What To Do When A Major Commercial Real Estate Tenant Goes Dark

Mar 15, 2018

As an investor, your ability to profit from an investment depends on making sure there are as few vacancies as possible, for as little time as possible.

That’s why an investor’s biggest fear is of a tenant “going dark,” or vacating a property, usually because they are unable to pay the lease.

Of course, if you’ve spent the time vetting a tenant properly then the risk of a tenant going dark is much lower, but in today’s economy, especially with the impact of e-commerce on retail brick and mortars, it’s always best to be prepared for the worst.

One of the best ways you can do this is to make sure you know the rules of what your rights are as a landlord when a tenant files for bankruptcy.

Knowing what rights your tenant has, how the wording of the lease affects those rights, and what you can legally do as a landlord can make the difference between a new tenant, or being stuck with a deadbeat who won’t pay rent and won’t allow you to bring in a new tenant who can.

How Bankruptcy Works

How bankruptcy works

Bankruptcy doesn’t necessarily mean all is lost. In fact, if you make sure to follow the proceedings carefully, not only will you be able to escape with the least damage possible, but there is even the possibility of retaining your tenant – even if they haven’t paid you in full in the past.

Here’s how bankruptcy works.

A business tenant can file for bankruptcy under either Chapter 11 or Chapter 7. While both refer to bankruptcy, each one differs in significant ways.

In Chapter 7, the court takes immediate action to ensure that as many debts as possible are paid off. In order to do so, the court appoints a trustee, who takes control of the business’ assets and then sells them, paying off creditors. A Chapter 11 bankruptcy, on the other hand, aims at allowing the business to continue to operate under the supervision of the court.

Also known as “reorganization,” the process is meant to give businesses time to restructure the business to be more efficient and pay off creditors.

Courts usually grant businesses a Chapter 11 bankruptcy if the value of the business is then its assets. In other words, if the business can make more money by remaining open then closing and selling off its assets, the court allows it to remain open.

If the business is unable to restructure itself successfully, Chapter 11 is converted to a Chapter 7, and the courts then take control of all assets.

It’s important to know that any debts created by a tenant files for bankruptcy are termed “pre-petition” claims, while debt accrued after the claim is filed is called a “post-petition” claim.

All attempts to claim a pre-petition debt are prohibited by the court until the business has restructured the business, set up financial arrangements to pay pre-petition debts, and received approval of the plan from a majority of creditors. As a landlord, you can legally continue efforts to collect money from a tenant’s guarantors, however.

On the other hand, post-petition may be paid in order to allow the tenant to remain in good standing with suppliers so they can continue to do business.

Let’s say that a tenant stays on your property even after they file for bankruptcy. The debt accrued during that time is a post-petition claim since it occurred after they filed a bankruptcy claim. Legally it must be paid before any other claims, and if there isn’t enough money left to pay all the creditors, then the remaining money is shared out proportionately between them.

However, rent owed before a bankruptcy claim is filed is termed “pre-petition” rent and is known as an unsecured claim. This is the worst type of claim as a creditor since legally it is the last to be paid – if it gets paid at all. Often payments are minimal.

Can A Tenant Be Evicted After They File For Bankruptcy?

Almost all leases have clauses that state the lease is void if a tenant files for bankruptcy.

However, legally you as a landlord are not allowed to evict a tenant because they file for bankruptcy. Furthermore, landlords aren’t even allowed to raise the rent, require a higher security deposit, or make the lease stricter in any way.

Thus, as an investor, it is critical that if you do not plan to work with the tenant, that you terminate the lease before bankruptcy is filed. That means if a tenant does not pay rent by the end of the period specified in the lease or by state law (whichever is greater), then the lease is null and void.

However – and this part is critical – if at any point after the lease is technically void you accept money for rent from the tenant, then the lease is still valid. This is true even if you’ve already served an eviction notice. In order to evict the tenant, you would need to serve a second notice to the tenant and wait for the new notice to reach its expiration date.

Thus if you accept payment from a tenant after the notice period ends, and the tenant files for bankruptcy, you will be unable to evict the tenant since legally the lease is still in effect.

What To Do If The Tenant Chooses To Continue The Lease After Bankruptcy

what to do if the tenant chooses to continue the lease after bankruptcy

If for whatever reason the tenant is still in the property once they file for bankruptcy, then under both a Chapter 7 and a Chapter 11 they have 60 days to either reject the leas or accept the lease. If they accept the lease, they are not only agreeing to pay the full rent from then and onwards, but they are also agreeing to pay back any back rent that is owed.

As the owner of the property and the landlord, you must be told when the 60-day period ends though the tenant may ask the court for an extension.

It’s essential that you keep track of when the 60 day time period begins and when it ends, as you will be expected to present your side of what the lease entails and how lack of payment affects your investment. This is your time to emphasize to the court how the burden of a non-paying tenant has (and will continue) to impact on your property by increasing your financial burden and ability to pay for essential expenses.

The laws surrounding bankruptcy are complex and sometimes confusing. However, just as you plan an exit plan for the property itself, planning an strategy in the event a tenant goes dark is not only a good idea but one that will help you earn a predictable income for years to come.

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