One of a landlord’s biggest worries is having a tenant who stops paying rent. When that happens, if the tenant doesn’t voluntarily move out, a landlord usually has to go through the eviction process to reclaim possession of the unit.
But what happens if a tenant files for bankruptcy? This is when things really start to get complicated for the landlord.
Tenant Bankruptcy: What Landlords Need to Know
First things first: landlords need to understand which type of bankruptcy the tenant has filed for. There are 4 types of bankruptcy under federal law, but most people will pursue either Chapter 7 or Chapter 13.
- Chapter 7 bankruptcy, sometimes referred to as “Straight Bankruptcy,” allows people who have a lot of unsecured debt (e.g. credit card debt, medical bills, personal or payday loans, utility bills) to dismiss that debt through a Chapter 7 discharge.
- Chapter 13 bankruptcy, known as “Reorganization,” allows a person to reorganize their debt and make payments to creditors, usually over a 3-5 year period. Chapter 13 is most commonly used by people who have faced short-term financial setbacks, such as job loss, illness, or large unexpected expenses (e.g. medical bills).
After a person files for Chapter 7 or Chapter 13 bankruptcy, the court will typically grant an “automatic stay”: a statutory injunction that prohibits further actions by creditors, landlords, and others seeking to obtain possession or control of the tenant’s property, or to assert claims against the tenant. This means that after a tenant files for bankruptcy, the landlord is automatically “stayed” from bringing action against the tenant.
If the tenant stays in possession of the leased premises after filing for bankruptcy, they are required to pay post-petition rent to the landlord, keeping those rent payments current as long as they stay in the unit. Some courts prorate the monthly rent. For instance, a tenant who files for bankruptcy mid-month will only be obligated to pay rent for the rest of that month (not the full month, if rent was due earlier in the month). Other courts hold that rent due on the first day of the month is for the entire month. If the tenant files for bankruptcy on the 15th day of the month, the rent for the entire month, including the remainder of the month after the tenant files, is considered pre-petition rent.
Almost all bankruptcy courts consider pre-petition rent to be unsecured debt, which is paid with other unsecured claims—but only after secured and priority claims are repaid.
So the good news for landlords is that tenants who file for bankruptcy don’t get to just stop paying their rent; but any rent that was past due will take some time to collect.
Tenant Bankruptcy: Can They Stop Paying Rent?
If a tenant stops paying rent after filing for bankruptcy, or fails to perform other lease obligations on a timely basis, the landlord can file a motion asking for relief from the automatic stay in order to evict the tenant. The court can also issue an order compelling the tenant to pay rent or reject the lease.
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“Reject the lease”—what does that mean? When a tenant files for bankruptcy, they have 2 options with respect to their lease: assumption or rejection. Assumption means that the lease continues in full force and effect in accordance with its original terms; rejection is a breach of the lease.
If a tenant rejects the lease, they must vacate the premises and turn over possession of the property to the landlord. The landlord can then seek relief through the bankruptcy court, but again—unpaid rent will be treated as unsecured debt. Although bankruptcy laws vary by state, most cap a landlord’s claim for breach of lease at an amount equal to the rent required to be paid under the lease for the greater of one year or 15% of the remaining term of the lease, not to exceed 3 years.
There are some circumstances in which a tenant cannot afford to pay rent and is willing to vacate the premises. In situations like these, the tenant can assign the lease to a new tenant. Some leases expressly prohibit assignment to others, but the bankruptcy code allows a tenant to assume the lease and assign it, provided the new tenant is credit-worthy and able to comply with the terms of the lease.
Tenant Bankruptcy: How to Respond
A tenant dealing with bankruptcy is stressful for everyone involved. However, there are some preventative measures that landlords and property managers can take to make things easier:
- Begin eviction proceedings before a tenant files for bankruptcy. It’s difficult to predict if and when a tenant will file for bankruptcy; but if you get the sense that it’s a possibility, begin the eviction proceedings ASAP. As soon as your tenant files for bankruptcy, the automatic stay makes it difficult for you to evict them.
- Know the exceptions. Most bankruptcy courts will happily lift the automatic stay if a tenant has violated his lease for reasons other than nonpayment of rent. For instance, if a tenant is using drugs or has caused damage to the property, a court will usually lift the stay within a matter of days.
- Work closely with the tenant’s bankruptcy trustee. When a person files for bankruptcy, he or she is assigned a bankruptcy trustee to oversee the case. The trustee determines who gets paid, how much, and when. Most trustees are inclined to let the tenant keep the lease, since it wouldn’t benefit the tenant’s creditors to force them to incur the costs associated with finding a new place to live. Landlords and property managers should work closely with the trustee to explain the details of the situation and gather additional information if necessary. For instance, landlords may want the bankruptcy court to show proof that the tenant can pay future rent.
Keep in mind that bankruptcy and eviction laws vary by state. This overview is intended to be a high-level overview of what a landlord can expect when a tenant files for bankruptcy. For more information, we suggest contacting a local attorney who can offer advice and explain the laws in greater detail.Read more on Legal Considerations