How to Navigate Change and Prepare for Bankruptcy in Commercial Real Estate
- Sep 20, 2021
During 2020, many retail tenants file for bankruptcy and then sold or shut down their operations because of COVID-19. The number of bankruptcies that occurred because of the pandemic significantly impacted landlords’ rights in signed leases. This also forced landlords to review leases more closely and determine how their tenants’ bankruptcies could affect them. Many landlords made amendments to tenants’ leases, allowing deferred rent for those who expected to reopen. Other tenants that were considered nonessential or small businesses were unable to recover financially from the pandemic and, unfortunately, filed for Chapter 11 or Chapter 7 bankruptcy protection.
During late 2020, President Trump signed the Consolidated Appropriations Act (“CAA”), which provided $900 billion in the second wave of economic stimulus relief. The CAA temporarily amended provisions of the U.S. Bankruptcy Code for any bankruptcy cases that initiated after December 27, 2020. Most modifications to the bankruptcy code, such as the CAA, are set to expire as of December 2021 and December 2022.
In a typical bankruptcy situation, a debtor can recover certain payments that were made during the 90 days prior to filing for bankruptcy as a preferential payment. One example is tenants who were allowed to defer rent by their landlords but paid it during the 90-day look back period after subsequently filing for bankruptcy. The debtor in these situations may then be possibly allowed to recover some portion of the deferred rent payments.
The CAA amendment limits the tenants’ ability to recover the deferred rent payments made within two years prior to filing for bankruptcy. Commercial rent deferral is defined as “covered payment of rental arrearages” under the CAA amendment. The goal of the amendment is to encourage landlords to provide rent deferrals for their tenants if they will not be required to return those funds if the tenant decides to later file for bankruptcy.
In addition to the CAA, it is important that landlords and commercial property owners put themselves in a better position by being educated on bankruptcy matters and better prepared for at-risk tenants. Most landlords should have the right to review their tenants’ financials pertaining to their lease agreements. This will allow the landlord to consider if a liquid option will secure the tenants’ obligations depending on the form of lease security, such as a cash security deposit, letter of credit or third-party guaranty. These are options that landlords should be aware of and, therefore, maximize prior to tenants filing for bankruptcy.
In the case that a tenant files for bankruptcy, it is very common that an automatic stay will be put in place. This allows a tenant to remain on the premises and does not allow the landlord to collect or foreclose on property being occupied by the tenant (debtor) while the bankruptcy case is pending, unless the court allows it. This does not often happen until after the first 120 days after the filing for bankruptcy; this is the debtor’s exclusivity period where only the debtor may propose a plan of reorganization. Although the situation may not be ideal to most landlords, they have the option to file a motion to lift the automatic stay to allow them to start an eviction process if the debtor failed to pay current rent obligations.
As the economy and laws pertaining to bankruptcy and real estate continue to change because of COVID-19, there is no better time than now for landlords to start reevaluating their leases and the financial condition of their tenants. Landlords should start working on ways to handle bankruptcy situations that would benefit both parties by having the conversation and proposing ways to adapt and adjust before it is too late.
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Shaquan Williams is an Audit Senior in the Bankruptcy and Restructuring Group with experience serving both public and privately held companies, and wealthy individuals.
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