The automatic stay is one of the most powerful protections provided to debtors in a bankruptcy proceeding.  The stay acts as an injunction that prohibits creditors (including landlords) from commencing or continuing any proceeding against the debtor which could have been commenced prior to the bankruptcy.  Applied to landlords, the automatic stay prohibits efforts to collect unpaid rent, or seek eviction, setoff, lease termination or foreclosure, among others.

It is important for landlords to realize that the automatic stay becomes effective without notice or a hearing.  Were a landlord (or any creditor) to be found in violation of the automatic stay, the debtor-tenant may be able to recover actual damages from the landlord, including attorneys’ fees.  If the violation is found to be intentional, the debtor-tenant may recover punitive damages.

In order to avoid the consequences resulting from violating the automatic stay,  landlords should seek relief from the stay by filing a motion with the bankruptcy court.  Under Section 362 of the Bankruptcy Code, creditors can seek relief from the automatic stay “for cause.” An example of “cause” includes the tenant’s failure to pay rent.

Carl D. Neff is a bankruptcy attorney with the law firm of Fox Rothschild LLP.  Carl is admitted in Delaware and regularly practices before the United States Bankruptcy Court for the District of Delaware. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

Once a tenant files for bankruptcy, it has three options regarding the lease:

  1. Assume the lease and continue performing all obligations, or
  2. Assume and assign the lease to a third party, or
  3. Reject the lease and surrender the premises and terminate performance.

Section 365 of the Bankruptcy Code gives the bankrupt tenant 120 days to decide if it will assume or reject the lease. During this period, the tenant can request one 90 day extension of time to decide whether to assume or reject. After the extension period expires, any further extensions require written consent from the landlord.

If the debtor-tenant fails to assume or reject the lease within the 120 day period, and no extension is granted, the lease is deemed rejected by operation of law. This is a significant provision for landlords and one of several reasons why landlords should stay fully informed as to the debtor-tenant’s intentions regarding its lease.

To be proactive, landlords (or their counsel) should review all pleadings filed in the tenant’s bankruptcy proceeding to see if the debtor-tenant sought an extension of time to assume or reject. Additionally, landlords should review the tenant’s motions to assume, motions to assume and assign, as well as motions to reject leases. The exhibits to these motions often contain schedules identifying the leases affected by the motion.

Carl D. Neff is a bankruptcy attorney with the law firm of Fox Rothschild LLP.  Carl is admitted in Delaware and regularly practices before the United States Bankruptcy Court for the District of Delaware. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

Introduction

When a company files for bankruptcy, often it will reject some or all of its commercial leases. Alternatively, some debtors in bankruptcy choose to assume and assign their leases to third parties. By assigning its lease, the debtor is in essence selling its lease to the highest bidder. Large retailers who file for bankruptcy have the potential to generate substantial revenue through the assumption and assignment of leases.

History Behind Preferential
Treatment For Shopping Centers

Years ago, Congress recognized the potential risks landlords faced should a debtor in bankruptcy have broad discretion to assign leases. To address this concern, Congress included language in the Bankruptcy Code requiring a debtor to provide a landlord with “adequate assurance of future performance” that the party receiving the lease performs according to the terms of the lease.

In 1978, Congress increased the protections governing the assignment of shopping center leases. The 1978 revisions to the Bankruptcy Code were intended to not only protect the owners of shopping centers, but also protect the remaining tenants within a shopping center once a tenant files for bankruptcy. Congress had three primary concerns when a tenant in a shopping center filed for bankruptcy:

1. Reduce any hardship imposed on the landlord and tenant due to
a vacancy, or reduction in operation, due to the assignment of the
lease to a third party;

2. Increase the likelihood that the owner of the shopping center
receives rental payments for rent arising before and after the
assignment of the lease, and,

3. Insure that the tenant mix is not disturbed by the assignment
of the lease to a third party.

Heightened Protections
Provided To Shopping Centers

Under the Bankruptcy Code, before a tenant in a shopping center lease can assign the lease to a third party, the party acquiring the assigned lease must provide proof of its ability to pay rent and that the percentage rent due under the lease will not decline substantially. Further, the assignment of the lease cannot result in a breach of radius, location, use or exclusivity provisions in the lease, nor can the assignment disrupt the current tenant mix.

These additional requirements provide shopping center landlord’s with greater protection than other non-shopping center landlords who have a tenant in bankruptcy. In essence, the protections increase the likelihood that the terms and intent of the lease are satisfied. Equally important, the heightened protections for shopping center leases increase the likelihood that a landlord will receive payment under the lease. Interestingly, when amending the Bankruptcy Code, Congress chose not to define what constitutes a “shopping center.” Instead, courts must decide on a case-by-case basis after considering the facts presented.

What is a Shopping Center?

With Congress unwilling to define what constitutes a shopping center under the Bankruptcy Code, Courts have stepped in and applied a broad definition. Some of the factors that support a finding that a property is a shopping center include (i.) whether the leases are held by a single landlord; (ii.) the existence of a common parking area; (iii.) the existence of percentage rent provisions in the lease; and, (iv.) the inclusion of tenant mix requirements in the lease.

Notice that aside from a common parking area, the physical attributes of the property are not determinative of whether a property is a shopping center. Courts reject the idea that the physical features of a property determine whether the landlord will receive the additional protections afforded to shopping center leases. Instead, the intent of the parties, as expressed through the terms of the lease (i.e. the inclusion of percentage rent, joint waste removal, etc.) determine whether the lease is a shopping center lease.

Ways Landlords Can Receive The
Added Protections of “Shopping Center” Leases

Before a debtor can assign its lease, it must file a motion with the court seeking authority to assume and assign the lease. Once a landlord learns that its tenant intends to assign its lease, it should make sure that the party purchasing the lease can provide “adequate assurance” that the new tenant can satisfy the terms of the lease. If a landlord does not receive adequate assurance, it should consider filing an objection to the proposed assignment. Landlords whose lease satisfies some of the criteria of a “shopping center” should assert their rights to greater protection under the Bankruptcy Code. Doing so will improve the likelihood that the terms of the lease are met.
 

As the economy fluctuates, tenant bankruptcies become a greater risk for commercial landlords. Yet some landlords are not familiar with the rights provided to them under the Bankruptcy Code, nor are they aware of the protections provided to a tenant in bankruptcy. For example, certain lease provisions are unenforceable once a tenant files for bankruptcy. Should a landlord attempt to exercise its rights under the lease without first seeking approval from the bankruptcy court, the landlord may be subject to strong sanctions. The purpose of this article is to provide landlords with the questions and answers they should consider when a commercial tenant files for bankruptcy.

1. What effect does a tenant’s bankruptcy have on the lease?

Once a tenant files for bankruptcy, it has three options regarding the lease: it can assume the lease and continue performing all obligations, or assume and assign the lease to a third party, or reject the lease and surrender the premises and terminate performance. The Bankruptcy Code gives the debtor-tenant 120 days to decide whether to assume or reject the lease. During this period, the tenant can request one 90 day extension to decide what to do with the lease.

If the debtor-tenant fails to assume or reject the lease within the 120 day period, and no extension is granted, the lease is deemed rejected. This is a significant provision for landlords. To be proactive, landlords should review all pleadings filed in the tenant’s bankruptcy proceeding to see if the debtor-tenant sought an extension of time to assume or reject. Additionally, landlords should review the tenant’s motions to assume, motions to assume and assign, as well as motions to reject leases. The exhibits to these motions often contain schedules identifying the leases affected by the motion.

2. How does the “automatic stay” of the Bankruptcy Code apply to landlords?

The automatic stay is one of the most powerful protections provided to debtors in a bankruptcy proceeding. The stay acts as an injunction that prohibits creditors (including landlords) from commencing or continuing any proceeding against the debtor which could have been commenced prior to the bankruptcy. Before a landlord seeks to enforce its rights under the lease (such as through eviction, termination or foreclosure), the landlord should seek “relief” from the automatic stay by filing a motion with the bankruptcy court.

It is important for landlords to realize that the automatic stay becomes effective without notice or a hearing. Were a landlord to be found in violation of the automatic stay, the debtor-tenant may be able to recover actual damages from the landlord, including attorneys’ fees. If the violation is found to be intentional, the debtor-tenant may recover punitive damages.
 

Continue Reading Ten Things Every Commercial Landlord Should Know About a Tenant in Bankruptcy