Institute, and the Dallas Bar Association. Mr. Billingsley received his B.B.A. from the University of Texas at Arlington, where he currently serves as an executive member of the alumni association, and his J.D., with honors, from the University of Texas at Austin School of Law.