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October 11, 2022

Bankruptcy Basics for Retail Landlords

Issue 2—Impact of the Automatic Stay

October 2022  |  Issue 2

The automatic stay is one of the most fundamental provisions of the US Bankruptcy Code. It protects the debtor, enhances equality of distribution to creditors in accordance with bankruptcy law, and preserves the value of the debtor. The stay is an injunction that prohibits landlords from taking most actions to enforce their rights against the debtor-tenant or its property, including eviction actions and actions to collect rental obligations from the debtor that arose before the bankruptcy case. The stay also prevents the landlord from setting off a pre-bankruptcy obligation against the debtor, such as a security deposit, against any claim owed to the landlord. A landlord’s violation of the automatic stay can result in serious consequences, such as being held in contempt and compelled to pay actual damages, including costs and attorneys’ fees and, in certain cases, punitive damages. Bankruptcy judges take violations of the automatic stay very seriously.

There are exceptions to the automatic stay. Landlords are not stayed from taking actions to obtain possession of nonresidential property subject to a lease that terminated because of expiration of the term of the lease before the bankruptcy case. This includes eviction actions based on this premise. However, the landlord should make sure the contemplated action does not violate the automatic stay in some other way. For instance, the debtor-tenant’s personal property will often be located at the premises, and the stay prohibits the landlord from taking any action to obtain possession of that property or exercise control over it. The stay still prevents the landlord from demanding payment or suing the debtor for rental obligations that arose pre-bankruptcy. Additionally, a landlord’s “crediting” of a debt it owes a debtor against a claim it has against the debtor—known as recoupment—is not subject to the stay (unlike setoff, which is) to the extent it arises from the same transaction. However, the concept of recoupment may be narrowly construed.

Given the potential serious consequences of violating the stay, landlords should carefully plan their strategy. This may include seeking a bankruptcy court order granting relief from the stay (and/or determining whether it applies) if there is any doubt about its applicability. Landlords can also ask for additional or alternative relief, such as the immediate payment of outstanding post-bankruptcy rent. Bankruptcy courts may be reluctant to grant such stay relief motions early in a case, preferring to give a debtor an opportunity to evaluate the lease in its business plan. However, bankruptcy courts are courts of equity, and the circumstances could warrant early stay relief. A summary of landlords’ specific options relating to the automatic stay such as seeking relief “for cause” will be included in a future Bankruptcy Basics issue.

The next issue of Bankruptcy Basics will cover the major players in a typical retail bankruptcy case. Unlike a standard two-party dispute in commercial litigation, there are many different agendas and views to consider in complex retail bankruptcies. For more on who the major players are and what roles they play, check out Issue 3 of Bankruptcy Basics for Retail Landlords later this month.
 

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