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What should landlords know if a tenant files for Chapter 11?

The bankruptcy of a business tenant can be financially cataclysmic for a commercial landlord. If a commercial landlord in New York believes that a tenant is on the verge of filing a Chapter 11 business bankruptcy petition, understanding the provisions of the Bankruptcy Code that directly affect a landlord's rights can save a landlord many thousands of dollars.

Three provisions of the Bankruptcy Code figure most prominently in untangling the landlord-tenant relationship. The first is the "automatic stay." Under the Bankruptcy Code, the mere filing of a petition seeking relief under Chapter 11 automatically stops all collection actions. If a landlord has sued a defaulting tenant for overdue rent, that lawsuit is stopped in its tracks. However, if the lease expired before the petition was filed, the landlord may still pursue an eviction action.

The second crucial provision is the section that gives the bankruptcy trustee or a debtor in possession the right to reject a lease. A debtor can reject any lease that is unexpired if the property is no longer useful or profitable or if the lease calls for higher-than-market-rate rent. A debtor who leases multiple properties may reject some leases and affirm others. Extending an existing lease may sometimes benefit the debtor or may benefit the landlord. If the debtor rejects a lease, the landlord will probably wind up with a claim for back rent.

A third provision is the ban on voidable preferences. Any payment by a bankrupt debtor within 90 days prior to filing the petition may be set aside by the trustee. Thus, a landlord who attempts to collect back due rent from the debtor during the 90-day period may find that the payment must be returned to the bankrupt estate.

The legal relationship between a commercial landlord and a bankrupt tenant is very complicated. It may be necessary for commercial landlords to seek the help necessary to fully understand all of their legal options if a tenant files for business bankruptcy.

Source: Commercial Real Estate Development Association, "Landlord Rights and Tenant Bankruptcy," Ian S. Bolton and David G. Michael, Summer 2014

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