Weathering the Storm: What Do I Do if the Counterparty to My Lease Files Bankruptcy?

02/18/2009

If the counterparty to your real property or personal property lease files bankruptcy, you should not pursue self-help remedies available in your lease agreement. Instead, you should promptly contact your bankruptcy counsel to insure that your legal rights are protected.

The Automatic Stay
Upon the filing of all bankruptcy cases, an automatic stay arises that prevents you from taking actions against the debtor even though your lease agreement may authorize such actions. A violation of the automatic stay could lead to serious monetary sanctions imposed by a Bankruptcy Court. Before taking any action against the debtor, consult with your bankruptcy counsel to avoid running afoul of the automatic stay provisions in the Bankruptcy Code.

Assumption or Rejection
A debtor in bankruptcy must either “assume” or “reject” all of its unexpired leases. If the debtor decides to reject the lease, such a rejection is deemed a breach of the lease as of the day before the bankruptcy was filed, and you may be entitled to a damages claim caused by the breach. If the debtor decides to assume the lease, then the debtor must (i) “cure” all defaults that may exist under the lease and (ii) provide “adequate assurance of future performance.” Adequate assurance of future performance is simply the presentation of evidence sufficient to demonstrate that the debtor is capable of performing its future obligations that will become due under the lease. The debtor may also seek authority from the Bankruptcy Court to assume the lease and then assign its rights under the lease to a third party. This tactic is common when a company sells its assets in bankruptcy and is enforceable over your objection even if your lease agreement contains a non-assignability clause.

Real Property Lease Issues – When the Debtor is Your Tenant
If the debtor is your tenant under a real property lease, you are entitled to be paid rent that comes due from and after the date the bankruptcy petition was filed until the debtor assumes or rejects the lease. The debtor must decide whether to assume or reject a real property lease within 120 days after the day the bankruptcy case was filed. This time period may be extended by the Bankruptcy Court, but for no longer than an additional 90 days. If circumstances warrant, you may file a motion with the Bankruptcy Court seeking to compel the debtor to immediately assume or reject the lease or to reduce the above time periods. If your real property lease is rejected, your damages claim will be treated as a pre-petition unsecured claim and your damages claim will be capped at the greater of one year’s rent due under the lease, or 15 percent, not to exceed three years, of the remaining term of the lease.

Real Property Lease Issues – Debtor as Landlord
If the debtor is your landlord and the debtor decides to assume the lease, then you will continue to remain in possession of the lease premises pursuant to its terms. If, however, the debtor decides to reject your lease agreement, you may elect to (i) remain in the premises for the remaining term of the lease, including all renewable terms, or (ii) terminate your lease and assert your claims for damages against the debtor’s bankruptcy estate.

If you elect to remain in the lease premises, the debtor will no longer be obligated to perform its obligations under the lease, except to the extent required under state law. You may, however, offset your future rent payments against damages you suffer as a result of the debtor’s nonperformance of its obligations, with certain limited exceptions.

Personal Property Leases
Similar to real property leases, the debtor’s available options regarding a personal property lease are to either assume the lease, assume and assign the lease, or reject the lease. Until the debtor decides to assume or reject the personal property lease, however, the debtor is required to pay the value of the debtor’s post-petition use of the personal property. The value of such use is presumed to be the contract rate, but this presumption is rebuttable by the debtor. Unlike real property leases, debtor parties to personal property leases are not required to assume or reject personal property leases within the 120 day period applicable to real property leases as discussed above. The Bankruptcy Code provides special provisions unique to leases of aircraft equipment and vessels. If you are a party to a lease of aircraft equipment or vessels, therefore, you should contact your bankruptcy counsel to review your options available under such leases.

File Your Proofs of Claim
To preserve your claims against the debtor, you must timely file proofs of claims prior to the applicable bar dates in your debtor’s bankruptcy case. Depending upon the facts in the case, you may hold several different claims against the debtor, including (i) pre-petition unsecured claims for amounts that were due and owing pre-petition under the lease agreement, (ii) pre-petition unsecured claims for damages caused by the debtor’s rejection of the lease, (iii) post-petition administrative expense claims, and (iv) potential secured claims.

Conclusion
If the counterparty to your real property or personal property lease files bankruptcy, your rights will probably be affected early in the debtor’s bankruptcy case. To insure that all of your rights are properly protected, you should move quickly to develop and implement an effective action plan.

For more information on the Restructuring, Workouts and Recapitalizations group and its members, go to Restructuring, Workouts, and Recapitalizations.

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