- Preliminary notes
- Types of bankruptcies
- Automatic “stay”
- Debts that are discharged
- Tenant options to reject or assume lease
The following information applies to bankruptcies filed by residential tenants. There are additional issues to be considered if a bankruptcy is filed by a commercial tenant – consultation with an experienced bankruptcy attorney is recommended.
We thank Casey Elliott, a bankruptcy practitioner at the Van Matre Law Firm, for her review of the following information to ensure accuracy.
There are two types of bankruptcies that can be filed by tenants:
Chapter 7 – This is a “liquidation” bankruptcy. If successfully completed, the tenant will receive a discharge of most debts, meaning they can no longer be collected (a creditor who sues on a discharged debt can be liable for actual and punitive damages and attorney fees). Certain types of property are exempt from liquidation in the bankruptcy and may be retained by the tenant. Non-exempt property is liquidated, and a pro-rata distribution from the resulting fund is made to creditors who have filed claims that have not been disallowed. It is rare for a landlord to receive a distribution on a debt owed by the tenant to the landlord, and if a distribution is received, it likely will be a very small percentage of what was owed.
Chapter 13 – This is a “reorganization” bankruptcy. The bankruptcy court analyzes the tenant’s assets and liabilities and orders a repayment plan. The plan may include reducing amounts to be paid to creditors. The tenant is ordered to make specified monthly payments to a bankruptcy trustee, who distributes the money to creditors based on the repayment plan allocations. If the tenant successfully completes the repayment plan, the debts are discharged.
In both types of bankruptcies, immediately upon the filing of a bankruptcy case, there is an automatic “stay” of any actions by creditors to collect debts from the tenant.
In Chapter 7, the stay applies only to the tenant(s) who has/have filed the bankruptcy.
In Chapter 13, the stay applies not only to the tenant who filed the bankruptcy but also to any co-debtors, meaning other person who is jointly liable with the tenant such as co-tenants or persons who have guaranteed the lease.
Following is additional information landlords and property managers need to know about the automatic stay:
- Violation of the automatic stay can result in serious financial penalties being imposed on the landlord and the landlord’s attorney by the bankruptcy court. Therefore, any pending court proceedings or collection actions should immediately be halted.
- If the landlord has a pending case against a tenant who has filed bankruptcy, the local court will enter a “stay” of proceedings pending the outcome of the bankruptcy. This means no further action can be taken on the case while the local court’s stay order remains in effect.
- However, bankruptcy law allows a residential landlord to enforce a judgment for possession against a bankrupt tenant if that judgment was obtained before the bankruptcy was filed. In addition, the automatic stay will not stop an eviction action against tenants who have engaged in illegal drug use on the property or who have endangered the premises somehow.
- If the landlord has not yet filed a case against a tenant who has filed bankruptcy, no case can be filed during the stay period.
- It is possible to obtain an order from the bankruptcy court to “lift the stay” while the bankruptcy case is on-going. If the tenant is still residing in a rental unit and is not paying rent, the bankruptcy court is highly likely to lift the stay and allow the landlord to proceed with an eviction. Because bankruptcy is a highly specialized area of law in which Scott Law Firm does not practice, we can refer landlords to an experienced bankruptcy attorney who represents creditors if a landlord wants to ask the bankruptcy court to lift a stay. The process to receive an order lifting the stay usually takes about one to two months.
- The automatic stay automatically expires if the bankruptcy case is dismissed. Bankruptcy is very complicated, and it is not unusual for tenants who have filed bankruptcy to fail to comply with all the rules, which can result in dismissal; this is particularly true if a tenant is trying to handle the bankruptcy without the assistance of an attorney. If the bankruptcy case is dismissed, the landlord can proceed with an eviction case or a case to recover monies owed by a tenant who has vacated the landlord’s rental unit. However, it is not unusual for a tenant whose bankruptcy case has been dismissed to get the bankruptcy case reinstated, which results in the automatic stay being reinstated.
- The automatic stay also expires when the tenant receives a discharge. As noted above, a discharge means a creditor cannot collect a discharged debt and can be liable for actual and punitive damages and attorney fees if the creditor attempts to do so.
Certain debts cannot be discharged. Such debts include, but are not limited to
- Student loans
- Most federal, state, and local taxes
- Money borrowed on a credit card to pay those taxes
- Child support and alimony.
Some additional debts may be nondischargeable, but only if the creditor objects to the discharge. These include: debts incurred based on fraudulent acts; debts from willful and malicious acts to another person or another person’s property; and debts from embezzlement, larceny, or a breach of fiduciary responsibility. If a landlord believes that a debt owed by a tenant falls in any of these categories, the landlord should seek the assistance of a bankruptcy attorney who represents creditors to file and argue the objection in the bankruptcy court.
In a Chapter 7 bankruptcy case, there are additional circumstances in which the bankruptcy court could declare debts nondischargeable. These includes instances in which the debtor:
- Destroys records of their finances
- Transfers property in an effort to hide it from creditors
- Does not fulfill the completion of a course in personal finance management
- Cannot account for certain missing assets.
Still other debts may be dischargeable if the debtor files a Chapter 13 rather than Chapter 7 bankruptcy – e.g., debts incurred in connection with a divorce such as a property settlement.
Finally, and most important to landlords and property managers, in a Chapter 7 bankruptcy case, the only debts that can be discharged are those existing at the time the bankruptcy case was filed. If a tenant remains in a rental unit after filing bankruptcy, debts owed under the lease that accrued after the bankruptcy was filed are not discharged and can be pursued after the bankruptcy stay is lifted or expires.
- Examples of such debts include rent, late charges, unpaid utilities, and attorney fees.
- Also, we believe that damages to the rental unit beyond ordinary wear and tear can be claimed if the tenant vacates after filing bankruptcy because the legal right to claim such damages does not accrue until the tenant vacates without restoring the rental unit to the condition it was in at the time of first occupancy, ordinary wear and tear excepted.
In a Chapter 13 bankruptcy case, payments are made on debts through a payment plan approved by the bankruptcy court, but generally these payments will cover only a fraction of the debt.
If a lease has not expired or has not been terminated before filing bankruptcy, a tenant has a 60-day deadline in a Chapter 7 case and until a repayment plan is confirmed in a Chapter 13 case to select one of the two following options:
- The tenant may reject the lease. This means the tenant voluntarily agrees to vacate the premises and is therefore no longer bound by the terms of the lease.
- The tenant may decide to assume the lease. This means the tenant can reaffirm his or her obligations under an unexpired lease.
Most of the time, tenants select rejection or assumption of a lease at the time of filing a bankruptcy case. If the tenant has selected rejection, the landlord should promptly seek permission from the bankruptcy court to move forward with an eviction.
However, if the tenant has not selected rejection or assumption by the deadline, and if the bankruptcy court has not extended the deadline, again the landlord should promptly seek permission from the bankruptcy court to move forward with an eviction.
If the tenant decides to assume the lease, bankruptcy law allows the tenant to do so only if the following two conditions are met:
- The tenant is current on lease payments or can “cure” any arrears in a prompt manner. Bankruptcy law requires a “prompt” cure of lease defaults but fails to define what “prompt” means. Most bankruptcy courts would consider payment over six months to be prompt. However, if the tenant proposes to cure past-due payments over a period of years, the court would most likely reject the proposal.
- The tenant gives “adequate assurance of future performance” under the lease. Again, bankruptcy law does not define “adequate assurance” concept. Therefore, it is generally applied by bankruptcy courts based on particular facts including the tenant’s financial condition, ability to pay based on income, and any offers to make prepayment of rent going forward.
When a lease is assumed, both landlord and tenant must continue to comply with all terms and conditions of the lease. If the tenant fails to comply with the lease, the landlord can ask the bankruptcy court for permission to terminate the lease and start an eviction case if the automatic stay is still in effect.
If a tenant assumes a lease in a Chapter 13 bankruptcy and subsequently defaults on the lease during the period of the repayment plan, a landlord will not only have a claim for the delinquent rent arising after the filing of the bankruptcy, but said rent will become an “administrative expense” in the bankruptcy. This means that the amount of rent accruing after the filing of the bankruptcy receives a priority status in the Chapter 13 bankruptcy, and should the tenant continue to make payments under the Chapter 13 bankruptcy plan, the landlord will receive payments on those amounts ahead of many of the tenant’s other creditors.
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