In bankruptcy, if a debtor is the landlord, the debtor has the option to assume the lease, assume and assign the lease, or reject the lease.
The Tenant Must Continue to Perform Under the Lease
In the event the debtor landlord files a Chapter 11 reorganization case, there is no deadline for a debtor landlord to decide what if anything it should do in connection with a tenant’s lease. More often than not, the debtor landlord will not make any such decision unless and until the plan is confirmed or sale takes place approved by the bankruptcy court. Now, this is not to say the tenant cannot force the issue, but generally speaking, a tenant will not file such a motion unless the debtor landlord is failing to perform its duties and obligations under the lease. If the debtor landlord is not performing its obligations, then it is incumbent upon the tenant to file a motion to assume or reject the lease and/or to seek a modification of the automatic stay for the purpose of seeking permission to litigate its rights under state law including termination of the lease. In the meantime, however, the tenant must monitor the bankruptcy case and continue to perform under the lease including paying the rent.
Tenant Choices Under the Bankruptcy Code
Now, this is not to say the tenant does not have certain protections under the Bankruptcy Code. Section 365(h) of the U.S. Bankruptcy Code prevents the tenant from being evicted and gives them two choices on how to proceed.
Under Section 365(h), if the debtor landlord rejects the lease, the tenant can treat the lease as terminated and vacate the property. The tenant may then file a claim for “rejection damages” arising from having to terminate the lease. Under this scenario, the debtor does not have to pay any rent.
The tenant can also continue to retain possession for the remainder of the lease term. That said, if the lease is rejected and the tenant retains possession, the debtor has no further obligations under the lease including paying for utilities, repairs, and such other expenses and obligations under the lease. Yet, the tenant can offset any damages arising post-rejection during the term of the lease in connection with having to pay for any such expenses and obligations that would have been otherwise incurred by the landlord. Even though the tenant has offset rights, the tenant waives all rights to file a claim in connection with the debtor having rejected the lease.
When the Lease is Assumed and/or Assigned to a Third Party
In the event the lease is assumed or assumed and assigned to a third party who has acquired the property, all of the landlord’s defaults which are capable of being cured must be cured before the lease can be assumed and/or assumed and assigned. Moreover, the debtor and/or assignee must provide proof that it can perform under the lease. This is commonly referred to as providing proof of “adequate assurance of future performance.”
An interesting issue arises when the property is sold “free and clear of all liens, claims, and encumbrances. Of course, the lease is assigned in connection with such sale unless it is rejected, but if the lease is to be assigned, then such broad language can include that such sale is free and clear of tenants’ rights under the lease including those rights under Section 365(h). If this arises, the tenant needs to be proactive and potentially object to the sale to protect its rights and preserve its claims in any order approving the sale of said property.
The Tenant Should Monitor the Bankruptcy Case
The key take way for any tenant is to monitor the case and start analyzing options going forward in terms of the landlord rejecting the lease and/or assuming and perhaps assigning the lease. And at all times, it is incumbent on the tenant to become proactive in terms of reaching out to the landlord regarding its options and considerations. The debtor landlord may be evasive but it does not hurt to ask. Moreover, in the event a motion to assume and/or assume and assign is filed, it is incumbent on the tenant to become proactive to protects its rights.
