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.

Managing the Business During Chapter 11: Reporting and Other Requirements

When a business files Chapter 11, it becomes a “debtor-in-possession” of its own affairs as a fiduciary to the bankruptcy estate. What this means is that management of the business during the Chapter 11 case will remain under the control of its prepetition management and principals, subject to certain duties to report and maintain the business in a manner consistent with the procedural rules of Chapter 11 business reorganization bankruptcy. While these mostly financial and administrative requirements for operating the business during Chapter 11 are relatively straight-forward and generally represent good business practices, failure to follow these requirements can result in an appointment of a trustee to takeover operations of the business or dismissal or conversion of the case to liquidation.

While the business is in Chapter 11 bankruptcy, it has an obligation to file both a comprehensive initial financial report as well as ongoing monthly operating reports. The monthly operating reports provide an itemization of cash receipts and disbursements, profit and loss statement, balance sheet, copies of all bank account statements and other financial information that facilitates an ongoing review of the debtor’s finances while it is in bankruptcy. These monthly operating reports may be reviewed by any party in interest to the case and also form a basis to determine the feasibility of a plan of reorganization. If the debtor continually sustains a monthly net loss as demonstrated on the monthly operating reports, its hope for reorganization may be diminished.

Additionally, the business debtor must also stay current in the filing of all applicable tax returns and payment of taxes, including monthly sales tax and employee withholding tax obligations. This may be a challenge for businesses that do not maintain regular accounting books and records, or may routinely default in the payment of taxes. If the business accounting records and tax reporting is not current or accurate prior to the Chapter 11 being filed, an effort should be made as soon as possible to arrange the resources necessary to ensure that correct and timely tax filing and payments are made as soon as the Chapter 11 is filed. Tax obligations accrued prior to the bankruptcy may be dealt with in the plan, which often means that pre-petitiion sales tax obligations in Chapter 11 are repaid over five years at low interest.

The Chapter 11 business debtor has additional requirements to these, including the requirement to immediately open new debtor-in-possession bank accounts and close all pre-petition bank accounts, to maintain all insurance standard in the debtor’s particular industry, to pay a quarterly fee to the Office of the U.S. Trustee that monitors the debtor’s finances throughout the Chapter 11 proceeding, to attend various interviews and hearings conducted by the U.S. Trustee, as well as adhere to other restrictions on compensation, partner distributions, use of cash and more.

Keep reading for more on the Chapter 11 process, timeline and fees involved in a reorganization.

A qualified Chapter 11 attorney can advise your business of all the requirements and obligations before a Chapter 11 bankruptcy case is filed. Wartchow Law Office provides initial Chapter 11 consultations to review the business liabilities and other circumstances affecting a possible Chapter 11 bankruptcy proceeding, and to advise on possible options and solutions that Chapter 11 can provide to keep a business operating and improve future prospects.

What is Individual Chapter 11 Bankruptcy and Why Would I File an Individual Chapter 11?

The vast majority of individuals who file bankruptcy chose to do so under either Chapter 7 or Chapter 13, which are the most common forms of consumer bankruptcy. However, there are certain individuals that may instead take advantage of the greater flexibility that Chapter 11 can provide, especially when the individual has considerable and/or income-producing assets to protect and distinctive objectives to attain in bankruptcy.

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

Chapter 11 arguably offers greater flexibility for an individual than other chapters of bankruptcy. A successfully confirmed individual Chapter 11 plan can restructure secured debts such as mortgages on rental properties and liens on other assets, yet without the close supervision of an appointed bankruptcy trustee. While some restructuring can be accomplished in Chapter 13, a Chapter 11 debtor maintains a higher level of control and input in the terms of the restructured debts as negotiated with creditors.

Especially for individuals having multiple real estate holdings, Chapter 11 provides an opportunity to protect non-homestead real estate equity which could otherwise be lost in Chapter 7 or Chapter 13, and opportunity to reorganize the underlying mortgages to rewrite more favorable terms including potentially stripping a wholly unsecured mortgage from commercial and rental real estate.

An individual may also opt to file Chapter 11 bankruptcy when they do not otherwise qualify for Chapter 7 or Chapter 13. In Chapter 7, individuals must be below a certain income level in order to be eligible for Chapter 7 pursuant to the “means test”. For higher income earners that do not qualify for Chapter 7, most can still file under Chapter 13, which typically involves a partial repayment plan over five years after which time any remaining debt is then discharged. Chapter 13 has certain statutory debt limits that, while for most people do not normally present a problem, pose a challenge for individuals that exceed those debt limits, in particular individuals that may have multiple real estate holdings with corresponding mortgages which easily aggregate to exceed the debt limits of Chapter 13. As of the date of this post, the statutory debt limits for Chapter 13 bankruptcy are $1,081,400 in total secured debt plus $360,475 in unsecured debt (see the current Chapter 13 debt limits).

As few general consumer bankruptcy attorneys practice individual Chapter 11s, it is especially important to consult with an attorney who has filed individual Chapter 11s before and can guide you through the more rigorous, yet arguably much more flexible process, on an individual Chapter 11 bankruptcy.

Lynn Wartchow provides initial Chapter 11 consultations to review liabilities and assets affecting an individual Chapter 11 bankruptcy proceeding. For more information on how Chapter 11 bankruptcy may impact your situation, contact Wartchow Law Office for a free bankruptcy consultation. Located in Edina, Minnesota, Wartchow Law represents clients in all forms of bankruptcy throughout the Minneapolis and St. Paul metro area of Minnesota.

What makes a Chapter 11 Business Reorganization a “Work of Art”?

A Chapter 11 reorganization proceeding facilitates a business’s ability to actually stay in business. A successful Chapter 11 is a creative composition thoughtfully sculpted from the good will of a business, crafted by the Chapter 11 attorney into an effective masterpiece of productivity and often with the patronage of key creditors added as the finishing touch. While a work of legal art that revives a business into profitability and longevity is always the goal with Chapter 11 proceedings, it is not always the case. The statistics on successful Chapter 11 reorganizations are discouraging, with over half not making it to the point of a confirmed plan.

So what is it that differentiates a Chapter 11 statistic from a Chapter 11 success? How can you know if your business has what it takes to survive the bankruptcy process and reemerge as a profitable going concern? As a Chapter 11 attorney having represented various types of businesses in reorganization proceedings, I would say the essential element present in every successful reorganization is the business’s ability to survive “but-for” the events that created the downturned circumstances. Phrased differently, if the business has what it takes to survive this economy and pull positive cash flow if only certain issues were not part of the equation, then it may have what it takes to achieve a positive result in Chapter 11 reorganization.

First, identify the factors that are causing the business to ail. Most common ailments are provided varying levels of flexibility in Chapter 11: income and sales tax liabilities, lease problems and commercial eviction, a pending balloon payment on secured financing, unmanageable unsecured debts or monthly payments, judgments, even pending lawsuits and adverse administrative actions such as liquor license posting—all of these can be positively resolved in Chapter 11. However there are some issues that even the Rembrandt of bankruptcy attorneys cannot artfully compromise: a truly defunct business venture that cannot compete in any marketplace will probably not be resurrected even with the benefit of Chapter 11. Knowing what forms of relief are applicable under Chapter 11 for the different business conditions is the starting point from which a successful  reorganization proceeding can launch toward success. Achieving those goals during the course of the Chapter 11 proceeding and sanctifying the results in a confirmed plan of reorganization is the art form.

Ultimately, every business is dependent on a favorable market and no amount of artistry in Chapter 11 can create a market that does not exist. But if your business has a track record of good will and also the tools to move profitability into the future, Chapter 11 may be the silver lining in a dark cloud. Just like in the paintings of late-19th century realism that depicted the ferocity of nature, even the bleakest landscape has a glimmer of hope on the horizon.

Attorney Lynn Wartchow has represented Chapter 11 business reorganizations proceedings involving restaurants, bars, nightclubs and other businesses in Minneapolis since 2008.

When sales tax threatens a business: Chapter 11 may be the answer

When I became aware of a popular local restaurant and bar recently close its doors due to unpaid sales tax and subsequent state shutdown, I had to wonder why no one suggested that the owners file a Chapter 11 business reorganization. True, I cannot be sure that the owners did not consult an attorney and make the decision not to file Chapter 11, but I have my doubts. The establishment was a long-standing popular Minneapolis hotspot, overflowing with patrons bursting out the doors even on weeknights—how could they not be making a decent profit? The zoning of the neighborhood may be to blame, which dictates a mandatory portion of receipts must be from food rather than alcohol, or the sales tax and penalties spike. Here in Minnesota, if a business that sells alcohol is delinquent in paying its sales tax, it can expect to have its liquor license posted within a month. Once a liquor license is posted, the business is not allowed to purchase liquor from wholesalers and distributors until they pay the tax in full, thereby leaving the business with a dwindling supply of inventory to sell to the public while it tries to generate enough revenue to pay the tax bill. Unlike other types of creditors that may be more negotiable, the state’s taxing authority is an unyielding force of government that demands payment under the threat of immediate adverse action. With the Minnesota Department of Revenue, you have to pay to play, and if you want to run a bar, you better pay your sales tax on time each month.

With one not-so-obvious exception: Chapter 11 business reorganization. While this means a business must file for bankruptcy, bankruptcy doesn’t necessarily mean it will go out of business. Quite the opposite—Chapter 11 is a mechanism established under federal law that provides significant flexibility for businesses to reorganize any number of liabilities so long as they can achieve future cash flow to actually stay in business. First and foremost, from the moment the Chapter 11 is filed, the state cannot post the liquor license—this is why it’s so important to head off the posting ideally before it happens. As for resolving the unpaid sales tax bill, the Bankruptcy Code generously allows businesses five years to repay federal and state tax liabilities. A five-year tax repayment plan sure beats the one month notice of liquor license posting.

Of course, other debts can also be reorganized in Chapter 11. Unsecured debt may be reduced to a fraction and paid over time while secured debts and financing agreements may likewise be restructured over more time with principal and interest reduced, and any other number of issues are given more flexibility inside a Chapter 11 bankruptcy proceeding. It should go without saying that, just as with most everything in life, it’s best to explore the bankruptcy option as early as possible and get an idea of what Chapter 11 may look like under your business’s specific circumstances.

The best general advice for a restaurant or bar struggling under sales tax liability: Talk to an attorney that does Chapter 11, and ideally before things go from bad to worse. Even if “bankruptcy” has not been part of your vocabulary before, it could be the solution that keeps your doors open and gets your business back in the black. As for the local favorite restaurant and bar I mentioned earlier in this post, I wish we had met sooner and hope you reopen soon.

Keep reading for more information about Sales Tax Obligations and Chapter 11 Business Reorganization.

Attorney Lynn Wartchow has represented Chapter 11 business reorganizations proceedings involving restaurants, bars, nightclubs and other businesses in Minneapolis since 2008.