By Lynn Koller
Reprinted from: Florida Real Estate Journal - December 1, 2003
Property owners can protect themselves against commercial tenants that file for bankruptcy protection by taking action both before and after a bankruptcy petition is filed.
The legal framework under which business tenants generally file bankruptcy is federal law -- Title 11, Chapter 11 of U.S. Code -- which allows them to restructure debt. Less frequently, businesses may file Chapter 7, allowing for liquidation of assets. As a result, creditors, including landlords, may be prevented from enforcing payment of debt or recovering property in a debtor's possession. Bankrupt tenants do not exactly become squatters, though it may seem that way to landlords. Florida landlords should also be familiar with Florida Statutes, Chapter 83.001-83.251, state law dictating landlord-tenant rights and obligations.
Most commercial tenants will never file for bankruptcy protection, and some effort by property owners can guard against leasing to one that will -- because some businesses certainly will. In the second quarter of 2003, across the U.S., 9,331 businesses officially went bankrupt, according to the American Bankruptcy Institute.
In Florida last year, 1,803 businesses declared bankruptcy. One of the lures of corporate bankruptcy is that it can halt proceedings in civil litigation. Patrick Ayers, a partner at Tampa law firm Cohn & Cohn P.A., became involved in bankruptcy law because many of his commercial litigation cases ended up in bankruptcy court.
"It is not infrequent that the borrower or tenant will file bankruptcy, because that stops pending litigation," Ayers says. "It slows down the process from the landlord recovering the property."
Lowering risk
Ayers has been practicing law in Florida for 17 years, primarily representing creditors in bankruptcy and other matters involving creditors' rights. He says that landlords can protect themselves from tenants prone to bankruptcy through educated preparation.
Investigate and analyze: Investigating all prospective tenants could save landlords from getting stuck with a bankrupt occupant. Ayers suggests analyzing a prospective tenant's credit history, financial statements, financial operating history, asset ownership, and whether it, or other businesses controlled by its principals, has filed bankruptcy in the past. Landlords can hire an investigator or law firm to do this, but Ayers points out that many public records are online and readily available to everyone.
"Hope for the best and plan for the worst," Ayers says.
Specify shopping center leases: When appropriate, landlords should emphasize that tenants are entering a shopping center lease. Special legal provisions protect shopping center landlords. The legal code specifically provides that these tenants have to satisfy a number of factors in order to assume and assign their leases.
"Many times, the tenant seeks to sell the business and/or assign the lease (during bankruptcy proceedings)," Ayers says. "That assignment can be concerning to a landlord, because if he has multiple tenants, who that assignee is will be critical. It could upset the mix or balance of the shopping center."
Assigning the lease might also affect restrictive-use clauses with some of the other tenants, such as an assignment that results in two drug stores in the same center. Ayers suggests making sure that prospective tenants understand that they are signing a shopping center lease to insure those landlord protections.
Consider drastic action: When things go sour, landlords may smell trouble brewing. Often, tenants show signs of weakness before filing for bankruptcy protection, such as making late or insufficient rent payments. The landlord may be negotiating with the tenant for back rent. Ayers says that the tenant could be trying to buy time, and the landlord may want to terminate the lease immediately upon default.
"It may seem drastic, but if you terminate a non-residential lease prior to the tenant filing the petition for bankruptcy, the lease isn't considered property of the tenant's estate in bankruptcy, nor is it subject to the automatic stay," Ayers says. "Obviously, if you're dealing with a tenant that has some means or assets, then you may not want to terminate. It's a case-by-case determination that a landlord has to make."
Ayers cautions that the tenant may dispute that the lease was terminated before it filed the bankruptcy petition; the landlord may still end up in bankruptcy court.
After a tenant files bankruptcy
After a tenant files a bankruptcy petition, the landlord becomes a creditor and all eviction or collection proceedings in state court halt. While landlords are vulnerable at this stage, they are not helpless. They can take several actions to mitigate damages.
Verify that the tenant filed the petition: Joshua Dobin, an attorney at Greenberg Traurig in Miami, represents landlords in bankruptcy. Dobin says that a landlord should immediately verify with the courts that a tenant has filed a bankruptcy petition. It is not uncommon for a tenant to threaten bankruptcy, knowing that certain rights under the lease available to the landlord will be affected by the automatic stay. If the tenant has not yet filed the proper court pleadings, the landlord may use that time to terminate the lease, if appropriate. Dobin says this situation has happened to his clients, including one with a pharmacy/restaurant tenant.
"The landlord called seeking advice regarding a tenant that filed for bankruptcy," Dobin says. "The first thing we did was check the court docket to see if the tenant actually filed. It turned out that they had not."
Dobin reviewed the lease and realized that the landlord was entitled to terminate it immediately based on the tenant's numerous defaults. The lease was terminated, and when the tenant filed bankruptcy a week later, the lease was not property of the debtor's estate.
"It worked out very well for the landlord, as they were able to get the property back very quickly," Dobin says.
Request legal relief: The commercial tenant has 60 days after filing bankruptcy to decide whether to assume or reject the lease. During that time, the tenant is required to perform all of the obligations under the lease, including paying the rent.
"Just because you've got that requirement, doesn't mean they'll do it," Ayers says. "I recommend that the landlord immediately file a motion with the bankruptcy court to obtain relief from the automatic stay."
If granted, the landlord will be able to pursue eviction in the state court. The landlord may also request that the bankruptcy court compel the debtor to make its post-petition payments. Ayers says that the courts are sometimes more inclined to grant these motions rather than a motion for stay relief early in the proceedings.
If not assumed by the tenant, the lease is deemed rejected after 60 days and the tenant is supposed to surrender the property. Ayers says that the landlord may still have to go to the bankruptcy court to encourage this surrender. Dobin adds that after a tenant has filed for bankruptcy, the landlord should follow up on whether the tenant rejects or assumes the lease.
"If the tenant wants to assume the lease, one of the requirements is that the tenant cures all defaults. If the lease is rejected, the landlord should accurately calculate its damages and file a proof of claim," Dobin says.
Landlords may be best served by contacting an attorney to calculate rejection damages and to file a proof of claim with the bankruptcy court.
No worries
While landlords may feel some pain when a tenant's finances go kaput, they should not worry about their property being confiscated by a rogue, bankrupt business operator. Ultimately, the legal system protects the commercial landlord's property ownership rights. Preparation and quick action by the landlord can make dealing with a bankrupt tenant less troublesome and costly.