Page 24 - August 17-September 6, 2022 C ommercial tenants are expected to temper the impact of rapid inflation, but experts believe that evolving market trends will play a role in future tenant defaults. Land- lords contemplating termi- nating or renegotiating a ten- ant’s lease should consider the Bankruptcy Code’s impact on such decisions. n Terminating the lease. In general, a landlord may ter- minate the lease prior to the tenant filing for bankruptcy. If done correctly, the lease does not become property of the estate, and thus is not sub- ject to assumption or rejection, allowing the landlord to mar- ket and relet the property. If the landlord does not terminate the lease prior to the petition date, the debtor has 120 days (currently 210 days under the CARES Act) to assume or reject the lease. Even if the debtor intends to reject the lease, until it is rejected, a landlord may not relet the property. The land- lord can market the property and condition any lease on the debtor’s formal rejection, but such contingency may make it difficult to relet the property. By terminating the lease prior to bankruptcy, a landlord can avoid waiting on the debtor to make a decision with respect to the lease and will be in a better posi- tion to relet the property. If a land- lord decides to terminate the lease prior to bankruptcy, the landlord should be aware of two things. First, a landlord must strictly comply with applicable law and the terms of the lease. With strict compliance, a landlord can bet- ter situate itself in the event a debtor considers challeng- ing the termination. Second, termination and eviction pro- ceedings can be lengthy events, and a debtor often files for bankruptcy on the eve of such events. If this happens, the “automatic stay” will prevent the landlord from taking fur- ther action against the debtor. Although a landlord can seek relief from the automatic stay, this can be difficult. Therefore, a landlord should terminate the lease when the tenant still has other options available to it and is not boxed into a corner. n Lease amendments or entering into a new lease. Rather than terminate the lease, a landlord may wish to press the reset button with the tenant, and amend the lease or enter into a new lease. This, too, should be done with an eye toward bankruptcy. As an initial matter, in con- nection with any lease amend- ments or new lease, the land- lord should obtain comprehen- sive financial information from the tenant. Not only will this allow the landlord to make an informed decision, but it may allow the landlord to argue that its claim is nondischarge- able in a future bankruptcy case. A landlord should be hesitant about accepting any payment from the tenant to satisfy past debt. On its face, this could con- stitute a “preference” that the debtor may attempt to claw- back in bankruptcy. Although a new defense affords a landlord new protections to account for arrearage payments, the land- lord should strictly comply with such provision. Another option is to “forgive” the old debt and enter into a new lease, whereby the new rent pay- ments are increased to account for the past-due amounts. In connection with a new lease, the landlord also should consider the form and amount of any security. Most landlords take a security deposit from their tenants, which renders a portion of the landlord’s allowed claim as a secured claim. However, even though the security deposit is often in the possession of the landlord, the deposit is considered the debtor’s property. In order to apply the deposit to amounts owed, a landlord must work with the debtor or seek court approval. A better option is using a letter of credit in lieu of a security deposit. A letter of credit is not property of the estate, because it allows the landlord to seek payment directly from the financial institution. A landlord can thus bypass the bankruptcy process, and immediately satisfy a por- tion of the tenant’s past-due rents. A landlord also should consider the amount of the security and take into account the tenant’s business and the cost of any cleanup. In most bankruptcies, cleanup costs are borne by the landlord. A landlord should explore obtaining a guaranty from a third party. If a tenant defaults on its rent obligations and files for bankruptcy, the automatic stay does not prevent the land- lord from collecting past-due rents against the nondebtor third party. A landlord also should ensure that the tenant’s rental obligations are properly char- acterized to maximize the amount of any “allowed” claim in bankruptcy. While a tenant’s fixed monthly payments cer- tainly are allowed claims, other obligations, such as common area maintenance charges and insurance premiums, may not be. The Bankruptcy Code con- tains a number of undefined terms, and courts have taken different approaches as to what is included in these terms. The amount a landlord can claim depends largely on the terms of the lease and the appli- cable law. Any new lease or lease amendment should take into account these differenc- es to ensure it maximizes the amount of any allowed claim in bankruptcy. Short of obtaining an astro- nomically large security depos- it, a landlord cannot safe-proof itself from a tenant’s bankrupt- cy case. However, amending or entering into a new lease with its tenant with bankruptcy principles in mind, a landlord can protect itself during the process. s Bankruptcy intel for workouts with defaulting tenants Law & Accounting Assurance, tax, and consulting offered through Moss Adams LLP. Investment advisory services offered through Moss Adams Wealth Advisors LLC. Investment banking offered through Moss Adams Capital LLC. Here, the sun rises on fresh ideas and boundless potential. With an abundant spirit of optimism, openness, and enterprise—we help clients in the real estate industry grow, manage, and protect their prosperity. RISE WITH THE WEST. M O S S A DA M S .C O M / R E A L E S TAT E I N S I G H T R I S E S I N T H E W E S T Patrick Akers Attorney, Moye White