What to Consider When Your Commercial Tenant Stops Paying Rent
Authors:
Matthew R. Johnson, Esq.
Devin K. Bolger, Esq.
May 19, 2020
Among the many economic fallouts of COVID-19, commercial tenants are struggling to pay rent as social distancing and stay-at-home orders grind enterprise to a halt. Many tenants have signaled financial insecurity or stopped paying rent, and scores more likely will follow. An uptick in bankruptcies is expected in the near future. For landlords whose tenants may threaten to file for bankruptcy, taking a hard negotiating position and pursuing the tenant for unpaid rent in bankruptcy might, at first blush, seem like the best way to maximize recovery. That choice, however, could stick the landlord with a claim for unpaid rent worth pennies on the dollar. Depending on the particular factual circumstances, the wiser approach might be to negotiate a lease modification with reduced rent. While tough to bear, the financial hit associated with a brokered rent reduction could pale in comparison to the amount a landlord might receive through filing a claim for unpaid rent in bankruptcy court.
First, some basics. After filing for bankruptcy, a commercial tenant generally has four months to decide whether to assume, reject, or assign an unexpired lease (the tenant can sometimes extend this time period by three months if it gives the court a good enough reason). If the tenant assumes the lease, then it must pay any back-rent and assure the landlord that it will continue making rent payments in the future. In that event, all is well that ends well. If the tenant assumes the lease but then fails to make rent payments or attempts to reject the lease, then the landlord will at least have what is called an “administrative” claim—one that is prioritized over other unsecured creditors—for unpaid rent. Such a claim is no guarantee of payment, but still positions the landlord better than all other unsecured creditors. The tenant can also assign the lease to another party, and while the third party may not be the landlord’s chosen business partner, the landlord will nevertheless receive assurance that the third party will be able to make rent payments moving forward.
If, on the other hand, the tenant rejects the lease (or lets the four months expire without assuming the lease or seeking a court-approved extension of time), then the landlord is largely out of luck: any claim against the tenant for rejection of the lease is capped by a statutory formula that prevents the landlord from getting more than the greater of: (1) one year’s rent; or (2) 15% of the remaining rent due under the lease (but only up to three years of rent); plus (3) any unpaid rent due under the lease by the earlier of the date of the filing for bankruptcy or the date on which the landlord repossessed, or the tenant surrendered, the leased premises. Further, courts will usually not interfere with a tenant’s decision to reject a lease, so there is little a landlord can do besides get in line with other unsecured creditors and hope the bankruptcy estate will have enough assets to pay an already limited claim. The landlord may have an administrative priority claim for unpaid rent accruing between the date of the bankruptcy filing and court’s approval of the tenant’s lease rejection, but the amount of such a claim will, in most instances, not make the landlord whole.
Thus, given the downside risks of chasing or pushing a commercial tenant into bankruptcy, commercial landlords would be well-advised to consider whether negotiation and compromise is a better approach. If you do want to work out such an arrangement with your tenant or tenants, we are here to help with the strategy and to ensure that any lease amendment or modification protects your rights.
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