In today’s commercial real estate market, the possibility that your landlord will declare bankruptcy is very real making it important that tenants are aware of their rights. When a landlord declares bankruptcy under Chapter 11 of the Bankruptcy Code, the bankruptcy trustee (the person or entity placed in charge of the landlord’s assets) is given the power to determine whether to accept or reject tenant leases.
If the bankruptcy trustee decides to accept a lease then the tenant must continue to satisfy its obligations thereunder as if the bankruptcy never happened. Both the landlord and tenant remain obligated to perform. Before the trustee can accept the lease, however, it must obtain permission from the bankruptcy court, cure any defaults that arose under the lease, compensate the tenant for any losses arising from the landlord’s breach, and provide sufficient assurances that the landlord will be able to perform its obligations under the lease in the future.
In the event the trustee rejects an unexpired lease, the tenant may terminate the lease so long as the rejection amounts to a breach under the terms of the lease or under applicable bankruptcy law. Alternatively, the tenant may opt to retain its rights under the lease, including rights to continued possession of the premises, rental amounts, due dates, use rights, exclusivity, quiet enjoyment and assignment. Essentially, tenants retain rights that are in or appurtenant to the real property for the balance of the lease term and any enforceable renewal or extension periods. However, the trustee is relieved from lease obligations requiring future performance by the landlord such as the provision of utilities, repair and maintenance and janitorial services. Tenants who opt to retain their rights after the trustee has rejected the lease are entitled to offset damages caused by the rejection and resultant failure of landlord to perform its obligations under the lease against rent due under the lease. This becomes tenants’ exclusive remedy for landlords’ failure to perform.
Generally, the rejection of a lease by a bankruptcy trustee doesn’t void the underlying lease but, rather, provides the tenant with a general unsecured claim against the estate. Consequently, such a claim should accrue to tenants who elect to treat an unexpired lease as terminated and vacate the premises after the trustee’s rejection in bankruptcy. A tenant desirous of obtaining a security deposit is also an unsecured creditor and said obligation by the landlord may be discharged.
The period before a decision to accept or reject a lease can be particularly problematic for tenants because they sit in bankruptcy limbo while the landlord has no obligation to perform under the lease. The landlord doesn’t have to provide essential services, repairs, or maintenance. Tenants, on the other hand, are still obligated to perform until such time as the status of the lease is resolved by the bankruptcy court – even if the landlord has already breached before filing for bankruptcy. Tenants are not entirely without recourse however. In some circumstances, Tenants can obtain an order from the bankruptcy judge requiring the trustee to make a decision to reject or accept and, depending on the terms of the lease, tenants may be able to enforce their statutory rights including offsetting costs incurred against future rent. In addition, tenants who continue to satisfy their obligations under the lease may make a claim against the bankruptcy estate.
Finally, tenants should be aware that Section 363 of the Bankruptcy Code permits the bankruptcy trustee to sell the landlord’s properties free and clear of any interests, including those of a tenant. In order to preserve any rights it may have to possession of a property, a tenant should object to the sale or risk having the bankruptcy court deem the failure to object a “consent” to the sale. In such cases, tenants rights are limited to those rights in or appurtenant to the real property and which directly benefit the tenant’s possessory interests. A buyer takes the property subject to the tenant’s possessory rights, but free and clear of other nonpossessory interests under the lease that can be reduced to a money judgment.
If you have questions about your rights as a commercial tenant, consult with a San Diego lease attorney to discuss options.