This fall marked the arrival of the most comprehensive changes to the United States Bankruptcy Code since its enactment in 1978.  Lessors of commercial and residential real property stand to benefit from some of these changes in cases where the bankruptcy petition was filed on or after October 17, 2005, the effective date of the Bankruptcy Abuse and Prevention Consumer Protection Act of 2005 (“BAPCPA”).  The former provisions of the Bankruptcy Code continue to apply in cases filed before October 17, 2005.

Assumption and Rejection of Unexpired Commercial Leases

Under the law prior to BAPCPA, a debtor who is a tenant under a nonresidential real property lease that has not expired as of the bankruptcy petition date has 60 days from the commencement of the case to assume or reject the lease.  This 60-day period can be, and often is, extended at the debtor’s request, even over the lessor’s objection.  In large Chapter 11 cases, bankruptcy courts often extend the assumption/rejection period until confirmation of the debtor’s plan, leaving lessors uncertain about future plans for their property for months or years at a time.

For cases filed under the new law, the debtor/tenant must assume or reject an unexpired lease of nonresidential real property by the earlier of:  (i) 120 days from the date of the order for relief, or (ii) the date of confirmation of the debtor’s plan.  If the debtor fails to act, the lease is deemed rejected.  The bankruptcy court has authority to extend the deadline for up to 90 days upon motion of the debtor or lessor and a showing of good cause.  However, the court may not grant any additional extensions unless the lessor consents in writing.  As a result, the debtor will have no more than 7 months to make the assumption/rejection decision, absent the lessor’s agreement to a longer period.

Should the debtor choose to assume and assign the lease to a third party, the new law clarifies that the debtor’s obligation to “cure” defaults under the lease does not extend to non-monetary defaults that are impossible to cure.  Thus, a lessor cannot block an unwanted assignment by lodging an objection that the debtor used the property for unauthorized purposes in the past or other similar acts which are impossible to “cure” once they have occurred.  Rather, the focus now will be on whether the proposed use by the new tenant post-assignment conforms to the terms of the lease.

Inevitably, some debtors will feel pressured into assuming a lease before the deadline, only to determine later that they cannot continue under the lease.  The debtor can reject the previously-assumed lease.  In such cases, the new law limits the lessor’s claim by granting the lessor an administrative expense (high priority) claim limited to the rent and certain other monetary obligations due for a period of two years following the later of the lease rejection or turnover of the premises.  The balance, if any, of the lessor’s claim for rejection damages will be treated as an unsecured claim capped by the existing statutory formula. 

Restrictions on Application of the Automatic Stay

Historically, the automatic stay, which comes into effect immediately upon the filing of a bankruptcy petition and prohibits creditors from taking or continuing collection action against the debtor, was triggered by the filing of a bankruptcy petition no matter how many prior cases the debtor had filed.  However, the new law includes changes designed to combat perceived abuse by debtors who used repeat bankruptcy filings to thwart evictions, foreclosures or repossessions.  The new law terminates the automatic stay 30 days after a bankruptcy petition is filed under Chapter 7, 11 or 13 if a prior case by the same debtor was dismissed within the preceding year. 

The court may extend the stay upon motion, but only if the movant demonstrates that the new case was filed in good faith.  In some cases, such as where the debtor’s prior case was dismissed because the debtor failed to perform the terms of a confirmed plan, a rebuttable presumption arises that the new case was filed in bad faith.  Additionally, if the debtor’s most recent case is the third case filed within one year, the stay will not come into effect at all upon the filing of the new case.

Finally, the new law helps residential landlords with tenants in default.  If, prior to the bankruptcy petition date, the landlord has obtained a judgment for possession of the leased premises, an exception to the automatic stay applies and allows the landlord to continue with eviction proceedings.  However, if applicable state law provides the debtor/tenant a right to cure the default and the debtor/tenant deposits into court the funds necessary to pay rent due during the thirty day post-petition period, then the debtor can obtain the benefit of the automatic stay until otherwise ordered by the bankruptcy court.  The debtor must file statutorily required certifications with the court in order to invoke the stay in such circumstances.

The Bankruptcy and Creditors’ Rights team at Poyner & Spruill LLP is monitoring these and other important changes in the law, and will be glad to advise you about how these changes impact your business.

If you have any questions regarding this article, please contact Lisa Sumner at 919.783.2869 or lsumner@poynerspruill.com. 

This electronic publication is published by Poyner & Spruill LLP to provide general information about significant legal developments. Because the facts in each situation vary, the legal precedents noted herein may not be applicable to individual circumstances.