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When a Tenant or Landlord Files Bankruptcy

12/11/2017

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Author: Andrew M. Thaler
A. Landlord and tenant bankruptcies; overview of rights of principal players
     1. Tenant files bankruptcy
          a) ​Tenant’s rights
               i.  Tenant benefits from an automatic stay that stops commencement or continuation of eviction,                                  collection, or other proceedings.[2]
               ii. ​Tenant has the right not to be evicted or have other action taken against it or the property without the                    landlord first making a motion in the bankruptcy court to lift the automatic stay.[3]
               iii. Tenant has the choice to assume, assume and assign, or reject the lease.[4]
               iv. Time periods for assumption and rejection gives the tenant time to attempt to successfully                                       reorganize.[5]
               v.  Tenant’s prior defaults are not a basis for the landlord to terminate the lease (i.e., ipso facto clauses                         are not enforceable in bankruptcy).[6]
          b) Landlord’s rights
               i. Tenant is obligated to continue making rent payments under the lease until such time as the tenant                         rejects the lease.[7]
                         a. “Stub rent” is the term used for the rent due during the month the tenant filed its bankruptcy                                   petition.  The bankruptcy court may order that the rent due for that month must be prorated,                                   entitling the landlord to administrative rent only for the portion of rent representing the time                                   period between petition date and the end of the month.[8]
               ii. ​Rent accruing post-petition and pre-decision to assume or reject the lease is given priority as an                                administrative expense.[9]
               iii. ​Tenant is obligated to comply with non-monetary lease provisions.[10]
               iv. If the tenant assumes and later breaches a commercial real estate lease, the landlord is entitled to                           damages equal to the sum of all monetary obligations due, aside from penalties, for the two year                             period “following the later of the rejection date or the date of actual turnover of the premises.”[11]
                         a. The landlord’s claim for remaining sums due under the balance of the lease term are limited to                                 the greater of rent for one year or 15% of three years of the remaining lease term.[12]
               v. If the lease expires on its own terms, the landlord cannot be compelled, absent a provision in the l                           lease, to renew or extend the lease.[13]
2. Landlord files bankruptcy
          a) ​Tenant’s rights
               i.  Tenant’s security deposit held by the landlord-debtor is generally safe and does not become property                     of the bankruptcy estate.[14]
               ii.  If the landlord-debtor rejects the lease, and rejection amounts to a breach entitling the tenant to treat                     the lease as terminated under the terms of the agreement or applicable nonbankruptcy law, the                               tenant has two options:
                         a. The tenant may treat the lease as terminated or, if the lease term has commenced, the tenant                                  may retain its rights under the lease for the rest of the lease term and for any renewal or                                            extension to the extent that such rights are enforceable under applicable nonbankruptcy law.                                   [15]
                                    i. This provision in effect protects tenants from eviction in the case the landlord files                                                        bankruptcy.
                         b. If the tenant elects to retain its rights under the lease or agreement it must continue to pay rent                              and fulfill other obligations required by the terms of the lease or agreement.[16]
                                    i. However, the tenant may offset against the rent it owes the value of any damage caused                                            by the debtor’s nonperformance after the date of rejection, but the tenant does not have                                            any other rights against the debtor for any damages resulting from the debtor’s                                                            nonperformance after rejection of the lease.[17]
                                           1.  For example, the bankruptcy court may permit the tenant to offset from the amount                                                   of rent the tenant owes amounts the tenant expended to make repairs the landlord-                                                    debtor was required to make under the terms of the lease.[18]
          a) ​Landlord’s rights
               i.  Landlord has the choice to assume, assume and assign, or reject the lease, subject to the tenant’s                            ability to retain its rights under the lease.[19]
               ii.  Landlord may, under certain circumstances, sell property free and clear of liens and other interests,                         including the interests of tenants.[20]
                         a. This right is qualified by certain protections for the tenant in the Bankruptcy Code, such as                                         limited grounds entitling the landlord to a free and clear sale and the right to adequate                                              protection if such a sale proceeds.

B. Review of the automatic stay and assumption and/or rejection procedure (commercial v. residential)
     1. Automatic stay
          a) ​Prevents the landlord from taking any action against the tenant without first obtaining the                                        bankruptcy court’s permission.[21]
               i.  Landlord must first make a motion in the bankruptcy court to lift the stay for cause (e.g.,                                            continuing damage to the property and lack of adequate protection).[22]
          b) ​The landlord cannot commence or continue an action in landlord-tenant court for nonpayment of                           rent or to evict the tenant without first obtaining relief from the automatic stay.[23]
               i.  Even if the landlord has already obtained a warrant of eviction, which terminates the landlord-                                 tenant relationship under the lease, if the landlord has not yet executed the warrant of eviction,                                the landlord must first obtain relief from the automatic stay before proceeding against the                                        tenant. [24] (See limitation below in residential cases where landlord has judgment for                                               possession)
          c) ​Landlord is not permitted to setoff a security deposit for unpaid rent without the bankruptcy court’s                        permission.[25]
     2. Assumption and rejection
          a) ​Generally
               i.  Assumption
                         a. In order to assume a lease, the tenant must cure any defaults and provide adequate assurance                                 of future performance.[26]
                                    i. By assuming the lease, the tenant confirms its continuing obligation to pay rent to the                                                landlord, and the landlord is obligated to continue to give the tenant possession of the                                                premises.[27]
               ii.  Rejection
                         a. After a tenant rejects a lease, the landlord can file a claim for damages, including damages for                                  unpaid past and future rents.[28]
                         b. Rejection does not result in automatic termination of the lease.[29]
                                    i. The landlord must take further action (i.e., obtain relief from the automatic stay) in order ​                                           to effect a termination.[30]
          b) ​Commercial real estate leases
               i.  In chapters 7 and 11, the tenant-debtor or trustee must determine within 120 days whether to                                 assume or reject a commercial lease.[31]
                         a. The court may extend the 120-day period by 90 days without the landlord’s consent, but any ​                                    further extensions of time require the landlord’s consent.[32]
                                    i. If the tenant-debtor or trustee fails to make a decision to assume or reject the commercial ​                                       lease within the specified time period the lease is deemed rejected, and the tenant-debtor ​                                         or trustee must immediately surrender the property to the landlord.[33]
          c) ​Residential real estate leases
               i.  In chapter 7, the trustee must assume or reject a residential lease within 60 days.[34]
                         a. In the Eastern District of New York, if the trustee files a motion seeking to extend the time to ​                                   assume or reject a residential lease that is returnable no more than 14 days after the expiration ​                               of the 60 days, the trustee must file with its motion a proposed order seeking an extension for ​                                 cause to the date of the hearing on the motion, which the court may enter without further ​                                         notice or a hearing.[35]  In the Southern District of New York, the trustee need not submit a ​                                     proposed order seeking an extension for cause to the date of the hearing on the motion, ​                                           because the time to assume or reject is automatically extended until the entry of an order ​                                         resolving motion.[36]
                                    i. If the trustee fails to assume or reject the lease within the specified time the lease is ​                                                   deemed rejected.[37]
               i.  In chapters 11 and 13, the trustee may assume or reject a residential lease at any time prior to plan ​                       confirmation, but the court may order the trustee to assume or reject sooner upon request of a party ​                   to the residential lease.[38]

C. ​Limitation of the automatic stay  for residential tenants in bankruptcy cases
          a) ​If the landlord obtained a judgment for possession prior to the residential tenant’s bankruptcy, the                         automatic stay will not prevent the landlord from enforcing the judgment immediately.[39]
               i.  But if the tenant files with his or her bankruptcy petition a certification that under state law the                                 tenant may cure any default and the tenant deposits with the clerk any unpaid rent, the tenant will                         have 30 days to cure.[40]
          b) ​If the landlord commenced an eviction action against the residential tenant for endangerment of the                      property or illegal use of controlled substances on the property prior to commencement of the                                bankruptcy case, the automatic stay will terminate 15 days after the tenant’s bankruptcy filing unless the                tenant objects to the landlord’s certification within that time period.[41]

D. Treatment of leases and executory contracts under the Bankruptcy Code
     1. Nunc pro tunc rejection
          a) Tenant-debtor can reject lease retroactively, effectively causing the rejection to be deemed to have                           occurred as of the date of the motion.[42]
               i.  If the date of the rejection motion is the same day as the petition date, by rejecting a lease nunc pro                         tunc the tenant might be able to avoid paying the landlord as an administrative expense rent that                            accrued post-petition but pre-rejection.
                         a. In order for this to not be inequitable to the landlord, the debtor must have previously stated its                              unequivocal intent to reject the lease.[43]
          b) Because retroactive rejection prevents the landlord from receiving administrative rent, bankruptcy                          courts consider the following factors in making the decision:
               i.  Absence of delay on the part of the tenant in moving for an order to reject the lease.[44]
               ii.  The date when the tenant vacated the premises.[45]
               iii.  The landlord’s motivation if opposing rejection of the lease nunc pro tunc.[46]
​               iv.  Other factors of equity (e.g., prejudice to the estate).
     2. Assignment
          a) A tenant with no intention to use a lease might choose to assume the lease for the purpose of assigning                 it to another party
               i.  If the lease is below-market or otherwise valuable to a potential assignee, the tenant-debtor or trustee                    might sell the lease in order to obtain value for the bankruptcy estate, notwithstanding provisions in                        the lease and applicable law restricting assignment.[47]
​                         a. For example, a trustee could assume a debtor’s apartment lease and assign the lease to the                                      debtor’s landlord in exchange for value.[48]
               ii.  Just as if the tenant were to assign the lease for itself, the proposed assignee takes the lease subject                       to its terms and must give the landlord adequate protection of its interest.[49]
               iii.  Assigning a lease relieves the tenant from any further liability for any breach occurring after                                       assignment.[50] 
     3. Abandonment
          a) While rejection serves as a breach of the lease, it does not automatically terminate the lease.[51]
          b) A rejected lease thus remains estate property until the landlord takes affirmative action to terminate                      the lease or the trustee abandons the lease in one of the following ways:
               i.  The trustee can affirmatively abandon the property during the pendency of the bankruptcy case.[52]
               ii.  A party an interest may seek an order compelling the trustee to abandon the property.[53]
               iii. The trustee can take no action at all to administer the property, and the property is abandoned to                           the debtor at the closing of the case, so long as the debtor properly scheduled the property in its                             petition.[54]
​_____________________________________________________________________________________________________________________
[1] Prepared by Andrew M. Thaler and Spiros Avramidis.  Mr. Thaler is a founding member of Thaler Law Firm PLLC, located at 675 Old Country Road, Westbury, New York 11590.  The firm concentrates in bankruptcy, debtor and creditor rights, mediation, and trustee representation.  Mr. Thaler is also a Chapter 7 Panel Trustee for the Eastern District of New York Bankruptcy Court.  Mr. Avramidis is an associate at Thaler Law Firm PLLC. 

[2] 11 U.S.C. § 362(a).

[3] 11 U.S.C. § 362(d).

[4] 11 U.S.C. § 365(a).

[5] 11 U.S.C. § 365(d).

[6] 11 U.S.C. § 365(e)(1).

[7] 11 U.S.C. § 365(d)(3).

[8] See In re Stone Barn Manhattan, LLC, 398 B.R. 359, 365–68. Not all Circuits follow the “stub rent” theory.

[9] 11 U.S.C. § 365(d)(3).

[10] 11 U.S.C. § 365(d)(3).

[11] 11 U.S.C. § 503(b)(7).

[12] 11 U.S.C. § 502(b)(6).

[13] In re Kong, 162 B.R. 86, 90–91 (Bankr. E.D.N.Y. 1991).

[14] In re Trafalgar Associates, 53 B.R. 693, 695–96 (Bankr. S.D.N.Y. 1985).

[15] 11 U.S.C. §365(h)(1)(A).

[16] 11 U.S.C. §365(h)(1)(B).

[17] 11 U.S.C. §365(h)(1)(B).

[18] In re Flagstaff Realty Associates, 60 F.3d 1031, 1034–35 (3d Cir. 1995).

[19] 11 U.S.C. § 365(a); 11 U.S.C. §365(h)(1)(B).

[20] 11 U.S.C. § 363(f); Precision Industries, Inc. v. Qualitech Steel SBQ, LLC, 327 F.3d 537, 547–48 (7th Cir. 2003).

[21] 11 U.S.C. § 362(a).

[22] 11 U.S.C. § 362(d).

[23] 11 U.S.C. § 362(a)(3).

[24] In re Eclair Bakery Ltd., 255 B.R. 121, 133–34 (Bankr. S.D.N.Y. 2000).

[25] 11 U.S.C. § 362(a)(7).

[26] 11 U.S.C. § 365(b)(1).

[27] In re Penn Traffic Co., 524 F.3d 373, 378 (2d Cir. 2008). 

[28] In re Child World, Inc., 147 B.R. 847, 850 (Bankr. S.D.N.Y. 1991).

[29] 11 U.S.C. § 365(g).

[30] In re Lavigne, 114 F.3d 379, 386–87 (2d Cir. 1997).

[31] 11 U.S.C. § 365(d)(4)(A).

[32] 11 U.S.C. § 365(d)(4)(B).

[33] 11 U.S.C. §365(d)(4)(A).

[34] 11 U.S.C. § 365(d)(1).

[35] E.D.N.Y. LBR 6006-1(a).

[36] S.D.N.Y. LBR 6006-1(b).

[37] 11 U.S.C. § 365(d)(1).

[38] 11 U.S.C. § 365(d)(2).

[39] 11 U.S.C. § 362(b)(22).

[40] 11 U.S.C. § 362(l).

[41] 11 U.S.C. § 362(b)(23); 11 U.S.C. § 362(m).

[42] In re Fleming Cos., Inc., 304 B.R. 85, 96 (Bankr. D. Del. 2003).

[43] Id.

[44] In re Thinking Machines Corp., 67 F.3d 1021, 1028–29 (1st Cir. 1995).

[45] Adelphia Business Solutions, Inc. v. Abnos, 482 F.3d 602, 608 (2d Cir. 2007).

[46] In re Jamesway Corp., 179 B.R. 33, 38 (S.D.N.Y. 1995)

[47] 11 U.S.C. § 365(f); In re Ames Dept. Stores, Inc., 316 B.R. 772, 794–95 (Bankr. S.D.N.Y. 2004).

[48] But see Santiago-Monteverde v. Pereira 2015 WL 868307 (2d Cir. March 2, 2015) The Second Circuit upheld the decision of the New York Court of Appeals, holding that an interest in a rent-stabliized lease is a local public assistance benefit under New York State Debtor and Creditor Law Section 282(2) and therefor exempt from a bankruptcy estate.   

[49] 11 U.S.C. § 365(f)(2).

[50] 11 U.S.C. § 365(k).

[51] 11 U.S.C. § 365(g); see In re Henderson, 245 B.R. 449, 453 (Bankr. S.D.N.Y. 2000).

[52] 11 U.S.C. § 554(a); see In re Henderson, 245 B.R. at 454.

[53] 11 U.S.C. § 554(b); see In re Henderson, 245 B.R. at 454.

[54] 11 U.S.C. § 554(c); see In re Henderson, 245 B.R. at 454.
​
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