Bankruptcy Implications for Commercial Landlords with Bankrupt or Near-Bankrupt Tenants

Tenant credit and security issues and certain lease negotiations (including modification or termination agreements) happening now may be impacted by a tenant bankruptcy in the future. Commercial landlords considering new lease negotiations, or the workout or evaluation of existing leases, with some understanding of such issues in the bankruptcy context will be in a better position to protect themselves in the event of a tenant bankruptcy.

As tenant closures and lease defaults are on the rise in the wake of the economic downturn caused by the COVID-19 pandemic, tenant bankruptcy filings are – and will continue to be – a very real concern for landlords across the real estate industry. This Holland & Knight alert is intended to serve as a guideline for commercial landlords in an evaluation of their leases and workout options – but it is not an exhaustive list of all of the intricacies and consequences that may follow a tenant bankruptcy.

1. Introduction: Landlords with Bankruptcy Knowledge Before a Tenant Files for Bankruptcy Will Be in a Better Position to Protect Themselves in the Event the Tenant Files for Bankruptcy

2. Pre-Bankruptcy Considerations

a. Types of lease security and bankruptcy implications: Landlords should analyze the benefits and risks associated with each "form" of lease security and determine which will best suit the landlord's needs during the lease term and in the event the tenant files for bankruptcy.

3. Post-Bankruptcy Filing Implications

a. The Automatic Stay: All pre-petition debts, including rent arrearages, are to be handled through the bankruptcy process. As such, when a debtor files for bankruptcy, the automatic stay is instituted to halt all lease enforcement and collection actions in connection with pre-bankruptcy lease arrearages against the tenant and its property. Once the tenant files for bankruptcy, the tenant is required to remain current on its financial obligations, including the payment of rent, unless the tenant seeks and obtains permission from the court not to do so through either a motion to extend the time period to make rent payments by up to 60 days or through a motion to reject the lease. Practically speaking, what can you, as a landlord, do and not do after the tenant files for bankruptcy?

b. Assumption and Rejection of Leases: A debtor must assume, assume and assign, or reject a lease within 120 days following the date that the tenant files its bankruptcy case, which can be extended for up to 90 days by court order for cause. Any further extension of this time period requires the prior written consent of the landlord. Failure to timely do so will require the tenant to surrender the leased space.

c. Preferential Transfers and Fraudulent Conveyances: Will a bankruptcy court be able to claw back a cashed security deposit or rent paid by the tenant prior to the bankruptcy filing?

d. Rent Abatement and Deferrals: Although there are a number of factors that will come into play when a landlord is considering different rent modification options, landlords should at least be aware of the treatment of these two primary structures in the event of a tenant bankruptcy.

• Rent Abatement: In some leases or rent modification agreements, a landlord will agree to abate certain months of rent but require, in the event of default, that all abated rent payments become immediately due and payable. If a debtor assumes the lease and cures the default, the abated rent may be reinstated. If the debtor rejects the lease, then context and circumstances will determine whether the landlord's claim for the abated rent will be considered "unpaid rent" or a prohibited penalty for default. As in many bankruptcy considerations, substance over label will be determinative.
• Deferral: In the event of a rent deferral agreement, the parties may agree that the landlord will forego enforcement of certain rental obligations for a set time frame and that such obligations are to be repaid at a later date. If the tenant files for bankruptcy before repaying these deferred amounts which come due post-petition, the landlord may have an administrative claim for those deferred rent payments, provided that the bankruptcy court determines that the obligations to pay arises post-petition.

4. Practical Takeaways

If you have the right to review your tenants' current financials, now is the time to do so. If your tenant is financially unstable and currently in default, send a notice of default (even if it is just a friendly one). There is no reason not to do this while you are engaging in workout discussions. Further, if you terminate the lease before your tenant files bankruptcy, the tenant does not have a leasehold interest that would be property of the tenant's bankruptcy estate protected by the automatic stay. It is never too late to review your lease to determine how secure your lease actually is.

As courts of equity, bankruptcy courts not only consider the specific facts and circumstances of each case but also, because of the overriding goal of reorganization in bankruptcy, may subordinate other legal rights and policies. Therefore, there is no one-size-fits-all answer to the challenges that commercial landlords are facing. For more information or for questions about a specific situation impacting your business, contact the authors or another member of Holland & Knight's Commercial Real Estate Leasing Team or Bankruptcy, Restructuring and Creditors' Rights Group.

DISCLAIMER: Please note that the situation surrounding COVID-19 is evolving and that the subject matter discussed in these publications may change on a daily basis. Please contact your responsible Holland & Knight lawyer or the author of this alert for timely advice.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem. Moreover, the laws of each jurisdiction are different and are constantly changing. If you have specific questions regarding a particular fact situation, we urge you to consult competent legal counsel.