Know Your Rights When It Comes to Commercial Real-Estate Rental, Reap the Rewards

Times are tough for many commercial landlords. Here's how to protect your business if your landlord files for bankruptcy.

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Thanks to a wide-scale trial forced upon us by the pandemic, telecommuting is growing by leaps and bounds. While this may augur heightened sales of standing desks and fancy chairs for the house, it could have the opposite effect on . Many owners of commercial real estate may need to declare in order to restructure their debt load as a result of falling rental income and demand.

How should you, as a tenant, protect yourself against a potential landlord bankruptcy?

Before the fall

If it's possible that your landlord might encounter financial distress, it’s time to take a look at your agreement. What you may find is a clause related to “attornment.” This clause is often required by the landlord’s lender, and it states that you agree that the lender can take over your lease in place of the landlord if the lender forecloses on the property because of non-payment by the landlord. If it’s not in your lease, what you need to seek is a non-disturbance agreement, whereby any successor to your landlord agrees not to disturb your occupancy of the space.

If your landlord appears to be in breach of your lease, perhaps due to lack of maintenance or other problems, the time to act is now. You should declare a default, and, if the lease permits, terminate the lease before a foreclosure or bankruptcy arises so you don't need to get the court involved to end the lease.

If you are negotiating a move-in to a new property with a landlord whose financial health is questionable, be careful about promises for tenant improvements used to entice you to sign the lease. A landlord that declares bankruptcy may renege on its promise to provide the tenant improvement funds.  

To protect yourself, you may want to require that the landlord put the tenant improvement funds into an escrow where the funds are automatically released when certain tenant improvement work is completed and paid for.

Related: Here Are Real Estate's Winners and Losers In the New Normal

Holding your ground

One of the special powers granted to debtors in the bankruptcy process is the ability to reject certain contracts to which they are a party, including leases. The aggrieved counterparties are left to file a claim, along with all the other creditors, in the bankruptcy court. Fortunately, there are protections for tenants under section 365(h) of the Bankruptcy Code, which provides that the tenant is either given the choice of deeming the rejected lease to be terminated or maintaining the lease for the balance of the term and any renewal or extension where the tenant has the unilateral right. 

There is a catch: If the tenant elects to stay after the landlord has rejected the lease, the tenant’s only remedy to recover damages due to nonperformance of the landlord is to deduct it from the rent owing.

Unfortunately, this right of tenants to stay is not always upheld because another provision of the Bankruptcy Code (in section 363) allows bankrupt companies to sell property that they own free and clear of other obligations on the property, including its leases. 

While a majority of the courts continue to protect the occupancy rights of tenants during such sale, a minority believe that a property could be sold free of the lease, despite the occupancy rights of the tenant under the aforementioned Section 365(h). If you find yourself in that situation, you may seek compensation for the loss of your leasehold interest from the property sale proceeds by demanding “adequate protection” of your interest in the property.

Related: There's Never Been a Better Time to Be a DIY Landlord

Staking your claim

If you’re owed money by your landlord, it’s time to file a claim in the bankruptcy proceeding. A skilled bankruptcy advisor can tell you whether there is a way to subtract what you’re owed by the landlord from what you owe the landlord using a mechanism called recoupment. There are many strategies for improving the priority of your claim in a bankruptcy that an expert advisor like the company I co-founded, Proxifile, or a specialized attorney can help you with.

Once the bankruptcy case has been filed, under no circumstances should you directly chase the landlord for money owed to you. This would violate a key provision of bankruptcy law called the Automatic Stay, resulting in major penalties from the bankruptcy court. Instead prepare to file a claim. If you are fortunate enough to have the landlord decide to continue the lease (known as “assuming” the lease), it will be obliged to cure its prior defaults and provide adequate assurance that it can perform its lease obligations in the future.

Related: Getting Your Feet Wet in the Rental Property Business

Keep it current

If your goal is to keep your lease, don’t miss any deadlines to pay rent. The fact that your landlord might be bankrupt does not give you carte blanche to withhold payments.  

Sometimes during the bankruptcy of a landlord, you may receive a notice to tender your rent payments to a new account or a new person. This change arises when a trustee has been asked to step in and operate the bankrupt company (your landlord) or the landlord has sought a new financing source that wants to receive payments directly.

Before directing payments to any new person or address or account, you should verify with the court or the landlord itself about where rent payment should be directed. Never accept changes to payment instructions without verifying them directly at an address or telephone number that you know to truly belong to the party that needs to be paid.

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