Landlords seen proactive with tenant bankruptcies

Real Estate Weekly, Jan 16, 2002 by Natalie Keith

When dealing with tenants teetering on the brink of bankruptcy, an ounce of prevention could be worth a pound of cure to landlords, according to lawyers who have worked with both tenants and landlords coping with bankruptcy.

"A landlord and property manager must be proactive in monitoring tenants, in watching for some of the warning signs of bankruptcy," said Jeffrey Moerdler, a real estate lawyer with the firm of Mintz, Levin, Cohn, Ferris, Glovsky & Popeo.

If a landlord spots a tenant that is experiencing financial difficulty, then steps may be taken to fend off the onset of bankruptcy. Moerdler said he recently worked with a landlord that renegotiated a larger security deposit from a tenant in exchange for reducing monthly rent payments.

With the change, the tenant was able to avoid financial trouble, but the landlord also benefited from the renegotiated terms, he said.

Even if a tenant is headed for bankruptcy, a proactive stance can be beneficial to a landlord. If a tenant wants to break a lease, then ending it prior to bankruptcy filing can give a landlord more leverage during court proceedings, said Timothy Duggan, an attorney with the New Jersey-based law firm of Stark & Stark.

"If a tenant is getting behind in the rent, you should contact them. I'm a big advocate of communication," Duggan said.

The national economic slowdown, the collapse of many dot-corns, and the aftershocks of Sept. 11 have created dubious economic conditions for many businesses in the New York area. As a result some companies have filed for protection under the Chapter 11 bankruptcy code, while others have been forced to close their doors altogether, officials said.

Some businesses are using bankruptcy as a tool to terminate leases signed at "above-market" conditions or capture value from leases signed under "below market" circumstances, officials said.

"Over the last several years, we've seen some creative applications of the law from tenants seeking to gain value from leases," said Mitchel Perkiel, a bankruptcy attorney with the law firm of Jenkens & Gilchrist Parker Chapin.

Once a tenant files for bankruptcy the law requires that all legal actions against it -- including eviction proceedings -- are halted. To resume the eviction, the landlord must obtain court approval for relief from the bankruptcy "stay," lawyers said.

After the bankruptcy is filed, a tenant has 60 days to make a decision to either assume or reject a lease. Under law, tenants can also reassign the lease to third party, even if the lease specifically prohibits it This is frequently done with retail chains that decide to close stores that are performing poorly so the company can improve its financial health. In these cases. leases are packaged with inventory as part of a sale to a third party they said.

"The landlord must be prepared to perform a financial analysis or credit check on the prospective assignee to make certain the new tenant will be able to perform under the lease," Duggan said.

Because the landlords can do little to address tenant issues during the first 60 days of a bankruptcy filing, it is important to complete an eviction or file necessary documents to terminate a lease prior to the filing, lawyers said.

"Landlords should send relevant notices prior to bankruptcy filing. what's an important tool because often a debtor has been dealing with a lot of issues and dealing with the landlord gets pushed back," said Claude Montgomery, an attorney with the Salans law firm.

By law the 60-day window can be extended at the request of the tenant, although the tenant is required to make "post-petition" rent payments -- or payments that come due after the date of the bankruptcy filing -- while the court is deciding the Chapter 11 company's fate, lawyers said.

"It's fairly common for courts to extend the 60 days, especially if post-petition rent is up to date," Montgomery said.

However landlords -- particularly those for whom long delays in making lease decisions would be especially detrimental -- should not sit idly by while the courts determine their tenants fate. For instance, a landlord may be in the process of refinancing a building and needs to know whether a tenant is planning to stay. The goal of the courts is to balance the rights of the landlord with the requirement that a Chapter 11 company maximize its value, Perkiel said.

"Landlords have the right to file a motion against extending the 60-day period. Landlords can object to any further extensions saying it is time for the tenant to fish or cut bait," Perkiel said.

Lawyers noted that, although addressing bankruptcy issues is important when tenants are experiencing financial difficulty, there are also steps landlords can take to minimize risk associated with bankruptcy even before a tenant takes occupancy to a space. During lease negotiations, one of the most important issues relates to a tenant's security deposit, lawyers said.

"The size of the security deposit is the landlord's biggest tool in addressing bankruptcy issues," Montgomery said.