What Happens When a Commercial Tenant Files Bankruptcy

Often commercial landlords have clues that a tenant is going to be filing for bankruptcy. Rental payments are often late several months in a row. Sometimes the tenant falls more than a month behind on the rent. But, it can still be shocking when a landlord opens the mail and instead of a rent check receives a notice from the Bankruptcy Court.

What Happens When You Get Notice of a Tenant’s Bankruptcy?

Most of the time commercial property owners will receive notice about a tenant’s bankruptcy filing from a letter sent by the Bankruptcy Court. That initial notice is called the “Notice to Creditors”. This letter gives the address of the court, the case number, and several important dates in the case for creditors.

The notice also signals that something called the “Automatic Stay” is in place. When any type of bankruptcy is filed the court automatically issues an order to all the creditors that they are not to pursue any collection actions. The automatic stay freezes all attempts to collect debts. This includes eviction proceedings and sending collection letters for back rent.

Because bankruptcy and creditor’s rights issues can be complicated and technical, the net step is to consult with a creditor’s right attorney. If the landlord and tenant are in the middle of eviction proceedings the landlord should let the court handling the eviction know about the bankruptcy. The tenant probably will as well, but failure to notify the court can have severe consequences for the landlord.

If a creditor doesn’t obey the automatic stay they can be held in contempt of the Bankruptcy Court and face paying a stiff penalty.

Not All Bankruptcies Are the Same

There are several different types of bankruptcy filings. A Chapter 7 bankruptcy seeks to erase all of the debts of the debtor. This most likely means you will be loosing out on back rent and that the tenant will not be continuing to occupy the property.

Businesses can also file a Chapter 11 bankruptcy. This allows them to restructure the debt. This often means that the tenant will want to continue to operate and will work out a plan with the supervision of court that will include payment of any back rent to the landlord.

If the business is small or has small enough debts to qualify, they can also file a Chapter 13 bankruptcy. Like Chapter 11, this type of bankruptcy looks to restructure debts and create a payment plan for creditors. Not all creditors will receive all of the money owed, but if the tenant plans on continuing to rent the same property, the landlord stands a better chance of eventually recovering back rents.

Protecting Your Commercial Landlord Rights

It can be frustrating to be stuck with tenants that are behind on their rent. Landlords can go to the bankruptcy court to ask for relief from the automatic stay. This means they seek permission to continue collection activities.

Depending on each state, landlords who are already in eviction proceedings often can get the right to continue to proceedings. However, the tenant may also have the right to cure the breach of the rental contract by paying the back rent.

Even if eviction proceedings have not started, landlords can still seek to collect back rent by getting relief from the bankruptcy stay. Typically, Bankruptcy Courts will not allow a tenant to stay in possession of the space if they are not current on rent or do not have a plan to make future rent payments and repay past due rent.

While bankruptcy is setup to give debtors an opportunity to get a fresh start or restructure debts, there are many protections in place for creditors. Landlords with tenants still in possession of the property have some of the strongest rights of any creditors and are often some of the first creditors to get paid from the bankruptcy.

However, to enforce their rights, landlords must meet all the Bankruptcy Court deadlines for filings and attend, or have their representative attend, they key hearings dealing with the lease.

If the landlord does not seek to actively protect their rights, the Court is not likely to do it for them.

If the tenant is seeking to stay in possession of the property and restructure their debts, the landlord won’t have many options. However, if after the bankruptcy the tenant fail to live up to the commitments made under the bankruptcy plan, the landlord will be able to remove the tenant and seek to collect past due rent, but they may have to get permission form the Bankruptcy Court first.

Tax Consequences of a Tenant’s Bankruptcy

Once a bankruptcy is completed, the landlord, even if the tenant cures any past due rent, will still be in a worse financial position than before. The landlord may have lost the right to collect some of the late rent interest and penalties the rental agreement calls for. In the worst cases the landlord will have a vacant space to fill and be out the expected future rent and some amount of past due rent.

Creditors such as commercial landlords are able to deduct the losses and legal expenses on their taxes. The losses from the future rent cannot all be deducted at one time. But, so long as the landlord is unable to fill the space, that loss is deductible in the tax year it occurs. As always, it’s best to consult with a CPA on all tax matters.

Because bankruptcy can add significant expense and increase the time it takes to remove a delinquent tenant, landlords should not allow commercial tenants to fall far behind on rental payments. But, even landlords who are vigilant about enforcing rental contract provisions may still find themselves on the receiving end of a bankruptcy notice.

The filing of the bankruptcy may not mean the end of the landlord–tenant relationship. The landlord may have the tenant for months or years afterwards. If a commercial landlord receives a bankruptcy notice they must take action right away to seek professional guidance and to protect their rights.

Conclusion

In this article we talked about what happens to a landlord when a tenant files for bankruptcy. A tenant bankruptcy can present several challenges to a landlord. Most notably is the Automatic Stay, which is when the court automatically issues an order to all the creditors that they are not to pursue any collection actions. This article gave and overview of what happens when a tenant files for bankruptcy and also discussed some potential solutions. However, as with all legal matters, it’s best to consult with competent legal counsel.