Commercial Real Estate Leases in Bankruptcy: What to Expect When Your Landlord Files for Chapter 11

The disruption from the COVID-19 and the recent social and political crises have wreaked havoc on commercial landlords and their ability to maintain occupancy, collect rent, protect commercial real estate and service debt. The costs associated with repairing property damage, securing business property, the loss of tenant occupancy and absorbing tenant defaults are expected to result in many commercial landlords seeking relief under Chapter 11 (or under Subchapter V of Chapter 11). Tenants should be aware of the impact that a Chapter 11 filing has on their rights and remedies under a lease, as well as bankruptcy provisions that uniquely impact tenants. Tenants should be mindful that:

• When a Chapter 11 petition is filed, the leasehold interest becomes property of the landlord’s bankruptcy estate and the automatic stay prevents a tenant from canceling or terminating the lease. 
• Lease provisions providing for a default or termination due to the landlord’s bankruptcy or insolvency are not enforceable.
• Where a lease is rejected, the tenant has the option to treat the lease as terminated or elect to retain its rights under the lease.
• If the tenant elects to vacate the leased space, the tenant can file a proof of claim for damages resulting from the landlord’s breach. Importantly, issues may arise regarding whether tenant improvements or equipment installation can be removed by the vacating tenant or have become fixtures integral to the leased property. Tenants are advised to proceed cautiously and seek legal advice with respect to removal of such property (which may be considered property of the bankruptcy estate).
• If the tenant elects to retain its rights under the lease, the landlord is not obligated to perform its duties under the lease (for example, to provide maintenance), but the tenant can continue to lease the premises for the remainder of the term of the lease plus any extensions or renewals provided in the lease that are enforceable under state law. In exchange for retaining its interests despite rejection, the tenant must forego any damages claims against the landlord and must continue to pay rent but may offset its rental obligations against any damages that result from the landlord’s breach. 
• The tenant’s right to continue leasing the premises after rejection of the lease may nevertheless be lost or affected if the bankruptcy court allows the landlord to sell its assets free and clear of interests or if the lease is a below market lease. Whether a tenant loses its rights under a lease if the landlord sells the leased premises free and clear of interests depends on the jurisdiction in which the landlord’s bankruptcy case is filed.
• Because only unexpired leases become property of the landlord’s bankruptcy estate, a tenant who is a holdover tenant under an expired lease at the time that the landlord files for bankruptcy does not have rights or options relating to the leased premises. (Though the landlord and tenant may enter into a new lease after the bankruptcy case is filed)
• All commercial real estate leases (including those that are in default) may be assumed by the landlord in bankruptcy and, where appropriate, assigned to third parties. To assume (and assign) a lease, the landlord must cure all existing defaults (including prepetition defaults) under the lease. 
• The landlord and tenant also have the option to modify an existing lease or enter into a new post-petition lease to resolve claims between them.

Commercial tenants are encouraged to seek legal counsel to navigate the bankruptcy process in the event that their landlord seeks Chapter 11 relief in order to best protect their ability to retain their business location. 

For further information about protecting your interests when a tenant files for bankruptcy, please contact Anne M. Aaronson, Jennifer L. Maleski, Yonit A. Caplow, or any of the attorneys in our Bankruptcy Group.