Commercial bankruptcies continue to soar, leaving frustrated landlords hung out to dry by bankrupt tenants. After filing for bankruptcy, a commercial tenant has a limited time to either assume or reject its lease as an executory contract. This election has significance to both the tenant and the landlord.
If the bankrupt tenant decides to reject the lease and leave the premises, the landlord is entitled to “rejection” damages, but these damages are unlikely to make the landlord whole.
A landlord’s claim for rejection damages are subject to a monetary cap under bankruptcy law and are treated as a general unsecured claim not entitled to administrative priority. See 11 USC §502(b)(6)(A). Lucky for commercial landlords, there are many exceptions to this harsh rule, including if the tenant rejects the lease after first assuming the lease postpetition (see 11 USC §503(b)(7)). Also, if the bankruptcy is dismissed, the landlord can claim the full damages allowed by state law under CC §1951.2.
The most important advice for commercial landlords dealing with a bankrupt tenant who has chosen to walk away is to move fast. Landlords can and should assert their unsecured claims for rejection damages by filing a proof of claim immediately after the rejection occurs and before any claims bar date. (Claims bar date is 90 days following the first date set for the meeting of creditors in Chapter 7 and 13 cases, and is set by the court in Chapter 11 cases).
Lest landlords get too discouraged, there are other potential claims against the tenant that are not subject to the limitations on rent and may be entitled to priority in the bankruptcy proceeding. For example, damages for failure to maintain the premises, damages for failure to keep the premises free of liens, and attorney fees incurred in litigating a prepetition breach of lease case.
For a detailed discussion of these issues, go to CEB’s new book California Real Estate Bankruptcies: Law and Litigation §§6.44–6.46, 7.59 (Cal CEB 2010). Also, check out the upcoming program The Impact of Bankruptcy on Real Property Transactions, which will be live in LA on October 1st and available On Demand beginning Sept. 27th.
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