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2005 Bankruptcy reform grants greater landlord protections.

Bankruptcy filings, both consumer and business, soared in anticipation of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), which was widely perceived to be less debtor-friendly than existing laws. According to the American Bankruptcy Institute, the leading non-partisan organization that researches bankruptcy issues, business insolvency filings were up 25 percent from last year in the three-month period ending Sept. 30, 2005--about two weeks before the new code took effect on Oct. 17.

For commercial real estate owners, BAPCPA brought greater protections when dealing with bankrupt tenants. In particular, the new code modifies the time period that commercial tenants have to assume or reject their leases after filing for bankruptcy. Under prior law, a tenant was required to make that decision within 60 days of filing. Frequently though, a bankrupt tenant, who was in possession of the property and possibly still operating a business, was able to get repeated extensions from the bankruptcy court, often up to 18 months or longer. A national chain going through a reorganization might use this time to decide which store locations to close without taking on the liability of future rent payments.

BAPCPA took a fair amount of discretion out of the bankruptcy court system in this regard. Commercial tenants now have to act on the assumption or rejection of their lease within 120 days of filing for bankruptcy. This initial 120-day period can be extended by the court for 90 days; however, no additional extensions may be granted without the prior written consent of the landlord. In total, bankrupt tenants now have a maximum of 210 days, roughly seven months, to make their decision.

The new code also altered the obligations of bankrupt commercial tenants after they assume a lease. In the past, the debtor was required to cure all non-monetary defaults, even impossible ones, or the lease would be terminated. For example, a car dealership's lease may state that it needs to maintain continuous business operations. If the dealership had already closed its doors for a period of time, it can not cure this type of default. Under BAPCPA, bankrupt tenants can assume their leases even if they can not cure all non-monetary defaults and are required to comply with all operating terms again going forward.

In addition, BAPCPA greatly affects commercial real estate owners in the area of designation rights. Under both the prior version of the Bankruptcy Code and BAPCPA, debtors may assign their rights in a lease to an entity that then designates who the replacement tenant is for the remaining lease term. However, the new code limits these designation rights by the same 210-day period in which debtors have to decide whether to assume or reject a lease. BAPCPA also adds the limitation that the replacement tenant must conform with any non-monetary obligations under the lease.

BAPCPA also changes the treatment of the claim that a commercial landlord has against bankrupt tenants when they initially assume the lease but then reverse course and reject it. BAPCPA grants the landlord's claim administrative status--in other words, payment in full--in an amount equal to two years of rent. Any portion of the landlord's claim in excess of this amount is treated as an unsecured, non-priority claim that is paid in a percentage equal to that received by other unsecured, non-priority claimholders. Under the prior Bankruptcy Code, the entire amount of the landlord's claim was entitled to administrative status when the debtor had initially assumed the lease but later rejected the lease.

It will take some time to assess all the effects of this sweeping bankruptcy law reform as the surge of filings prior to Oct. 17, 2005 still filters through the bankruptcy court system. In the meantime, commercial real estate owners and managers should be aware of these amendments and comprehend how they affect their dealings with bankrupt tenants.

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Author:D'Aries, Michael
Publication:Real Estate Weekly
Date:Apr 5, 2006
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