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Know the law: When your tenant files for bankruptcy

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Robert Thorn

Bankruptcy filings stop evictions. Under our Federal Bankruptcy laws, when a person files bankruptcy, all state court procedures, including unlawful detainers, must immediately stop. This is referred to as an "automatic stay." The automatic stay gives the Bankruptcy Court Trustee time to take control of the bankrupt estate's assets, which includes the lease or rental agreement. Eviction delay firms, sophisticated tenants and our legal system have allowed bankruptcy to cause major delays in the eviction process. Therefore, it is important to understand the process to minimize delays and maximize a landlord's collections.

Motion for Relief from Automatic Stay

Court permission is required to continue an eviction after a bankruptcy has been filed. A "Motion for Relief from Automatic Stay" must be filed with the Federal Bankruptcy Court. The time it takes to receive an Order granting relief from the automatic stay varies from judge to judge and from court to court — anywhere from a few days to six weeks.

Sometimes tenants will file multiple bankruptcy actions in the same case to cause further delays. In these cases, some bankruptcy court judges grant an Order to be effective for six months to prevent future filings from delaying the eviction process.

Types of Bankruptcy

Individual tenants file bankruptcy petitions under either Chapter 7 or Chapter 13.

1) A Chapter 7 bankruptcy is a liquidation bankruptcy. The debtor's assets are sold and the proceeds disbursed to creditors.

2) A Chapter 13 filing, otherwise known as a "wage earners plan," restructures the tenant's debts to be paid off through an approved payment schedule.

Business entities file bankruptcy petitions under Chapter 7 or Chapter 11.

1) A Chapter 7 bankruptcy is a liquidation bankruptcy.

2) A Chapter 11 is like a Chapter 13. It reorganizes business debt through a payment plan.

Whether the bankruptcy filing was under Chapter 7, 11, or 13, the landlord is entitled to rent accrued after the filing. This rent is considered an "administrative expense" that, in theory, must be given a high priority of payment. A landlord may also be entitled to recover rent or other amounts that became due before the bankruptcy was filed. However, landlords must file a timely claim with the Bankruptcy Court to ensure payment. We can assist landlords by filing claims with the Bankruptcy Court and obtaining relief from stay to proceed with evictions.

It is also very important to serve a notice to pay rent or quit when it is legally correct to do so, as under bankruptcy law, notice to pay rent or quit that expires before the petition is filed terminates the lease, entitling the landlord to quick relief from stay.

A trustee's right to assume or reject a commercial lease must be exercised within 120 days from the date the bankruptcy petition is filed. The 120-day period for commercial leases can be extended for cause by the court for an additional 90 days. Any further extension requires the landlord's consent.

The trustee must perform non-monetary covenants required under the lease unless the covenant by its nature is impossible to perform, in which event the landlord is entitled to damages caused by the breach.

If the tenant/debtor is insolvent when the payment is made to a creditor, bankruptcy law may allow the trustee to demand that the creditor return that payment in certain situations. The law allows the landlord to retain the payment (rent) if the payment

(1) was made to satisfy a debt incurred in the ordinary course of business between the landlord and tenant/debtor,

(2) was made in the ordinary course of the debtor and landlord's business or

(3) was made according to ordinary business terms between the parties. Before the new law became effective, this issue used to require expert testimony regarding what was a business standard for payment of rental. Now the issue seems to be what ordinary business between the parties is. For example, if the rent is due on the first, but ordinarily not paid by the tenant until the 20th, that might not be in line with the industry standard. But if it is the customary business practice between the parties, the landlord may be able to retain the payment.

Bankruptcy law is complex. When a tenant files for bankruptcy, seek legal advice.

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"Know the Law" is a service for commercial property owners and managers from the law firm of Kimball, Tirey & St. John LLP. This article is informational only and should not be used as legal advice. For more information, please call (619) 231-1422.

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