The following was adapted from a portion of a client alert prepared recently by Ira Herman and Lynn Gray Ruvang, partners in our New York and Fort Worth offices, respectively. The full alert includes useful information about the impact of a tenant’s bankruptcy on the landlord/tenant relationship, how the bankruptcy process works, strategies that commercial landlords may employ to protect their interests once the tenant has filed, and protective lease provisions that landlords can include in their leases to reduce the financial consequences of tenant financial distress. A copy of the full alert may be obtained by clicking here.
If a tenant files for Chapter 11 bankruptcy relief, a landlord should act expeditiously to protect its interests. Absent a compelling reason not to do so, the landlord, though its counsel, should file a Notice of Appearance and Demand for Notices with the bankruptcy court. This ensures that the landlord will receive notice of all important events in the bankruptcy case, including those that might affect the landlord’s interest, and will position the landlord to monitor the tenant’s case. Such monitoring enables the landlord to evaluate legal and financial developments during the administration of the case that might impact the landlord-tenant relationship.
At the earliest stages of a tenant’s bankruptcy case, the landlord should focus on the tenant’s access to funds to perform its post-filing-date obligations to the landlord and other creditors. In today’s environment, virtually all Chapter 11 filers will seek either financing in the form of a debtor-in-possession loan or authority to use the cash proceeds of a pre-bankruptcy lender’s collateral. Critically important to the tenant’s attempt to secure such financing will be a budgeting process; every request to obtain bankruptcy financing will require the tenant to disclose its proposed budget for periods that may be as short as several days or as long as six months or more. For a landlord, the tenant’s motion for financing is an opportunity to make sure that rent is included in the tenant’s proposed budget. The proposed budget also will provide the landlord with a “snapshot” of the tenant’s financial condition.
Another critical issue for a landlord at the earliest stages of a tenant’s Chapter 11 will be determination of whether the tenant’s interest in the lease is of value. The landlord should seek answers to some or all of the following questions:
Can the tenant survive without occupying the leased premises? Is the lease rent above or below market? How much of the lease term remains? Does the tenant have any remaining term extension rights under the lease? Is there anything unique about the leasehold that will increase its value to the tenant or others (e.g., a unique location or market penetration issues)?
The leasehold’s value will be an important driver of the landlord’s strategy during a tenant’s Chapter 11 and, in particular, the decision of whether to try to recapture the leasehold or try to keep the tenant in possession.
Notwithstanding the Bankruptcy Code’s provisions that generally are favorable to a tenant’s interest in its bankruptcy case, a landlord can take steps to avoid what the landlord is likely to view as an overly harsh outcome. Procedurally, a tenant in bankruptcy is required to file a motion with the court when it seeks to assume, reject, or assume and assign an interest in a lease. Such motion practice provides the well-counseled landlord with an opportunity to respond and complain about a tenant’s overreaching, its failure to comply with the Bankruptcy Code regime, and the impact on a landlord’s rights of the tenant’s chose course of action (assumption, rejection, or assumption and assignment, as the case may be).
The landlord in this situation is advised to:
Be familiar with and vigilant about the time periods governing assumption or rejection. Pay attention to assumption and rejection motions filed by the tenant that might not appear to directly involve the lease in question. Pay attention to events in the tenant’s case that will reveal information about the tenant’s plans for the future and its ability to finance its operations. Pay careful attention to deadlines for filing proofs of claim for “rejection” damages or estoppel notices with regard to monetary defaults to be paid as “cure” when a tenant’s interest is being assumed or assumed and assigned. Carefully review any plan of reorganization filed by a tenant, as the plan may purport to effect assumption or rejection and otherwise impact a landlord’s interests.
A tenant’s bankruptcy sets into motion a complex chain of events that has far-reaching effects on a landlord’s rights under its lease agreement with the tenant. Landlords with financially distressed or bankrupt tenants would be well advised to have an attorney assess what steps should be taken to protect the landlord’s interests, both before and after the tenant files for bankruptcy protection.
