With the leasing market for commercial property continuing to suffer from the reduced need for office space caused by the COVID-19 pandemic, 2022 introduced additional financial stress in the form of higher interest rates and inflation. The Federal Reserve has continued to raise interest rates in an effort to bring down inflation, and Federal Reserve officials are signaling further interest rate hikes in 2023. American consumers are suffering from the ramifications of increased borrowing costs, as well as a more volatile stock market, and other turbulence and uncertainty in the world.

Commercial landlords and tenants have been particularly impacted by these developments. While the light at the end of the tunnel might seem dim, there are steps that commercial landlords and tenants can take as they try to see the light, including negotiating new leases, restructuring current leases, or, if necessary, seeking some form of bankruptcy protection.

In 2022, as a result of the pandemic, inflation, and the increased borrowing costs, many commercial landlords and tenants have been considering various ways to restructure leases. While some parties have restructured leases, tenants have generally had a difficult time negotiating amendments. As the economic devastation of the pandemic, inflation and interest rate hikes continue, some tenants might need to seek bankruptcy protection.

This article is intended to highlight some important points for both commercial tenants and landlords to consider from a real estate and bankruptcy perspective while evaluating the best path forward. Although commercial landlords routinely conduct extensive due diligence regarding a potential tenant prior to entering into a lease transaction, the circumstances, planning, and financial health of many large, well-known tenants often change during the term of the lease and some could file for bankruptcy.

• Bankruptcy Benefits to Tenant - As a general guideline, while some tenants have found themselves in a challenging position given landlord-friendly force majeure clauses in commercial leases, once a tenant files for bankruptcy protection, the tenant has additional options vis-à-vis its lease and its landlord.  For example, the tenant’s interest in its lease is protected by the automatic stay that goes into effect upon the filing of the tenant’s bankruptcy and a landlord would need to get relief from the automatic stay in order to take action against the tenant.  Further, if the tenant elects to reject the landlord’s lease effective as of the date the bankruptcy case is filed, the landlord’s claim for damages will be limited to a pre-petition unsecured claim.  In addition, a landlord’s claim for damages from a lease rejection is capped under the United States Bankruptcy Code (the “Bankruptcy Code”).  Specifically, under Section 502(b)(6) of the Bankruptcy Code, a landlord-creditor is entitled to a claim for unpaid rent only for the greater of one lease year or fifteen (15%) percent, not to exceed three years, of the remaining lease term.  This capped amount reflects Congress's intent to limit lease termination claims in order to prevent landlords from receiving a disproportionate share of the bankruptcy estate over other creditors.
• Bankruptcy Benefits to Landlord - There could be benefits to a landlord in not granting rent relief or an early termination and forcing the tenant to file for bankruptcy.  For example, all rent that is due to a landlord by a tenant after the filing of a bankruptcy case is entitled to administrative expense treatment. This means that the landlord’s rent claim is entitled to be paid before most other types of claims, including general unsecured claims. Further, if the tenant seeks to assume the lease, the tenant would be required to cure all unpaid rent and provide the landlord with adequate assurance of future performance under the lease.
• Awareness of Bankruptcy in the Discussions - Both landlords and tenants would benefit from familiarizing themselves with the legal impacts of bankruptcy when considering whether to amend the terms of, or terminate, a lease.   For both parties, a pre-bankruptcy solution could avoid the additional expense of an insolvency proceeding.  For the landlord, an amendment avoids the time during which it could have vacant space and the significant difficulty in finding an income producing tenant during the current pandemic. The tenant might seek to leverage during the negotiations the threat of some of the benefits it could obtain if it elected to file. 
• Potential Rent Relief Programs - Since the outset of the COVID-19 pandemic and continuing to date, many commercial landlords have been able to delay or even avert struggling tenant bankruptcies through the use of forbearance agreements or re-negotiated lease terms, including the following:
  • Rent Forgiveness – Some landlords have granted either a full or partial rent abatement for a specified, limited time period.  We have seen various arrangements between landlords and tenants regarding abatements to tenants for periods of time to help keep them in business and viable as tenants during times when many businesses have been unable to operate at normal capacity as a result of the COVID-19 pandemic or government-imposed restrictions resulting therefrom. In some instances, we have seen abated rent forgiven at the expiration of the lease provided there has been no lease termination for an event of default and there has been no bankruptcy filing. However, the landlord can include the abated rent in its bankruptcy claim if there was a filing and the tenant elects to reject the lease.
  • Deferred Rent Program – In lieu of the abatement program described above, some landlords have agreed to defer rent for a specified number of months, with the rent for those months becoming due and payable in their entirety at some future period of time or during the term of the lease spread over a specific number of months.  Some of the delayed payments from such deferral arrangements have or are now coming due, and it is unclear whether tenants have the means to now pay the deferred rent and also satisfy their current obligations. Landlords may not be willing to agree to any further deferrals. If the tenant files for bankruptcy after the deferred amounts have become due, then the landlord should have a pre-petition unsecured claim for the deferred amounts. If the tenant files for bankruptcy before repaying these deferred amounts which come due post-petition, the landlord will have an administrative claim for these deferred rent payments.