If a tenant files for bankruptcy, an automatic stay goes into effect. The automatic stay immediately prohibits a landlord from taking any action against the tenant or its property. The landlord cannot send default notices, file or continue an eviction action, collect a judgment against the tenant, demand the payment of delinquent rent or other amounts, or terminate the lease (even if the lease provides that the landlord may terminate if the tenant files bankruptcy) without first obtaining relief from the bankruptcy court.
If a landlord violates the automatic stay, the landlord can face damages for such a violation. The tenant may seek actual damages, punitive damages, attorney’s fees and costs. Further, the landlord can face consequences for contempt (violating a court order) because the automatic stay is a court order. The sanctions a court can order for contempt include fines, attorney’s fees and damages.
Despite the automatic stay, the tenant must pay rent first coming due after the bankruptcy filing, but the landlord must be prepared to enforce this right in the bankruptcy court. Bankruptcy Code Section 365(d) requires debtors to perform all commercial lease obligations until the lease is assumed or rejected. If the tenant fails to pay rent or other amounts first coming due after the bankruptcy filing and thereafter, the landlord can move for the bankruptcy court to compel payment.
The tenant has three options for dealing with the lease in the bankruptcy case.
One option is to assume the the lease. If the tenant elects to assume the lease, it must cure all defaults under the lease and the lease will otherwise continue in accordance with its terms.
A second option is to assume and assign the lease to a third party. This is likely to happen if the tenant is selling its business as part of the bankruptcy. If the tenant elects to assume and assign the lease, the tenant must cure all defaults, and the assignee must demonstrate the ability to perform all future obligations under the lease. Generally, the tenant may assign the lease regardless of any assignment prohibitions in the lease or requirement for landlord’s consent. If the lease is assigned, the tenant will be relieved of all future obligations under the lease, and the assignee will be the new tenant under the lease.
The third option is to reject the lease. If the lease is rejected, all obligations of the tenant will cease, the landlord may retake the space, and the landlord may file a claim for damages just like any other creditor.
If a tenant files bankruptcy, it does not render a landlord helpless. Instead, the landlord must work within the framework of the bankruptcy laws in exercising its rights and remedies. Since bankrupt tenants are often permitted to disregard valid lease provisions absent an objection from the landlord, landlords should consult with experienced counsel to ensure their rights are enforced in the bankruptcy case.