Tenants get significant protections in Chapter 11 bankruptcy cases, but those protections come with obligations to landlords and other creditors. If a tenant fails to comply with those obligations, it is up to the landlord to seek relief from the Bankruptcy Court.
The Bankruptcy Code generally requires tenants to timely comply with their lease obligations while in a Chapter 11 bankruptcy case. This obligation extends to ongoing monetary as well as nonmonetary obligations under a lease. However, if a tenant fails to comply with its lease obligations, the Bankruptcy Code does not specify a remedy for the landlord. Furthermore, nothing is going to happen “automatically”—it is up to the landlord to submit a motion seeking an appropriate remedy.
Landlords may be faced with lease defaults that the tenant is unwilling or unable to remedy. In these circumstances, landlords most commonly move to compel the tenant to pay outstanding rent or fulfill other defaulted lease obligations or grant the landlord an administrative priority claim for the unpaid rent. Unless the landlord is violating the lease or the Bankruptcy Code, the tenant is not likely to have material defenses to a motion to compel. In many cases, a default letter, call to counsel, or the filing of a motion to compel is sufficient to prompt the tenant to come back into compliance with its lease obligations. A Bankruptcy Court ruling on a motion to compel will likely order the performance of the defaulted lease obligations by a near-term deadline. If that deadline passes without compliance by the tenant, the order may provide for a remedy or require the landlord to come back to the court.
A motion to compel is often paired with a request for alternative relief compelling the tenant to assume or reject the lease by a date certain (or deeming the lease rejected), and, if the lease is rejected, further compelling the tenant to surrender the leased premises to the landlord. Although often requested, it is uncommon for Bankruptcy Courts to order a lease rejected. There is no express authority for this type of relief in the Bankruptcy Code, and courts that grant it must rely on generalized equitable principles or a vague Bankruptcy Code provision authorizing Bankruptcy Courts to enter appropriate orders.
If a tenant is not complying with many of its obligations under the Bankruptcy Code, a landlord could move to convert the case from Chapter 11 (reorganization) to Chapter 7 (liquidation), or, if in the best interests of creditors, to dismiss the bankruptcy case. Where there is serious mismanagement or even fraud, a landlord could move to appoint a Chapter 11 trustee. A Chapter 11 trustee takes over the management and control of the tenant, ensuring that a court-appointed, neutral third party will be responsible for making the best of the tenant’s situation. Often, the support of the US trustee and major creditors is needed before a Bankruptcy Court will enter an order converting a case to Chapter 7, dismissing a case, or appointing a Chapter 11 trustee. These extreme remedies are generally granted only if the tenant is unable or unwilling to pay its ongoing operating costs, the tenant is suffering significant ongoing losses without a reasonable ability to reorganize, or there is mismanagement or fraud.
In the next installment of Bankruptcy Basics for Retail Landlords, we will discuss another possible, and likely, remedy that Bankruptcy Courts may grant a landlord in circumstances where the tenant is not complying with its lease obligations—relief from the automatic stay to pursue eviction of the tenant and to regain possession of the premises in state court.