What Landlords Need to Know When a Tenant Files Bankruptcy

When a commercial tenant files for bankruptcy, landlords face immediate challenges and must navigate complex federal bankruptcy laws. Understanding the key implications can help protect your interests and maximize recovery.

1. The Automatic Stay Takes Effect Immediately
   
   The moment a tenant files for bankruptcy, an "automatic stay" goes into effect, prohibiting all collection activities. This means landlords cannot send default notices, make collection calls, proceed with evictions, or apply security deposits without court permission. Violating the automatic stay can result in actual damages and attorneys’ fees, and any actions taken in violation are void. The stay can only be lifted by bankruptcy court order.

2. Tenant's Decision: Assume or Reject the Lease
   
   Bankruptcy gives tenants a powerful tool – the right to either assume (keep) or reject (terminate) their lease. To assume a lease, the tenant must promptly cure any defaults, provide adequate assurance of future performance, and accept the lease in its entirety without modifications.
   
   If the tenant chooses to reject the lease, landlords face a more complex situation. The tenant must surrender possession, but landlords become unsecured creditors for most damages. Recovery includes amounts due as of the filing date, administrative priority claims for rent accrued between filing and rejection, and limited future damages capped at the greater of one year's rent or 15% of the remaining lease term, not to exceed three years.
   
   For example, if a tenant rejects a lease with four years remaining at $10,000 per month ($120,000 annually), the landlord’s claim for future damages would be capped at $120,000 (one year’s rent), since that exceeds 15% of the remaining term’s total rent ($72,000).

3. Critical Timing Considerations
   
   Tenants typically have 120 days after filing to decide whether to assume or reject the lease, although courts can extend this period. During this time, tenants must continue paying rent – failure to do so provides grounds for landlords to seek stay relief and proceed with eviction.
   
   Strategically, tenants often use this period to market their business for sale, with prospective buyers influencing which leases to keep. Only clearly unprofitable locations are rejected immediately, while marginal properties remain in limbo.

4. Special Rules for Shopping Centers
   
   Shopping center leases face additional restrictions under the Bankruptcy Code. A “shopping center” generally includes properties with multiple tenants sharing common areas and where tenant mix and co-tenancy relationships are important to the overall enterprise.
   
   Even if assumed, tenants cannot assign these leases unless the assignee meets strict financial and operational standards, percentage rent won't substantially decline, and the assignment won't breach radius, exclusivity, or tenant mix provisions.

5. Proactive Protection Strategies
   
   Smart landlords can take steps when they see warning signs of tenant distress, including late payments, high employee turnover, or frequent complaints. Key protective measures include applying security deposits if permitted, demanding immediate payment, obtaining additional collateral or guarantees from solvent parties, and maintaining detailed payment records.

6. Stay Relief Options
   
   Landlords can petition the bankruptcy court to lift the automatic stay "for cause," typically when tenants aren't performing lease obligations, or if there's no equity in the property and it's not needed for reorganization. Success depends largely on whether the lease is above or below market rate and the length of the remaining lease term.

Understanding these bankruptcy basics helps landlords protect their interests and make informed decisions when facing tenant financial distress. Given the complexity of bankruptcy law, consulting experienced bankruptcy counsel early in the process is essential for navigating these challenging situations successfully.

If you have questions about a tenant’s bankruptcy filing or want to discuss protective strategies for your commercial properties, please contact our commercial real estate or creditors’ rights team to schedule a consultation.