Commercial Leases in Bankruptcy

By Sanford R. Landress and Charles R. Markley

July 2011

As the ongoing recession squeezes Oregon businesses, commercial bankruptcies are continuing to occur at record levels. Bankruptcy affects not only the bankrupt companies' employees, vendors, suppliers, and customers, but also commercial landlords who are left holding a problem lease.

First and foremost, commercial landlords in this situation want to know whether the bankrupt tenant has the legal right to stay on the property. Depending on the specific details of the lease and the bankruptcy filing, as well as the discretion of the Bankruptcy Court, the landlord may or may not be able to force the tenant out of the premises. Naturally, it is important to consult with an attorney to discuss the specific circumstances of any particular case, but the following general guidelines should help commercial landlords understand their basic options under the Bankruptcy Code relating to commercial leases.

Lease Termination
When a tenant files for bankruptcy, the commercial landlord's first priority is to determine whether the lease terminated before the bankruptcy filing date. The debtor can assume a commercial lease only if the lease is in existence at the commencement of the bankruptcy case. If the lease has expired by its own terms, or has been terminated under applicable law before the commencement of the bankruptcy case, there is nothing left for the debtor to assume or reject. That is the best situation for a landlord. If the lease was terminated before the bankruptcy filing, the debtor cannot assume the lease, and the landlord can promptly gain possession of the premises by filing a motion with the Bankruptcy Court.

If, on the other hand, the commercial lease was not terminated before the bankruptcy petition was filed, then the landlord should monitor the case, wait for either assumption or rejection, and then proceed to enforce the alternative rights explained in this article. In an emergency, the landlord can file a motion in the Bankruptcy Court to expedite the debtor's decision to either assume or reject the lease, or to compel the payment of rent pending that decision.

Assumption or Rejection
The Bankruptcy Code gives the debtor the option to "assume . . . any . . . unexpired lease of the debtor." Consequently, under some circumstances, the bankrupt tenant can elect to remain in the leased premises. The tenant, however, will have to cure any monetary defaults as the price of assuming the lease.

The tenant must also act quickly. The tenant must assume the lease within 120 days after the bankruptcy filing. If the tenant fails to act by that deadline, the lease is deemed rejected. Rejection is a breach of the lease. Upon rejection, the landlord is entitled to possession of the leased premises and to file a proof of claim in the bankruptcy case for breach damages.

Calculating the Proof of Claim
As discussed above, upon rejection of a lease, the landlord is entitled to file a proof of claim as a pre-petition, non-priority creditor for whatever damages it has incurred as a result of the breach. However, the Bankruptcy Code limits a landlord's damages for breach.

As a rough rule-of-thumb, if the remaining lease term is less than 80 months (6.7 years), the landlord's claim will be capped at one years rent. If the remaining term is between 80 months and 240 months (20 years), the landlord's claim will be capped at the damages for 15% of the remaining term. If the remaining lease term is greater than 240 months, the landlord’s claim will be capped at three years' rent. Keep in mind that these are simply statutory maximums - the landlord must still prove its actual damages, which includes showing attempts to mitigate damages by finding a new tenant.

Collection from Guarantors
Upon the filing of a bankruptcy case by the tenant, the Bankruptcy Code enjoins the landlord from enforcing its collection remedies against the tenant. However, if a member or officer of the tenant has guarantied the lease, the tenant's bankruptcy case will not stay collection efforts by the landlord against the guarantor. Moreover, the discharge of the tenant does not discharge the liability of non-debtor third parties such as guarantors. Pursuing collection efforts against a guarantor can be the commercial landlord's best option for recovering the lost rental income when a tenant files for bankruptcy.

Unfortunately, all these scenarios put commercial landlords in an unenviable position. As long as bankruptcy filings persist at these levels, expect commercial lenders to be wary of signing long-term leases without adequate guarantees to cover their potential losses.

Sanford R. Landress is a partner at Greene & Markley. His practice focuses on the representation of business debtors and creditors in bankruptcy proceedings. He can be reached at sanford.landress@greenemarkley.com or (503) 295-2668.

This article appeared in the July 2011 issue of the Coast River Business Journal.