By Amelia Martin Adams
Guidance from Stoll Keenon Ogden
As the COVID-19 pandemic continues to cause seismic shifts, the economy is preparing to address its long-term effects. Retailers are restructuring to offer consumers curbside pick-up and online shopping, and restaurants are creating new ways to treat customers to dining at home. A multitude of workers have transitioned to telecommuting, and organizations are adjusting to videoconferences for team communications. While these changes have allowed some businesses to adjust to a “new normal” for the foreseeable future, others have been unable to maintain operations and either closed or made difficult decisions to defer large expenses—like rent—to stay afloat.
Facing dramatically reduced revenues, landlords are evaluating what’s to come as business tenants consider reducing spaces to curb expenses or closing their doors. Some of those landlords may consider bankruptcy to address defaults on their own mortgages or other financial shortfalls, leaving commercial tenants wondering what will happen to their leases if the real estate becomes part of a bankruptcy case.
Operation of leases during a bankruptcy
In a chapter 7 case, a trustee is appointed to wind down the landlord’s operations, liquidate its assets, and distribute proceeds to creditors in the priority set by the code. In contrast, in a chapter 11, the landlord becomes a debtor in possession upon filing its bankruptcy petition, meaning that the landlord retains control of its operations and assets except in rare instances where a trustee is appointed. The goal of a chapter 7 is to liquidate the debtor’s assets. The goal of a chapter 11 could be liquidation or reorganization under a sale of assets, a “chapter 11 plan,” or both, approved by the Bankruptcy Court. In either case, the landlord has three options for a lease: assume and retain the lease, assume the lease and assign it to a third party, or reject the lease.
The code sets a specific deadline for a chapter 7 trustee to assume a residential real property lease or it will be deemed rejected. It also sets a deadline for a chapter 11 DIP to assume or reject a commercial lease where the tenant is the DIP. Yet, the Code does not set a deadline for a chapter 7 trustee or chapter 11 DIP to assume or reject a commercial lease where the landlord is the debtor. The practical impact of that lack of specificity depends on the case. However, because the Code requires landlords to timely perform nearly all obligations under commercial leases during bankruptcy until assumption or rejection, the likelihood of a landlord wholly ignoring a lease is slim.