Landlord’s Rights During A Tenant Bankruptcy

According to the Administrative Office of the U.S. Courts, bankruptcy filings in the U.S. increased to 452,990 in December 2023 from 387,721 in 2022, or a 65,269 or 16.83% increase in one year. Despite a significant decline in the total bankruptcy filings made during the COVID-19 pandemic, bankruptcy filings continue to plague businessmen—especially real estate landlords—on tenants defaulting from lease payments.

As a landlord, it is crucial for you to know the ins and outs of your contract with your tenants and the associated risks involved in case a tenant files for bankruptcy and cannot continue paying for the lease, whether it’s because of a bad or good debt, a business failure, or an event that has caused tenants to not have enough resources to reach a certain household income for social security benefits.

While a tenant’s bankruptcy can become a massive headache, there are options you can explore with your tenant and rights you can exercise as a landlord to protect yourself from financial damages. 

Risks when a tenant files for bankruptcy

We often hear about a tenant’s rights when their landlord files for bankruptcy, including the right to not be immediately kicked out of a property until the end of a lease, regardless of who retains or owns the property after the bankruptcy has been filed.

Those who aren’t property owners have little to no knowledge of the inherent risks of tenant bankruptcy filing and non-rental or lease payment on a landlord’s income streams and business operations. Some of the risks a landlord may face when a tenant files (or plans to file) for bankruptcy include but are not limited to:

  1. Non-payment of rental resulting in loss of income
  2. Restriction on eviction rights
  3. The right of ‘automatic stay’ for tenants
  4. Tenant can still make three elections (assumption, assignment, or rejection) on an unexpired lease
  5. Some tenants use filing for bankruptcy as a threat to make landlords agree to their demands

“Safe to say that most Bankruptcy Law principles are geared toward protecting the tenants from losing their homes or rented properties despite filing for bankruptcy, however, the landlords are not without rights during these cases,” says Allison Kesselring, Sales Manager at Oaks Roofing and Siding.

Landlord’s rights and course of action during a tenant bankruptcy

Claims on security deposits despite an ‘automatic stay’ order

In an automatic stay (Section 362(a) of the Bankruptcy Code), a debtor (or in this case, the tenant) becomes a debtor in possession and is protected from the creditor gaining possession of the assets and properties of the bankruptcy estate. This includes judicial, administrative, or civil action that a landlord may make against the tenant. 

Bert Hofhuis, Founder of Every Investor, says, “Simply put, the landlord cannot force or demand payment from a tenant who has filed for bankruptcy any unpaid claims before the bankruptcy filing was made—including eviction or lease termination notices.” 

What about security deposits?

According to the Bankruptcy Code, cash security deposits are still part of the tenant’s bankruptcy estate, and thus cannot be used by the landlord for any unpaid claims. 

However, the case is different if the security deposit is through a letter of credit from a bank or a third party with the landlord as the beneficiary. Since in this case, it can be construed that the tenant does not ‘own’ the letter of credit and has paid the bank or third party in favor of the landlord, the landlord may, in some cases, use the letter of credit for any unpaid obligations despite an automatic stay order. 

What a landlord can do in this case is make sure that:

  1. Make sure that the conditions in drawing upon the letter of credit do not require any kind of authorization from the tenant which may delay or prevent drawing funds
  2. The letter of credit can be withdrawn upon, in the case of tenant bankruptcy, when the landlord shows any proof of bankruptcy by the tenant to the third party
  3. The letter of credit permits partial withdrawals, so that any excess in unpaid obligations versus cash value of withdrawal will not be subject to automatic stay hold

Rights on post-petition claims

An automatic stay only applies to pre-petition claims or claims that remain unpaid before the bankruptcy filing was made which means that landlords cannot force tenants to pay for unpaid dues pre-bankruptcy, including rent, utility dues, share on contractor insurance, or other administrative fees. 

Landlords have different rights for post-petition claims, however, because these are generally considered administrative expenses. Under the Bankruptcy Code, a tenant is required to pay all post-petition claims until they either assume, assign, or reject the lease. 

Ian Sells, CEO at Million Dollar Sellers, says, “A claim for post-petition claims payments does not violate automatic stay and does not require any order from the bankruptcy court. Furthermore, these should be paid in cash by the tenant, as it is due unless the court grants an extension to the tenant in its first 60 days after its bankruptcy filing.”

Assumption, assignment, or rejection of lease by the tenant

A tenant in Chapter 11 of the bankruptcy case should decide whether to assume, assign, or reject an unexpired lease within 120 days of the bankruptcy filing date. 

When a lease is assumed, the original contract between a tenant and a landlord remains in full force, which means that the tenant recognizes its ability to uphold the contract and pay any damages that may occur. 

When a lease is assigned, the landlord acquires a new tenant for the duration of the pre-existing contract. 

When a lease is rejected, the tenant is required to surrender the property to the landlord. In this case, the landlord should have a claim for post-petition rent, a claim for damages, and other administrative fees, and the automatic stay no longer applies.

However, landlords need to know that despite the tenant’s right to assume, assign, or reject the unexpired lease, the tenant is not allowed to modify the lease without consent from the landlord. This is a critical aspect of rental property management, ensuring that lease terms remain unchanged and comply with the landlord’s policies and legal obligations.

“A tenant’s election whether to assume, assign or reject is not an immediate imposition to the landlord,” says Tony Mariotti, CEO at RubyHome. He emphasizes, “Their decision still needs to pass the bankruptcy court and satisfies each requirement of the elected choice.”

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