Understanding Tenant Bankruptcy as a Landlord

If you’re a landlord suddenly having to go through a tenant bankruptcy, most likely the first words that come to mind is “oh great, now I have to let this deadbeat tenant live free of rent until this gets all sorted out.” While that may be true to a certain extent, you as a landlord need to really understand your options dealing with tenant bankruptcy and the process in general so that you can minimize your loses.

Preparing yourself mentally and staying focused on what needs to be done rather than remaining frustrated and angry can help you recover your loses quicker with a tenant bankruptcy than the other creditors that are also at a loss because of your tenants situation. When your tenant files for bankruptcy, it’s important to know where you are at with your lease, what rights your tenants can exercise, and what your options are.

The Basics

Before we continue, you need to understand the basics behind a tenant bankruptcy and what types of bankruptcies you will encounter as a landlord.

Chapter 7

If the tenant files for Chapter 7 Bankruptcy, the court appoints a third party known as a “trustee” to seize all of the persons’ assets and liquidate them. The money is then used to pay off as many debts as possible, most of the time with significant discounts.

Chapter 11

Chapter 11 Bankruptcies are a little different in the fact that the person filing for bankruptcy maintains control of their businesses and assets with the intent to pay off all of his or her debts, and usually the recovery of the affected creditors is a lot better than the case of a Chapter 7. The court can decide at any time after a Chapter 11 is filed to convert it to a Chapter 7, in the case where no progress is being made to pay off his or her debts.

Understanding how you will be paid

There are two types of claims you as a landlord can petition for with a tenant bankruptcy. Pre-petition claims are for any monies owed to you before the person files for bankruptcy. Post-petition claims are for those monies owed to you after the person has filed for bankruptcy.

For the most part, pre-petition claims are a lot more difficult to recover than post-petition claims. Any goods or services provided to the tenant after he or she files for bankruptcy are known as “administrative claims.” In both cases of Chapter 7 and 11, these claims are the first to get paid. If for example the court rules that a Chapter 7 is to be executed, all of the money will be used to first pay off all administrative claims. If there isn’t enough money to cover all of these debts, the money will then be distributed proportionately among the administrative claimants.

So as you can see, any rent money owed to you before the fact they filed for bankruptcy will be difficult to recover as in most cases the money is all used up to cover post-petition claims. If you do get to recover any of those loses, it is usually at a substantial discount.

Automatic Stay

As soon as the court approves the bankruptcy, the tenant is automatically granted Automatic Stay. What this means is that all debt collection calls and attempts to recover losses must stop immediately. This includes tenant eviction notices and all other efforts to collect money. This does not include, however, an attempt to collect back rent from a co-signer on the lease; in the case one was used.

Termination of lease

Most leases contain clauses that speculate that the lease is automatically terminated if and when the tenant files for bankruptcy. Regardless of what the lease says, however, it is unlawful to begin the eviction process after the tenant has filed for bankruptcy unless you have written permission from the court. The law forbids the landlord to determine a breach of contract that has been caused by a bankruptcy petition. A landlord may also not raise the rent amount or create additional clauses to the lease because of the tenant bankruptcy.

If you have filed for an eviction before the tenant files for bankruptcy, however, you are free to proceed with the eviction process. If you issue your tenant the first step of the eviction process, which is usually a 3 day pay or quit, the lease is officially terminated. It is very imperative that you remember that if you accept any type of payment from the tenant either partial or in full during the eviction process, the process is officially terminated and the lease will remain in effect.

Remember that these proceedings are very, very technical. Once the lease has been terminated by the tenants’ failure to pay the owed rent amount after the three day to pay or quit, the tenant has no right to continue the lease after the bankruptcy is filed.

Lease Status

The status of the lease at the time bankruptcy is filed is the most crucial part of this entire process. If the lease is still active at the time the tenant files for either Chapter 7 or 11 Bankruptcies, the tenant has 60 days to either accept or reject the lease. This could mean 2 full months of unpaid rent for you. It gets a bit worse by the fact that the tenant can apply for an extension of these 60 days.

What can a landlord do in this case? You can have a day in court and express how the failure of payment of rent by this tenant is impacting your financial situation and business. As you can assume, it is something the judges hear quite often and you may need to bring your A+ game for this one.

Light at the end of the tunnel

It’s not safe to assume that all bankruptcies end in bitter dispute. There are also some cases where a trustee in a Chapter 7 Bankruptcy case can sell the business rights or certain locations or assets for a lot of money, and you get to recover all outstanding debts. In the best case scenario, your tenant can assume the original lease once the bankruptcy case has been settled and every one lives happily ever after. Even in a Chapter 11 Bankruptcy case where the owner of the business can sell off a location or a franchise and get caught up with all of your debts. I’m not saying this happens more often than the tenant rejecting your lease at the end of the 60 days, but it has happened and will continue to happen every now and then.

Bottom line, if your tenant declares bankruptcy it is essential to understand the process and your legal rights and limitations collecting the rent due to you as it is a very technical legal process and mistakes can be very expensive.