The Bankruptcy Code and Commercial Leases: The Basics
When any entity files for bankruptcy protection, an automatic stay immediately halts most actions against the debtor or the debtor's property. For commercial leases, this means landlords generally cannot evict a tenant-debtor without court approval, and tenant-debtors cannot easily be forced out of their leased space.
The governing provision is Section 365 of the Bankruptcy Code, which gives the bankruptcy trustee or debtor-in-possession (DIP) the power to assume or reject executory contracts and unexpired leases. This single provision has enormous consequences for everyone in a commercial lease relationship.
Two Scenarios, Two Sets of Problems
| Scenario | Who Filed? | Primary Concern | Key Statute |
|---|---|---|---|
| Landlord Bankruptcy | Landlord (property owner) | Will my lease be rejected? Can I stay in my space? | 11 U.S.C. § 365(h) |
| Tenant Bankruptcy | Tenant (business operator) | Must I assume or reject? What are the deadlines? How much do I owe? | 11 U.S.C. § 365(d)(4) |
When Your Landlord Files for Bankruptcy
Landlord bankruptcies became increasingly common during the retail apocalypse, COVID-era distress, and the ongoing correction in office and retail valuations. When your landlord files, your immediate concern should be: what happens to my lease?
The Automatic Stay and What It Means for Tenants
The automatic stay doesn't help or hurt tenants in landlord bankruptcies as directly as it does in tenant bankruptcies. In a landlord bankruptcy, the stay prevents secured creditors from foreclosing on the property — which indirectly protects the tenant's right to stay.
Section 365(h): The Tenant's Bill of Rights in Landlord Bankruptcy
This is the most important protection for tenants in a landlord bankruptcy. Under § 365(h), if the landlord (debtor) rejects the lease, the tenant has two options:
| Option | What It Means | Best For | Risks |
|---|---|---|---|
| Option 1: Accept Rejection | Treat the rejection as a lease termination, vacate the premises, and file a claim for rejection damages as an unsecured creditor | Tenants with above-market leases, bad locations, or when the landlord's estate is insolvent | Unsecured claims may recover only cents on the dollar; relocation costs are real |
| Option 2: Remain in Possession | Continue occupying the premises for the full remaining lease term, including any renewal options, while offsetting landlord defaults against rent | Tenants with below-market leases, established locations, or significant TI investments | Landlord services may deteriorate; new owner may be uncooperative |
The § 365(h) offset right: If you elect to remain in possession after lease rejection, you can offset the value of landlord's obligations (HVAC maintenance, common area upkeep, utilities, etc.) against your rent payments. If the landlord-debtor was failing to provide services before the bankruptcy, you can quantify those defaults and reduce rent accordingly. This is a powerful right that many tenants don't know they have.
What Happens When the Property Is Sold in Bankruptcy
When a landlord's property is sold through a bankruptcy §363 sale, the buyer typically takes subject to existing leases under § 365(h) — meaning your lease survives the sale if you elected to remain in possession. However, if the landlord sells the property free and clear of all encumbrances and the court approves that approach, the interaction with tenant lease rights becomes more complex.
Tenants with recorded leases (or leases with recorded memoranda) have the strongest protection in a landlord bankruptcy property sale. Unrecorded leases may face challenges if a §363 buyer claims they took without notice of the lease.
Record your lease or a memorandum of it. Recording provides constructive notice to potential buyers and strengthens your § 365(h) retention rights. Ask your landlord to sign a memorandum of lease for recording at or shortly after lease execution.
The Critical Timeline: Landlord Bankruptcy
When the Tenant Files for Bankruptcy
When a commercial tenant files for bankruptcy, the landlord faces a different set of challenges. The debtor-tenant gets time to decide whether to keep or shed the lease — and the landlord is largely at their mercy during this period.
Section 365(d)(4): The 120-Day Rule
A debtor-tenant must assume or reject its commercial real property lease within 120 days of the bankruptcy filing. If the lease is not assumed within 120 days, it is deemed rejected by operation of law. This is automatic — no court order required.
The 120-day period can be extended:
- By 90 additional days with the landlord's written consent
- For cause upon court order, with no specific time limit (though courts scrutinize extended delays)
Landlord strategy: Withholding consent to a 365(d)(4) extension — especially when you want the tenant out — is a legitimate landlord tactic. Refusing consent forces the automatic rejection at 120 days, which terminates the lease without requiring a rejection motion or court order.
Requirements to Assume a Lease in Bankruptcy
If the tenant-debtor wants to assume the lease (keep it), they must satisfy all three conditions under Section 365(b)(1):
- Cure all existing defaults — Every past due rent payment, unpaid CAM reconciliation, expired certificate of insurance, or other breach must be cured in full at the time of assumption. No partial cure is permitted.
- Compensate for actual pecuniary loss — The debtor must compensate the landlord for any actual losses suffered from the default (late fees, legal costs of collection, damage from delayed maintenance, etc.)
- Provide adequate assurance of future performance — The debtor must demonstrate the financial ability and operational capacity to perform lease obligations going forward.
What "Adequate Assurance" Means in Practice
| Evidence Type | What Courts Look For | Landlord Can Demand |
|---|---|---|
| Financial capacity | Reorganization plan cash flow projections; DIP financing availability; post-emergence balance sheet | Audited financials; lender commitments; business plan |
| New security deposit | Increased deposit or letter of credit commensurate with default risk | Up to the equivalent of 3–6 months rent as additional security |
| Operating plan | Evidence that the business will continue generating revenue to pay rent | Detailed operational projections; store performance data |
| Management continuity | Key management team remaining; turnaround plan in place | Management retention agreements; key man provisions |
Lease Rejection by Tenant-Debtor
When the tenant rejects (or is deemed to have rejected) the lease, the rejection is treated as a pre-petition breach — meaning the breach is deemed to have occurred the day before the bankruptcy filing. The landlord then has an unsecured claim for rejection damages.
The Section 502(b)(6) Cap on Landlord Rejection Damages
This is one of the most significant — and sometimes overlooked — provisions affecting commercial landlords in tenant bankruptcies:
§ 502(b)(6) Cap Calculation:
Greater of: (A) 1 year of rent, OR (B) 15% of remaining rent (not to exceed 3 years' rent)
Example: Tenant rejects lease with 5 years remaining at $200,000/year
Total remaining rent: 5 × $200,000 = $1,000,000
Option A: 1 year = $200,000
Option B: 15% × $1,000,000 = $150,000 (less than Option A, so use A)
Capped Rejection Damage Claim: $200,000 (unsecured)
Example 2: Tenant rejects 10-year lease with 8 years remaining at $300,000/year
Total remaining rent: 8 × $300,000 = $2,400,000
Option A: 1 year = $300,000
Option B: 15% × $2,400,000 = $360,000 — but capped at 3 years' rent = $900,000
Greater of A or B = $360,000 (under 3-year cap of $900,000)
Capped Rejection Damage Claim: $360,000 (unsecured)
This cap significantly limits landlord recovery in tenant bankruptcies. A landlord with 10 years of rent at $300,000/year ($3,000,000 total) can only claim $360,000 as an unsecured creditor — and in a Chapter 7 liquidation, may only recover 10–15 cents on the dollar ($36,000–$54,000 actual recovery against a $3,000,000 economic loss).
Assumption and Assignment: The Bankruptcy Sale of Leases
In retail and restaurant bankruptcies, leases are often the most valuable assets. Prime location leases with below-market rents can be sold — through an assumption and assignment — to competing operators as part of the bankruptcy case.
Protections Against Unwanted Assignment
The Bankruptcy Code limits but doesn't eliminate lease-specific assignment restrictions. Under § 365(f), anti-assignment clauses in leases are generally unenforceable in bankruptcy — the debtor can assign the lease to a third party despite lease language requiring landlord consent or prohibiting assignment.
However, the assignee must still provide adequate assurance of future performance. For shopping center leases, § 365(b)(3) provides additional protection:
- The assignee must satisfy financial condition and operating performance standards similar to those in the original lease
- Assumption/assignment of a shopping center lease cannot disrupt the tenant mix or balance of the shopping center
- The assignee must satisfy all percentage rent and continuous operation requirements
Shopping center landlords have more leverage. The § 365(b)(3) protections give shopping center landlords grounds to object to assignment to tenants who don't fit the center's concept, can't satisfy percentage rent requirements, or would conflict with exclusive use clauses of other tenants.
Protections to Negotiate Before the Lease Is Signed
The best time to address bankruptcy risk is at lease execution — not when the bankruptcy filing arrives. Consider negotiating these provisions in your lease negotiation:
| Provision | Protects | Effect in Bankruptcy |
|---|---|---|
| Ipso facto clause | Landlord | Technically unenforceable in bankruptcy (§365(e)), but still a signal of intent and may affect non-bankruptcy default remedies |
| Personal guarantee with broad scope | Landlord | Guarantor's separate estate may be reachable even if tenant files; guaranty survives unless guarantor also files |
| Letter of credit security deposit | Landlord | LC is not property of the bankruptcy estate; landlord can draw without stay violation (unlike cash deposits which may be frozen) |
| Recorded memorandum of lease | Tenant | Establishes constructive notice; protects § 365(h) rights against landlord's secured lenders and §363 sale buyers |
| Leasehold mortgagee protection clause | Tenant's lenders | Tenant's leasehold lender gets notice and cure rights before lease can be terminated in landlord proceedings |
| SNDAs with NDA language | Tenant | Non-disturbance from lender survives landlord bankruptcy if lender takes over property |
Practical Checklist: What To Do When Bankruptcy Is Filed
- Engage a bankruptcy attorney immediately — within 48 hours of filing notice
- File a notice of appearance in the bankruptcy case to receive all pleadings
- Continue paying rent post-petition — administrative expenses have priority over pre-petition claims
- Identify all landlord defaults or service failures to quantify § 365(h) offset rights (tenant in landlord BK)
- Gather all TI documentation (contracts, invoices, receipts) to quantify improvement claims
- Confirm whether your lease is recorded; if not, record a memorandum immediately if possible
- In tenant bankruptcy: identify all lease defaults that must be cured to assume
- Calculate cure cost accurately (all unpaid rent, CAM reconciliations, late fees, attorney fees)
- Prepare adequate assurance package: financial projections, DIP lender commitments, business plan
- Calendar the 120-day assumption/rejection deadline and any extensions
- In landlord bankruptcy: monitor for §363 sale motions and lease rejection motions
- Analyze whether lease retention (§365(h)) or rejection damage claim is financially superior
- File proof of claim for pre-petition defaults before the claims bar date
- Preserve business records for lost profits claims if applicable in your state
- Attend key hearings: assumption/rejection motions, plan confirmation, §363 sale approval
Understand Your Lease's Bankruptcy Exposure Before It Happens
LeaseAI analyzes your commercial lease for bankruptcy-related provisions — including SNDA language, security deposit structure, assignment restrictions, and landlord default remedies. Know your rights before they're tested.
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