Commercial Leases and Chapter 11 Reorganization: The Requirements and Timelines under the Bankruptcy Code

Problems with commercial leases of real property are one of most common precursors to a Chapter 11 Business Reorganization bankruptcy filing, at least in this attorney’s experience. What a lessee can and cannot do with a problematic commercial lease is something that should be fully considered before a Chapter 11 bankruptcy is filed. It is essential to have careful course of action regarding a commercial lease since timelines are short and monetary obligations come quickly once the Chapter 11 is filed. This article intends to give a comprehensive yet general enumeration of the timelines and lease options under the Bankruptcy Code that a debtor-lessee (i.e., the tenant) can expect with regard to their commercial lease of real property. Note: Leases of personal property have different timelines and requirements than leases of real property.

(For other detailed discussions on chapter 11 procedure, common issues and more, be sure to read Wartchow Law’s Chapter 11 Blog.)

Terminated Leases and Expired Leases may not be Assumed in Chapter 11

What has transpired as of the date that a Chapter 11 is filed—also called the ‘date of the order for relief’—is determinative of the rights of both the debtor-lessee and the lessor (i.e., the landlord) and what course of action may be undertaken in the Chapter 11 proceeding. If the lease has expired or terminated under its own terms and/or under state law prior to filing the bankruptcy proceeding, the lease is unlikely to be resurrected in the bankruptcy except by agreement with the lessor. While the filing of Chapter 11 bankruptcy may stall an eviction proceeding and generally buys more time for the debtor-lessee to negotiate terms of a lease with its lessor, bankruptcy cannot ‘un-ring the bell’ of a lease that has already terminated or expired prior to filing. Simply stated, a terminated or expired lease cannot be assumed in the Chapter 11 proceeding except by voluntary agreement with the landlord. Bankruptcy also will not restore the rights of an already evicted tenant.

A pending eviction proceeding does not necessarily imply that the lessor has also terminated the lease or that the lease has already expired and a tenant in midst of an eviction proceeding may nonetheless still have a lease that may be cured and assumed in Chapter 11. This is why it’s imperative to know the precise status of the lease—terminated, expired and/or evicted—in order to determine what opportunities may be presented by a Chapter 11 filing. For more information on eviction and Chapter 11, see Chapter 11 Bankruptcy: Can it Stop Eviction under a Commercial Lease?

“Post-Petition” Rent and Other Lease Obligations are Timely Due after Filing

Assuming the debtor-lessee is operating under a non-terminated and unexpired lease, the Bankruptcy Code requires that once a Chapter 11 is filed all obligations under the commercial lease must be timely performed. Typically this means that as soon as a Chapter 11 is commenced, the next payment of rent is still due and owing on the regular rent due date under the terms of the lease. Some lessors may even push for the balance of the current month’s rent to be paid on a prorata basis, and in this case the Chapter 11 debtor will pay the prorated rent due from the file date of the Chapter 11 case to the end of that first month of the bankruptcy proceeding and all subsequent months’ rent when those become due. For this reason, a Chapter 11 business debtor should be confident in its ability to pay all normal rent going forward as well as anticipate the timely performance of all other obligations under the lease including any tax payments that may be due after filing Chapter 11 as well as most non-monetary lease obligations.

The Chapter 11 Debtor-Lessee has 120 Days to Assume the Commercial Lease

The Bankruptcy Code specifies that a non-residential real property lease must be either assumed or rejected within 120 days of the Chapter 11 case being filed, with one extension of this deadline available for good cause. Lease assumption is essentially a reaffirmation of all terms of the commercial lease along with whatever changed terms may be negotiated between the parties. Lease assumption requires that the debtor-lessee cure monetary and non-monetary defaults under the lease and provide adequate assurance of future performance. Adequate assurance may take the form a replacement deposit particularly if the former lease deposit has already been set-off by the lessor prior to filing Chapter 11. Generally, the bankruptcy court will approve a lease assumption even over a lessor’s objection if the lease is not terminated or expired, a full cure of defaults can be immediately made, additional adequate assurance will be provided if needed, and there is the likelihood that the business can reorganize under Chapter 11.

If a commercial lease is not assumed within 120 days, the lease is deemed rejected under the law and the debtor-lessee must immediately vacate and surrender the property to the lessor. If a lease is rejected, the lessor may also be entitled to rejection and termination damages as claims that can be reorganized.

Rental Arrears and Other Defaults must be Cured in Full for the Lease to be Assumed

In addition to the timely payment of post-petition rent, if there has been a default under the lease, that default must be cured at the time the lease is assumed, i.e., 120 days after the case is filed at the earliest. The cure of the pre-petition date default may involve both monetary compensation for unpaid pre-petition rent as well as unpaid real estate taxes due under the lease and sometimes compensation for the lessor’s actual expenses such as attorney fees. The cure required upon lease assumption may also mandate the debtor-lessee’s actual performance of other, non-monetary defaults under the lease such as operational restrictions and an affirmative responsibility to improve or repair the premises. Note that the act of filing of bankruptcy itself is not an event of default under the law that must be cured even if the lease says otherwise. Such anti-bankruptcy provisions are sometimes called “ipso facto clauses” and are rarely enforceable with the bankruptcy court. Once a commercial lease is assumed, the debtor-lessee’s rights under that lease are fully resurrected (except as may be altered by the terms of the lease assumption) including future lease renewal options.

The bottom line: A Chapter 11 business debtor-lessee should fully expect to pay all ‘post-petition’ rent as it becomes due immediately once a Chapter 11 case is filed. Additionally if the debtor wishes to keep operating the premises under the lease, they also must cure all pre-petition defaults including rental arrears within a short period after filing bankruptcy or otherwise plan to vacate the premises within this same short period of time. While commercial leases are often are renegotiated in the course of a Chapter 11 proceeding with a cooperative landlord, sometimes the most that a debtor-lessee can expect is for Chapter 11 to provide a relatively short window of opportunity to either make good on a defaulted lease or move into another suitable property without the immediate threat of eviction.

You should always consult an attorney regarding your specific rights under your particular circumstances. Lynn Wartchow of Wartchow Law Office is an experienced Chapter 11 attorney with a track record of successful Chapter 11 reorganizations in MinnesotaContact Wartchow Law for a consultation.

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