Tenant bankruptcy is one of the more frightening things that can happen to a landlord. You may find yourself unsure if your tenant can or will pay their rent any longer, and ambiguities in the law can make it difficult to know if you can (or should) evict your them.
We’re here to help you tackle those questions. This article will cover:
- How to proactively protect your rental
- Types of bankruptcies tenants are most likely to file
- Recouping lost rent
- Lease options after the bankruptcy is filed
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.
Avoiding Problems Down the Line
Let’s start with the best-case scenario: avoiding problematic tenants.
Tenant Screening is your first line of defense to protect your rental property. The score on the credit report will give you an at-a-glance description of the client’s credit, but don’t stop there. Look at the entire credit report to give you a broader understanding of your potential tenant’s credit history.
Armed with that information, you’ll be able to answer applicable questions like:
- Does the potential tenant have a history of late payments?
- If so, how long has the tenant’s credit been suffering?
- Are the late payments due to a one-time emergency or are they a trend?
Multiple bills that have gone to collections in the credit report can be a red flag.
A tenant screening will help you form an educated opinion about the tenant’s ability to pay rent and avoid bankruptcy. If you’re unsure about anything in the report, you can ask them for clarity.
No matter how diligent you are in your screening process, you cannot predict every scenario. Even the best tenant may lose a job or be overwhelmed by expensive emergencies. Some will get back on track quickly, while others find themselves too far behind to catch up. Let’s take a look at the kinds of bankruptcies you may encounter from your tenants.
Kinds of Tenant Bankruptcies
There are several kinds of bankruptcy, each with its own considerations.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy is sometimes called a “straight bankruptcy.” It’s most commonly filed by individuals, but it can be filed by a business as well.
When an individual or a business successfully files for Chapter 7 bankruptcy, the court appoints a trustee. This individual handles the liquidation of the entity’s assets so that all creditors can be paid back as much as possible.
Chapter 11 Bankruptcy
A Chapter 11 Bankruptcy will not liquidate assets. The entity will retain complete and independent control of their finances, but they must pay back their debts in full (plus some extra). They are given some extra time to do this.
If they fail to pay their debts, the Chapter 11 bankruptcy may be converted to a Chapter 7 bankruptcy. If that happens, the court will assign a trustee and order the liquidation of assets and the payment of creditors.
Other Types of Bankruptcies
You may also see some other types of bankruptcies.
Chapter 12 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 encounter Chapters 7 and 11.
Recouping Lost Rent
If you get that dreaded call that lets you know that your tenant has filed bankruptcy, your first thought will likely be how to recover any lost rent. To answer that question, first we need to understand how claims are filed.
Pre-Petition and Post-Petition Claims
The process of filing for bankruptcy is called “petition”.
Pre-petition claims are financial burdens that are put on a tenant before they file for bankruptcy. Post-petition claims are financial burdens placed afterward.
Rent is considered a claim, but when that rent was due will depend on what kind of claim.
There’s a chance your tenant will remain in your property after filing for bankruptcy. Any rent 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.
Alternatively, if money was due before the tenant filed for bankruptcy, that is 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.
Now comes the big question:
Can I Still Collect Back Rent?
The court will institute what’s called an automatic stay when the tenant files bankruptcy. This means that most creditors cannot pursue any collection actions against the entity without the permission of the court. However, as the entity’s landlord, you are not subject to this restriction. You may still collect back rent as you normally would.
Remember that because back rent is an unsecured claim, it’s considered a low-priority payment and you may never get all of it back.
Terminating the Lease
Tenant Bankruptcy isn’t easy on anyone. If the tenant can’t pay you, they accumulate more debt and you lose income. Terminating the lease may be an option.
When the Landlord Terminates the Lease
There needs to be a breach of the lease to file a notice to quit or start the eviction process. Often this will come in the form of late or nonpayment.
There are some landlords or property managers that will add a clause to their lease stating that filing for bankruptcy breaches that lease. Keep in mind that many jurisdictions do not permit you to terminate a lease because a tenant has filed bankruptcy, and you may not put additional requirements on a tenant (such as increased rent or fees, or requiring payment in cash rather than a check) due to their bankruptcy.
Terminating the lease on your end may be tricky because of this, but there’s a chance that your tenant will want out as well.
When the Tenant Assumes (or Terminates) the Lease
Chapter 7 bankruptcy, in particular, lets the tenant decide whether they wish to assume or terminate the lease. This means that they can reconsider the financial obligation of the lease in light of their current situation.
If they decide that it’s too heavy of a burden in their current state, they may choose to terminate the lease within 60 days without a breach of contract. If they cannot decide during that period of time, they may file a request for an additional 60 days to decide, so long as they give an explanation of their circumstances and the court accepts this.
In response to this request, you are within your rights to explain to the court the stresses that this puts on you as the landlord or property manager. If the tenant chooses to terminate the lease, they agree to pay all outstanding rent within a reasonable time (which may vary by the locality, but is often within 60 days).
If the tenant requires additional time to pay, they’re going to have to make a motion for that with the court.
If your tenant gives notice of termination, you cannot stop them from terminating the lease. In this scenario, you should start showing the property immediately. You may have already lost money during this period, and the last thing you want is to have your property sitting empty.
Because of how the re-leasing process works and how long it can take to get a new tenant into the property, most landlords try to block any motions from the tenant to extend the 60-day period of assumption or termination of the lease.
Three months is a very long period of time to not know if you’re going to need to start screening new tenants.
When your tenant files for bankruptcy, it can initiate a period of uncertainty for you, and possibly even create conflict between you and your tenant.
There’s no doubt that it’s going to be difficult, but if you educate yourself about the bankruptcy process and what it means for you, you’ll be able to save yourself and your business potential financial losses—and a lot of headaches. Again, you’ll want to familiarize yourself with local and federal laws. Reach out to your legal counsel if you need clarity at any step along the way.