What Happens to Leases in Bankruptcy?

The effect of bankruptcy laws on a lease varies depending on the type of lease at issue. Commercial real estate leases are governed by specific bankruptcy laws. Under these laws, if a commercial real estate lease is not expired at the time of a bankruptcy filing, it is deemed an unexpired lease and will trigger conflicting interests for landlord and tenant where the debtor is the tenant. In cases where the landlord is the debtor, a tenant under a sublease is only protected if that lease provides subordination and non-disturbance rights.

In cases of residential leases, certain protections are given to tenants if their landlord files for bankruptcy.

Effects of Bankruptcy on a Commercial Lease (Tenant-Debtor)

Assumption or Rejection of a Commercial Lease

Certain issues arise during a bankruptcy that involves an unexpired commercial lease where the tenant is the debtor. One of these issues is whether the debtor will assume or reject the lease within the statutory 120-day period of the bankruptcy filing.  If the debtor is a tenant under the unexpired commercial lease, the debtor must assume the lease within this period or the lease will be considered rejected. With the landlord's consent, this time period may be extended for an additional 90 days.

If the debtor assumes the lease, it must then reaffirm the lease and cure any pre- or post-filing defaults. It must also show that it can meet any future obligations under the lease.

However, if the lease is rejected, the lease is considered breached and the landlord can force the debtor-tenant to vacate the property. The landlord may also go after the breaching tenant for any penalties addressed in the lease. The landlord's damage claims will be considered as a pre-filing unsecured claim and will be capped at an amount that is equal to the greater of one year's rent or 15 percent of the remaining lease term up to a maximum of three years' worth of rental payments.

Assignment of a Commercial Lease to a Third Party

Even though many leases prohibit a tenant assigning the lease to a third party, these prohibitions are usually unenforceable in bankruptcy. A third party can then assume rent obligations, sometimes below current market value rates.

Effects of Bankruptcy on a Commercial Lease (Landlord-Debtor)

When the debtor is the landlord of commercial property, a tenant faces more risks, especially if the landlord-debtor rejects the governing or master lease. In this circumstance, the tenant may lose any possession rights to the premises. This risk is why many tenants obtain a subordination and non-disturbance agreement (SNDA) as part of their subleases.

SNDAs are only needed where a landlord takes out financing on commercial property already occupied by subtenants. As part of the loan agreement, lenders usually require that the tenants' leases be "subordinate" to the lender's security interest. In these cases, the lender may also require that the tenants pay rent directly to the lender in case of a foreclosure. In exchange for this subordination, the lender may provide non-disturbance rights to the tenant, which provides that the lender not terminate the tenant's sublease. Without this provision, the lender could terminate the sublease and force the tenant to enter into a less favorable contract or vacate the premises.

Effect of Bankruptcy on a Residential Lease

In the case of bankruptcy involving a residential lease, both tenant and landlord are given the same rights of assumption or rejection. If the lease is assumed by both landlord and tenant, the tenant must continue performing the obligations set out by the lease. These obligations include rent and keeping the premises livable. The landlord must continue to provide habitable and safe premises with adequate provisions of power, water and heat.

However, if either reject the lease, then penalties for breaking the lease are activated. These penalties should already be included in the lease's language. If the tenant rejects the lease, the landlord must give the tenant 30 days to move out. If the landlord rejects the lease, the tenant has the right to file a claim in the landlord's bankruptcy for damages arising from early termination. The tenant has the right to remain on the premises until official eviction proceedings are concluded. The tenant may also offset or reduce rent payments by any damages suffered.

If the landlord has not filed an eviction order, the tenant may file bankruptcy to receive an automatic stay against the eviction. However, this stay does not protect the tenant if eviction proceedings began before the bankruptcy filing.

Talk to an Attorney

If you are a tenant or landlord under a commercial or residential lease, bankruptcy laws provide certain protections as well as protections for each party. Rights may include assumption and rejection of the lease or subordination and non-disturbance in certain circumstances. In any case, you should consult an experienced bankruptcy attorney as soon as possible to protect your rights.