By Jones Osborn II

It happens all too often. Your tenant files bankruptcy, and the rent checks stop. You've heard about the "automatic stay" which prohibits all legal action against the debtor who's filed bankruptcy, so you know you can't sue your tenant or evict him. You wonder what, if anything, you can do to protect yourself.

The general rule is that the debtor (or the trustee if there is one) has 60 days after filing bankruptcy either to assume or reject the lease. In other words, he has the right for 60 days to decide whether he wants to terminate the lease or continue with it. The 60-day period can be extended with approval of the bankruptcy court.

Payment of Rent. In the case of non-residential leases, the bankrupt tenant is supposed to pay rent coming due after the filing on a current basis until assumption or rejection of the lease. In practice, however, the rent is often late because of the disorganization and distraction caused by the bankruptcy, or the lack of available funds. However, it should eventually be paid, although the court can for good cause extend the time for payment of rent until 60 days after filing. If rent isn't being paid on a current basis, the landlord should complain to the tenant or the trustee or its bankruptcy counsel. If this doesn't work, the only remedy is to petition the bankruptcy court for the payment; unfortunately, the landlord cannot terminate the lease or evict the tenant while the tenant is in bankruptcy. This is true even if the lease contains a provision giving the landlord the right to terminate the lease in the event of the tenant's insolvency or bankruptcy, because such provisions are unenforceable.

Pre-Filing Termination. If the lease was validly terminated prior to the bankruptcy filing, it remains terminated. A bankruptcy filing does not revive a terminated lease. It is not necessary to have evicted the tenant before the filing--it is only necessary to have terminated the lease under state law. This is normally done by written notification, usually after a grace or cure period specified by the lease. If the lease was validly terminated prior to the filing of the bankruptcy but the tenant is holding over, the landlord should be able to seek an eviction order in state court despite the automatic stay, although some attorneys will first seek bankruptcy court approval to do so.

Landlord's Duties. If the lease was in effect at the time of filing, then unless and until the lease is rejected, the landlord must perform in accordance with its terms, even though the tenant is not paying rent. One exception, however, is that the tenant must pay the landlord for services and supplies that are incidental to the lease, such as heating, cooling, janitorial service, and so forth. If the tenant does not pay for such services and supplies, the landlord may cease providing them.

Assumption and Rejection. If the tenant assumes the lease, he must bring it current and provide adequate assurance that he will be able to meet his future obligations under the lease. This might take the form of a cash deposit or letter of credit, or in some cases, it might just be the debtor's promise to pay. It is also possible for the tenant to assume the lease and simultaneously assign it to a third party, notwithstanding any restrictions on assignment in the lease.

If the tenant rejects the lease, the landlord has a claim for the breach of the lease. This claim, which covers unpaid rent which accrued prior to the bankruptcy filing and damages for the tenant's premature termination of the lease, is made by filing a proof of claim with the Bankruptcy Court. This claim is considered a general unsecured claim and in most cases will not be paid in full. In addition, the landlord's claim is in any event limited to a ceiling amount equal to the unpaid rent which had accrued at the time of the bankruptcy filing, plus the rent payable under the lease for the greater of one year or 15% of the remaining term of the lease but not to exceed three years. The practical result is that the landlord generally receives only a small percentage of the actual unpaid rent and damages. The landlord is, however, entitled to rent on a priority basis for the period of the post-filing occupancy (that is, for the time between filing and rejection). He is not entitled to exercise his landlord's lien rights against the property of the tenant, however.

Conclusion. In most cases, it is not necessary for the landlord to do anything. The post-filing rent should eventually be paid, and the tenant should eventually assume or reject the lease. If post-filing rent is not paid and falls into arrears, the landlord may need to petition the bankruptcy court for payment of the rent. However, if the tenant owes pre-filing rent, or if the lease is rejected, it may be necessary to file a proof of claim in order to share in the distributions to the general creditors.