Recent Bankruptcy Developments Impacting the Landlord-Tenant Relationship

Legal Compliance Resource
December 16, 2013 — 945 views  

The Congress had intended that commercial landlords should be entitled to significant safeguards while drafting the Bankruptcy Code provisions that are related to nonresidential real property. The protections for these commercial landlords include:

  1. The requirement of a debtor to remain current in the payment of post-petition rent;
  2. Landlords are allowed to drawdown on letters of credit without having prior court approval for bankruptcy;
  3. Landlords are permitted to lease rejection damages;
  4. Landlords can setoff pre-petition unpaid rent against a security deposit where the lease obligations cannot be assumed and is terminated according to its terms;
  5. Landlords can also limit the time in which a debtor can extend the time it has to reject or assume a commercial lease in the absence of landlord consent.

In spite of having such protections, this relationship is still extremely complicated. Recent decisions in the bankruptcy courts of the District of Delaware and the Central District of California have thrown new light on the complexities of this relationship. They offer more guidance to landlords and tenants that are going through the process of a tenant that faces bankruptcy.

Indemnification

Nearly all commercial leases contain indemnification language, in accordance to which a tenant has to indemnify the landlord for any liability that has been incurred within the lease term. When a tenant files for bankruptcy protection this indemnification right depends upon the events’ time and jurisdiction. However, Judge Gross in the District of Delaware Bankruptcy Court has recently held that a claim that arose from an indemnification provision of a non-residential real property lease rejected post-petition was entitled to administrative priority that was pursuant to the Bankruptcy Code.

Debtors’ Retroactive Rejection

The terms of section 365(a) of the Bankruptcy Code10, where flexibility is afforded to a debtor, becomes especially valuable when the debtor is a tenant who is paying rent that is over-market. It is also helpful when a tenant is planning to close specific office or retail locations. The terms provided in this section do not offer guidance related to the effective date of rejection or even whether the rejection date may be retroactive. In another recent court decision, Judge Carroll in the Central District of California Bankruptcy Court concluded that under specific circumstances a commercial lease can be rejected retroactively to a date that is preceding the date of the filing of the rejection motion.

For a landlord to effectively utilize all the tools available and ensure that there is a maximum financial recovery, it must develop a suitable strategy as fast as possible after the petition of the tenant is filed. Landlords need to keep in mind the decision in the District of Delaware Bankruptcy Court when filing proofs of claim to preserve pre- and post-petition claims that were related to debtor-tenant’s lease compulsions. Adding to this, the District of California case made it clear that the effective date of rejection is generally important in order to be able to assess the nature of any tenant’s liability and its priority of payment.

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