Recessionary Real Estate-An Overview of Landlord and Tenant Default Issues
Jun 15, 2009 QuickCounsel Download PDF
By Lex Mundi
Landlord and tenant defaults create additional burdens in conducting business, whether counsel represents landlord or tenant, the defaulting or non-defaulting party. This QuickCounsel provides a road map of non-residential lease remedies in bankruptcy and in three sample jurisdictions: California, Florida and New York.
It is well known that the filing of a bankruptcy petition operates as an automatic stay of acts to commence or continue legal proceedings against the debtor.
The tenant's bankruptcy trustee in Chapter 7, or the debtor in Chapter 11 or 13, may assume or reject a lease, subject to court approval. United Sates Bankruptcy Code, 365(a). If the lease is rejected it terminates, and the landlord has a general unsecured claim for damages for breach of the lease. If a landlord files bankruptcy and rejects a lease, the tenant may continue in possession for the term of the lease and pay rent. USBC 365(h)(1)(A).
If the debtor assumes the lease, it is again a binding contract on the debtor as tenant and the landlord. A lease provision that the lease terminates on the tenant’s bankruptcy is unenforceable. USBC, 365(e). A Chapter 11 debtor must assume the lease within 60 days after filing Chapter 11 (or, some courts may say, file a motion to assume within 60 days). Otherwise, the lease is deemed rejected. USBC, 365(d)(4). To assume the lease, the trustee or debtor must: (a) cure the default or provide adequate assurance that it will be cured; (b) compensate the landlord for its actual loss resulting from the default, and (c) provide adequate assurance of future performance. In a shopping center lease, this may include the requirements that a new tenant has similar financial ability as the old tenant, percentage rent will not decline substantially, and a new tenant will not disrupt the tenant mix.
The bankruptcy trustee or debtor may assign the lease notwithstanding a provision in the lease prohibiting assignment. USBC 365(f). Assignment of the lease requires satisfying the requirements to assume the lease. USBC, 365(f)(2). The assignee may be required to give the landlord the same security deposit as the tenant. USBC, 365(1). The assignment relieves the original tenant from any further liability under the lease. USBC, 365(k). The court may permit an assignment of the lease to a tenant who will make a different use of the property. Collier Real Estate Transactions and the USBC, 3.01, In the Matter of U. L. Radio Corp., 19 BR 537 (Bankr. S.D. N.Y., 1982). Some drafting suggestions to improve the landlord’s position in bankruptcy may be found in Collier Real Estate Transactions and the USBC 3.06.
After the filing of Chapter 11, the tenant usually continues to occupy the premises, and the automatic stay prevents the landlord from evicting the tenant for failure to pay pre-petition rent. Although the landlord is entitled to collect rent on a current basis after Chapter 11 is filed, tenants don’t always pay it because they are usually short of cash.
The non-residential landlord enjoys certain special protections under USBC 365(d)(3) and (4): (a) The debtor (or trustee) must file a motion to assume or reject the lease within 60 days after it filed bankruptcy; (b) within that 60 days, tenant must pay the rent on a current basis. The court can give the debtor more time to pay the rent during that period, but may not give it longer than 60 additional days. Therefore, all of the rent for the first 60 days must be paid within 60 days after the bankruptcy is filed, but the landlord is not safe, because at the end of the 60 days the debtor may not have the money to pay the rent. Accordingly, Landlord should consider requesting one month’s advance rent as soon as the bankruptcy is filed and, if not paid immediately, the landlord should file a motion for relief from the stay requesting permission to evict the tenant. This will usually result in an order requiring the debtor tenant to pay current rent on a current basis.
If the lease is terminated before bankruptcy is filed, there is no lease for the debtor to assume or assign. Whether the lease has been terminated before bankruptcy is a matter of state law, and should also be resolved by referring to lease provisions governing the landlord's basis for termination. A landlord that believes a defaulting tenant may file for bankruptcy, who would rather have possession of the premises, should consider giving notice of termination as soon as possible, therefore attempting to accomplish a termination before bankruptcy is filed. If the lease has been terminated before bankruptcy, the landlord must still file a motion for relief from stay before evicting. A successful pre-petition termination is devastating to the Chapter 11 case of a debtor whose business depends on its location, such as a restaurant. Termination of the lease before bankruptcy greatly increases the landlord’s bargaining power if the landlord wants to negotiate a lease with new terms.
Generally, a landlord must file a proof of claim in the bankruptcy case before the deadline for doing so in order to receive any distribution from the bankruptcy estate. In some states, like Florida, the landlord loses its landlord's lien in bankruptcy. The landlord’s claim may include (a) a general unsecured claim for pre bankruptcy unpaid rent and other amounts due under the lease, damages for rejection (breach) of the lease subject to the limit on amount in USBC, 502(b)(6), and other damages such as repair and cleanup. Chapter 11 Priority Administrative Expense Claims include unpaid rent during Chapter 11 and other items of damages that accrued during Chapter 11. This is a high priority claim. If the debtor obtains confirmation of a plan of reorganization, this claim must be paid in full in cash. If the case is converted to Chapter 7, some payment on this claim is likely. Chapter 7 Priority Administrative Expense Claims include unpaid rent during Chapter 7, if the bankruptcy trustee occupied the premises. This is the highest priority type of claim. If there is any money in the bankruptcy estate, there will be something paid on this claim.
Article 7 of the Real Property Actions and Proceedings Law ("RPAPL") governs tenant defaults that can be either a non-payment proceeding or a holdover proceeding. A landlord in a non-payment proceeding seeks to recover possession of real property based upon the tenant's default in payment of rent and/or additional rent. Many New York commercial leases contain lease provisions barring the tenant's assertions of counterclaims and right to a trial by jury in non-payment proceedings. Nonetheless, tenants may raise various affirmative defenses to justify the withholding of rent. The outcome of a landlord's successful action for recovery of possession, either through trial or stipulation of settlement, is the court's issuance of a judgment of possession in favor of landlord. The RPAPL provides a statutory five-day period where the tenant is permitted to cure its rent default and tender full payment to the landlord. If payment is timely made, the judgment is satisfied and the proceeding is terminated. If the tenant fails to timely cure, the court issues a warrant of eviction to a city marshal (or county sheriff outside New York City) directing the marshal (or sheriff) to recover possession and deliver same to the landlord.
A holdover proceeding, may be brought upon the natural expiration of a lease term or upon the utilization of the default clause (conditional limitation) by the landlord as a result of a material tenant default under the lease. Most New York leases exclude the failure to pay rent as a material default under the default clause; as a result, rent defaults are dealt with through the non-payment proceeding. Non-monetary defaults of a serious nature and the abandonment of the premises are two of the potential claims in most Default Clauses in New York. When there has been a non-monetary default, the landlord is required to send the tenant a formal notice of default/demand to cure, complying with the notice requirements under the lease, setting forth all significant details, the nature and scope of each of the tenant's defaults, the relevant paragraph of the lease, and the significance of its failure to cure the default within the applicable time period set forth in the default clause of the Lease. The commercial tenant is given the opportunity to cure the enumerated defaults or seek judicial intervention through the issuance of a "Yellowstone" injunction by the Supreme Court of the State of New York. If the tenant fails to cure and has not obtained injunctive relief from the court, the landlord may serve a formal notice of termination advising the tenant that the lease term shall end and terminate on a date certain pursuant to the terms and conditions found in the default clause. Thereafter, the landlord may commence a holdover eviction proceeding seeking to recover possession of the real property through the service of a Notice of Petition and Petition with the Civil Court of the City of New York. Commercial tenants are free to raise affirmative defenses, but are generally precluded from raising a counterclaim or seeking a jury trial as a result of prohibitions included in lease provisions in most commercial leases in New York. Upon resolution of the case (either by trial or through a stipulation of settlement) in favor of the landlord, the court grants the landlord a judgment of possession along with issuing a warrant of eviction to the city marshal (or county sheriff for property outside New York City). In commercial cases, tenants have no ability to cure their defaults and avoid an eviction once the warrant of eviction has been issued.
In the event a landlord default, most New York commercial leases preclude the tenant from raising a counterclaim in a Landlord-Tenant eviction proceeding. As a result, commercial tenants are required to commence an action in the Supreme Court claiming a breach of contract and seeking either money damages or injunctive relief.
In California, under the Code of Civil Procedure Sections 1161 et seq., after proper notice to the tenant, a landlord may terminate the tenancy before the end of the term: (a) when the tenant surrenders or abandons the premises; (b) when the premises are used for an unlawful purpose or in a manner that is contrary to the lease agreement; (c) when the tenant permits or commits waste; or (d) for the failure to pay rent or perform other financial obligations. Generally, the landlord may not terminate a lease for minor defaults. A landlord may recover possession from a tenant by either ejectment or by unlawful detainer or a summary proceeding to recover possession, available only in certain circumstances, such as when there is a landlord-tenant relationship. (But, for instance, an owner seeking to recover possession against a mortgagee or receiver would be restricted to filing an action for ejectment, rather than unlawful detainer.) Unlawful detainer is purely statutory in origin, and provides special procedures for an expeditious recovery of possession that are constitutional, but are construed strictly to protect the tenant’s right of possession. Under the special statutory procedure, the landlord commences the unlawful detainer proceeding by serving the tenant with a three-day notice to pay rent or quit. If rent is not timely received, the landlord files the unlawful detainer action, and the tenant must respond to the complaint within a shortened five-day period. The tenant is also significantly limited in its right to file a counterclaim or cross complaint or to raise affirmative defenses. Should the tenant abandon the premises, an action for unlawful detainer no longer lies, and the case becomes an ordinary action for money damages. In 1971 there was a substantial modification to California law. Generally, in the absence of a conflicting lease provision, if a tenant defaults in the terms of the lease, the lease “automatically” terminates, and the landlord is given an immediate cause of action for damages. However, if expressly provided for in the lease, the landlord may elect to continue the lease and recover the rent periodically as it comes due. The current statutes also recognize the validity of a liquidated damage provision and affirm the availability of appropriate equitable relief.
The remedies available to a tenant for a breach by a landlord, except in the situation of a residential property that is deemed uninhabitable because of health or building code violations, are very limited. The tenant has no right of a summary proceeding and must file an ordinary civil action against the landlord. Specifically, a tenant is prohibited from withholding rent as an offset against the damages caused by the landlord. Should a tenant withhold such rent, notwithstanding the landlord’s default, the tenant would be subject to an unlawful detainer proceeding.
Chapter 83 of the Florida Statutes generally controls non-residential tenancies in Florida, although the commercial lease agreement can frequently override the statute, both to waive (for the strong landlord) and enhance (for the strong tenant) statutory requirements. County courts have exclusive jurisdiction for evictions under commercial lease agreements, although circuit courts have jurisdiction for monetary damages exceeding $15,000. Section 57.011 permits summary proceedings for eviction. County court judges may not accept jurisdiction for licenses, early occupancy agreements, and similar writings that are not clearly identified as lease agreements. If the tenant has failed to pay rent, the commercial landlord generally has the option to: (a) terminate the lease and take possession of the premises for its own account; (b) not terminate the lease, and take possession of the premises for the account of tenant, (c) not terminate, stand by, and sue monthly for rent as it comes due; or (d) if the lease includes an acceleration clause, evict the tenant, take possession for the benefit of tenant, and sue tenant for accelerated rent. If the landlord relets the premises, it will need to credit the tenant in the amount of its recovery to avoid double collection. Florida law does not generally permit the landlord to exercise self-help by changing the locks to the premises except in the instance of when the tenant has surrendered possession of the premises to landlord or the tenant has met the requirements under Section 83.05 of the Florida Statutes for abandonment. The Florida Statutes also prescribe specific requirements for property abandoned by the tenant.
In the absence of a specific provision governing remedies for landlord's default, the commercial tenant may look to Florida Statute 83.201, which provides that when the lease places maintenance and repair obligations on the landlord that the landlord does not satisfy, and when the lease does not address procedures to be followed on such default, the tenant may withhold rent if: (a) the premises are wholly untenantable; and (b) the tenant gives the landlord written notice and 20 days to make designated repairs. The statute provides that the tenant must remit rent withheld once the repairs have been accomplished or, if the premises remain wholly untenantable, that the tenant may abandon the premises and terminate. Counsel is cautioned to examine the entire lease for terms that may alter these statutory provisions including, for example, the casualty and force majeure sections of the lease.
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