The legal issues surrounding leases in bankruptcy cases can depend on what type of bankruptcy is being talked about. Chapters 7, 13, and 11 each have separate rules and procedures with regard to leases. In a Chapter 7 case, the bankruptcy trustee has the option of assuming the debtor’s interest in the lease or curing any default under it. In practice, this only happens on rare occasions with commercial leases (not residential leases). Chapter 7 trustees almost never bother with residential leases, since they provide no value to the estate. In commercial lease situations where the rent provided under the lease is significantly below the market rate, or where the premises have some sort of value to the estate in a business liquidation, this type of thing is possible in theory.
In a Chapter 7 business liquidation, the trustee has the right to commandeer the premises and use them for storage or for a bankruptcy sale. Here again, this rarely happens. Even in a liquidation, it often happens that by the time the case is filed, there is little value to the estate that can be had by operating the business. In situations where Chapter 11 cases are converted to Chapter 7, or where the business has a large amount of liquidation value, this can change. When the bankruptcy petition is filed, the landlord is prevented by the automatic stay from attempting to enter the premises and repossess the inventory or equipment on the premises, even if the rent has not been paid and a state court has ordered the debtor to be evicted.
The Chapter 7 trustee can use the leased premises to store the property until it can be sold, if it has significant value for the estate. If the trustee does not assume the lease of the business, and uses the premises for storage, it may not be easy for the landlord to collect rent from the trustee. The trustee typically claims that the estate is only liable for a lower amount, or only for the period in which the trustee was actually in possession. And if there is not enough funds in the estate to pay for the expenses of administration, then the amount might not be paid. Landlords and their attorneys are often unfamiliar with the nuances of bankruptcy law and their rights under it.
They may be unpleasantly surprised to find out that their statutory landlord lien is invalid in bankruptcy. Rent arrearages that may exist at the time of the filing of the case might get treated as a general unsecured claim in the estate, which usually amounts to very little in recovery. A landlord subject to the automatic stay by the filing of a bankruptcy case cannot simply ignore it. This is true regardless whether he has received notice from the court. One of the basic purposes behind the automatic stay with regard to leases in Chapter 7 is to permit the trustee time to assess the condition of the premises and any property in it. Generally the trustee has 120 days to assume or reject a lease of nonresidential real property. The court can extend this for another 90 days if needed.
In business liquidation cases where a lease is involved, it is not always a simple matter for a landlord to collect rent during the time the trustee is in possession of the premises. In situations of nonresidential real property, the trustee has an obligation to “timely perform all the obligations of the debtor” arising under the lease, until the lease is assumed or rejected. In Re Cukierman, 265 F.3d 846 (9th Cir 2001). If the lease has significant value, it is even possible that the trustee may assume and the possibly assign or sell it. Before it can be assumed, he would have to cure any default under it, and compensate the landlord for any damages suffered by the breach of the lease.
If the property continues to be used by the trustee after the filing of the bankruptcy, it is possible that the landlord can request compensation under Section 503(b) of the Bankruptcy Code (administrative expense). The landlord would be entitled to the “reasonable value” of the use of the premises. This is not necessarily the rent amount specified in the lease agreement; in fact, it may be significantly less than this. And even if the estate can afford to pay the landlord administrative rent, claims will be based on the actual value received by the estate, not on the value that was lost by the landlord. However, the landlord may be entitled to “adequate protection” payments during the pendency of the case. As can be seen from this discussion, a landlord’s attorney will need to be aggressive and persistent if he wishes to recover anything for his client from the Chapter 7 trustee once a business liquidation is filed.