WHEN A LANDLORD FILES BANKRUPTCY

When a landlord files a bankruptcy case (generally speaking, both a Chapter 7 and a Chapter 13 bankruptcy will be available to individual landlords), both the landlord and the tenant have a great deal of anxiety.  How will the bankruptcy affect the tenancy?  Does the tenant continue to pay rent?  Is the landlord still obligated for repairs?  Fortunately the Bankruptcy Code contains specific provisions for dealing with the rights of both the landlord and the tenant during a bankruptcy. 

The Bankruptcy Code seeks to balance the contractual rights of the tenant against the interest of the bankrupt landlord in discharging overwhelming financial obligations.  Section 365 of the Bankruptcy Code allows a bankrupt landlord to either assume or reject a lease.  In the majority of the cases the landlord accepts the lease and the tenancy continues with the mutual promises and obligations of the lease contract remaining fully enforceable.

If the landlord rejects the lease, then the tenant may treat the lease as terminated and "walk away" without further obligation.  Alternatively, the tenant may choose to stay, however the landlord no longer has any obligation under the lease contract.  The tenant treats the lease as breached and may offset any damages resulting from the breach from rent payments.  If the damages incurred exceed the amount of rents due under the contract, the tenant may be able to submit a proof of claim and participate in the landlord's bankruptcy as a creditor.

To make matters more complicated, section 363 of the Bankruptcy Code permits a landlord to sell the rental property "free and clear" of any contractual interest, such as a tenant's lease.  However, the Bankruptcy Code also enables the tenant to ask the bankruptcy court to "prohibit or condition" any sale to protect the tenant's interest.

Sorting out the legal rights of a landlord and tenant can become highly complex when the landlord files a Chapter 7 or Chapter 13 bankruptcy.  If you are a landlord seeking to file bankruptcy, or the tenant of a bankrupt landlord, discuss your case with an experienced bankruptcy attorney.  The federal bankruptcy laws are flexible on this subject and a resolution that is mutually beneficial can almost certainly be reached.  Make sure your legal interests are protected by retaining qualified counsel.