Tenant Bankruptcies: What Commercial Landlords Need to Know and How to Move Forward

May 2020

As we continue to navigate COVID-19, the commercial real estate industry is still figuring out how to function as many businesses remain closed due to governmental orders. Some states with stay-at-home orders are planning for re-openings, while others are planning for partial re-openings with restrictions. Depending upon the state and type of business, re-openings may involve limiting the number of customers at a tenant’s location resulting in less traffic, which means less business. Additionally, with rising unemployment claims, consumers will have less discretionary income.

As we previously reported here, landlords may face tough challenges in finding new tenants in these unique financial times. Instead, some landlords are providing (or are considering providing) rent relief. In negotiating rent relief with a tenant, landlords may want to consider strengthening its position by seeking additional guaranties, increasing tenant financial reporting, reducing special tenant rights, strengthening critical lease terms, or adding additional bankruptcy protections. For example, a landlord may want to consider seeking a third-party letter of credit as security for the lease rather than a cash deposit. In some jurisdictions, depending on the terms, a letter of credit may be outside the tenant’s bankruptcy estate, thereby allowing some recovery to the landlord despite a bankruptcy filing.

As months pass under the “new normal” and states attempt partial re-openings or even complete re-openings, the financial toll on tenants is expected to result in more bankruptcy filings. Just last week, J.Crew filed for bankruptcy with $1.7 billion of debt and 181 retail locations plus 170 factory stores and 140 Madewell locations and Neiman Marcus filed for bankruptcy with nearly $5 billion of debt, 43 Neiman stores, two Bergdorf Goodman stores, and over 24 Last Call outlet stores.

With increased bankruptcy filings, more landlords will be forced into the bankruptcy venue by the bankruptcy filing of tenants. Upon a bankruptcy filing, the automatic stay will go into effect and stop actions against the debtor such as evictions. The automatic stay also prevents setoffs, such as applying a security deposit. At the start of a bankruptcy, the most important question to ask is: will the tenant want to remain in the premises and assume the lease or will the tenant reject the lease and vacate? Unfortunately, sometimes that answer does not come as quickly as landlords may like, because the tenant has 120 days to make that decision (and a tenant may seek to extend that deadline).

If a landlord is considering forbearing some rent and collecting it later, it is important to keep in mind that the tenant is required to pay rent in full for its post-bankruptcy use of the premises. As to any unpaid amounts owed for pre-bankruptcy rent (such as any amount that was forborne), the tenant will be required to pay it in full (or “cure” the defaults) only if the tenant assumes the lease. Otherwise, if the lease is rejected, then the landlord would have an unsecured claim for the pre-bankruptcy rent (including any forborne amounts). Even though a tenant is required to “cure” pre-bankruptcy defaults if it assumes a lease, many tenants attempt to re-negotiate lease terms are part of the process.  Additionally, when in bankruptcy, a tenant might seek to sell some or all of its assets (included leases). This can raise numerous risks and concerns for landlords, especially when the tenant mix is a significant concern.

If you have questions about the above information, our Bankruptcy & Insolvency and Real Estate attorneys can help. FMJ has experience assisting landlords navigate pre-bankruptcy issues and representing landlords in bankruptcy cases.  If you have questions or are interested in learning more, please contact Lorie Klein at lorie.klein@fmjlaw.com or Kristi Riley at kristi.riley@fmjlaw.com.