The effect of bankruptcy on a lease

Written by ken burnside Google
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The effect of bankruptcy on a lease
Bankruptcy filings have several interactions with leases. (Justice image by MVit from Fotolia.com)

When a tenant declares bankruptcy, there are certain interactions with a lease that you should be aware of. While not all of it is good (from the perspective of the landlord), there are obligations that should be noted.

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Type of Bankruptcy

If the tenant files a Chapter 11 bankruptcy, the implicit assumption is that they're getting out of the current nature of their debts to creditors, and will restructure their business to resume normal operations. As a landlord, a Chapter 11 bankruptcy is theoretically the one that favours you the most because if she can get her business functioning again, her ability to pay back the lease will favour you. In a Chapter 7 bankruptcy, the business is being liquidated and the assets sold by a trustee--but most creditors are only going to see a fraction of the outstanding debt.

Bankruptcy and Back Rent

Rent owed prior to the petition for bankruptcy is an unsecured claim. This type of claim is the lowest priority amongst all creditors and is the one likeliest to be steeply discounted. This is modified by any guarantees written specifically into the lease; they may make it into a partially secured claim for rent.

Administrative Claims for Rent Post-Bankruptcy

Once the bankruptcy has been filed, any time the tenant spends on the premises is subject to rent as an administrative claim, which is a post-petition claim; these are paid out first, in either form of bankruptcy. In short, rent accrued after the filing for bankruptcy gets first call on any funds released by the bankruptcy. Depending on the number of creditors, and the amount of money released, you may not get all that is owed to you--available funds will be distributed proportionately among all administrative claimants.

Bankruptcy, Lease Terms and Eviction

It is possible (and quite common) to include a clause in a lease saying that the filing of bankruptcy by the tenant breaches the lease and is cause for eviction. However, if this is not present in the lease, the landlord may not declare the lease broken by the simple act of the tenant filing bankruptcy, nor may the landlord increase rent solely due to bankruptcy, or declare that an additional security deposit be filed.

Partial Payments and Leases

If the landlord accepts a partial payment, the lease remains in effect and the landlord must submit a new request for payment, even if the landlord made a prior termination of the lease. Termination of the lease requires that the new notice expire without any payment being made. This is one reason many leases explicitly forbid partial payments.

Court Actions

Bankruptcy proceedings have a number of 30- and 60-day deadlines, not limited to termination periods of leases, assembling structured debt settlements, meetings with the bankruptcy trustees and filing deadlines for creditors. Be aware of these deadlines (and consult an attorney as part of the filing, or in response to a tenant's filing) early in the process so that they don't get missed.

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