Bankruptcy, Nonresidential Lease Defaults, and Security Deposits: Protecting Landlord and Tenant Interests

Description

Assuming they do not terminate the lease pre-petition, landlords of nonresidential tenants have many issues to consider. Practitioners differ on whether applying a tenant security deposit (and requiring replenishment) to unpaid pre-petition arrears outweighs the risks and costs of triggering bankruptcy or defending a potential preference action. Although the deposit becomes part of the tenant's bankruptcy estate, it typically is subject to the landlord's security interest (perfected by possession) and unavailable to other creditors. After bankruptcy, the deposit could be applied to pay either cure amounts or rejection damages. Complex issues can arise over what are and are not rejection damages and what happens if a security deposit exceeds the cure or rejection amount.

In a landlord bankruptcy, if a lease does not require the landlord to segregate the security deposit or hold it in trust, there is risk that the landlord's secured lender could capture the deposit, leaving the tenant with only an unsecured claim in the landlord's bankruptcy. Tenants may be confused by assignments of rents, and how those are enforced can vary by jurisdiction and by the language of the relevant agreement. The tenant's options vary if the landlord rejects the lease or attempts to sell the underlying asset "free and clear" under Section 363. Not all bankruptcy courts agree that the rights of a tenant to remain following lease rejection are available to the tenant after a free and clear sale.

Listen as this experienced panel guides bankruptcy counsel through issues related to a tenant's security deposit under a nonresidential lease and the maze of bankruptcy rules for assumption, assumption and assignment, or rejection of leases and discusses strategies for landlords and tenants to protect their rights and interests in their leases.