Help, My Tenant Filed for Bankruptcy! (Part 1)
A tenant's bankruptcy is one of the more frightening things that can happen to a landlord. You may find yourself suddenly unsure if your tenant can or will pay their rent any longer, and thanks to some of the ambiguities in the law, you may not know if you can (or even should) evict your tenant.
This two-post series goes over everything landlords and property management companies need to know about bankruptcy, how it affects tenants and what a landlord can—and should—do about it. Be aware that laws may change quickly, and that there may be state- or local-level laws that affect how landlords can handle bankruptcies. Always check with the most recent version of the law, and you may want to hire a lawyer if you have questions.
Avoid Problems Down the Line
Most landlords and property managers already know this, but it's never a bad idea to repeat: Always be sure you run a credit check on your tenants before they move in. The score will give you an at-a-glance description of the client's credit.
But don't forget to look at the entire credit report rather than just the score. The report gives you the full story of your potential tenant's credit. Armed with that information, you'll be able to answer applicable questions like: How long has the tenant's credit been suffering? Is this a slow decline in their financial health, or is this a sudden, precipitous inability (or refusal) to pay their bills or other outstanding obligations? If you see a lot of bills that have gone to collections in the credit report, you can assume that there's a problem.
By looking at the credit score and report, you'll be able to form a more educated opinion about the tenant's ability to pay their rent and avoid bankruptcy. If you have any questions about what you see in the report, but are still interested in having the applicant as a tenant, you may want to ask the tenant questions about what you're seeing in the credit report before you make a determination about their suitability. Be aware, however, that they may not want to answer your questions, and they may dodge questions or even lie under pressure.
Kinds of Bankruptcy: Chapters 7 and 11
If you're not an accountant or a lawyer, or if you've never considered filing for bankruptcy yourself, you may not know that there are several kinds of bankruptcy, each with its own considerations.
The first type of bankruptcy is called a Chapter 7 bankruptcy filing. Chapter 7 bankruptcy is sometimes called a "straight bankruptcy," and is the kind most commonly filed by individuals (as well as some businesses). When an individual or a business successfully files for Chapter 7 bankruptcy, the court appoints a trustee who handles the liquidation of the entity's assets so that all creditors can be paid back as much as possible.
With Chapter 11 bankruptcy, no assets are liquidated, and the entity retains complete and independent control of their finances. They must pay back their debts in full plus some extra, but they are given additional time to do so. If they fail to do so, the Chapter 11 bankruptcy may be converted to a Chapter 7 bankruptcy, meaning that the court will assign a trustee and order the liquidation of assets and the payment of creditors.
You may also see some other types of bankruptcy. Chapter 12, for instance, deals with small-business fishermen and farmers, and Chapter 13 is a rehabilitation program that focuses on regular wage-earners. But these are more unusual, and most landlords will only encounter Chapters 7 and 11 .
Pre-Petition and Post-Petition Claims
The process of filing for bankruptcy is sometimes called "petition". Pre-petition claims are financial burdens put on a tenant before they file for bankruptcy; post-petition claims are those placed afterward.
Rent is considered a claim. If the tenant remains in your property after filing for bankruptcy, any rent that comes due during that time is a special type of post-petition claim called an administrative claim. Administrative claims are high-priority claims that tenants must prioritize paying off.
By contrast, unpaid rent or fees that were due before the tenant filed for bankruptcy are a type of pre-petition claim called an unsecured claim. Unsecured claims are typically low priority for tenants to pay off, in comparison with other claims. As the landlord, you may not be able to get back the entirety of what is due to you, either.
When a tenant declares bankruptcy, their landlord may not be sure exactly what that means, or what procedures to follow. But if you follow the guidelines laid out in this post, you'll be prepared for any tenant bankruptcy situation you run into -- and you may even be able to take steps to more carefully screen potential tenants, to avoid any bankruptcy problems at all.
In the second part of this series, we'll go over some more considerations surrounding tenant bankruptcy, and how landlords should best respond when they learn that a tenant has filed for bankruptcy.
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