• Darling Milligan

Effects of tenant bankruptcy on eviction, collection of unpaid rent

Colorado Real Estate Journal -

Under 11 U.S.C. §362(a) of the U.S. Bankruptcy Code, the filing of a bankruptcy petition automatically stays most proceedings against the filing party (debtor). Among other things, the stay prevents a creditor from taking any action to collect pre-petition debt or to enforce lien rights, including the following: 1) the commencement or continuation of any action or proceeding that was or could have been commenced before filing the petition or to recover a claim against the debtor that arose before filing the petition; 2) any act to collect, assess or recover a claim against the debtor that arose before filing the petition; 3) any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate; and 4) the setoff of any debt owing to the debtor that arose before filing the petition against any claim against the debtor. The purpose of the automatic stay is three-fold: to prevent certain creditors from gaining preference for their claims against the debtor; to forestall the depletion of the debtor’s assets due to legal costs in defending proceedings against it; and, in general, to avoid interference with the orderly liquidation or rehabilitation of the debtor. In re DBSI, Inc., 407 B.R. 159 (Bkrtcy.D.Del., 2009). Once the debtor notifies creditors of a bankruptcy filing, the debtor is not required to do anything else. The automatic stay operates just as its name states – “automatically.” Consequences for violating the automatic stay can be severe and, in addition to actual damages, can include punitive damages, sanctions and reimbursement of the debtor’s attorneys’ fees. Several key questions arise when a tenant files bankruptcy: Can the landlord still pursue the tenant for unpaid rent? The automatic stay prevents a landlord from initiating or otherwise pursuing the tenant for pre-petition unpaid rent or other damage due under the lease. Under the statutory framework, at the conclusion of the typical Chapter 7 (liquidation) case, the automatic stay is replaced by a “discharge injunction,” which eliminates (or discharges) the debtor’s liability for pre-petition debt owed to the creditor (unless the debt is nondischargeable). However, once the debtor’s debts are discharged or the bankruptcy case is closed, the landlord can usually still pursue the tenant for post-petition debts incurred. It sometimes is the case that a creditor is already in the process of collecting an unpaid debt from the tenant when the tenant files bankruptcy, and the creditor may also have a bench warrant for the tenant’s arrest for failing to respond to post-judgment discovery efforts by the creditor. In that case, as soon as the creditor has notice of the bankruptcy filing, the creditor would be wise to immediately take affirmative steps to vacate or quash the warrant to avoid violating the automatic stay or discharge injunction. Can the landlord pursue a personal guarantor of the lease? As a general rule, the automatic stay protects only the debtor and property of the debtor’s estate. It does not protect nondebtor entities or their property and, therefore, typically does not stay actions against nonparty lease guarantors. Can the landlord initiate eviction proceedings against the tenant? The automatic stay does not apply to a commercial landlord’s action to obtain possession of property under a commercial lease that has terminated by the expiration of the stated term of the lease before filing the bankruptcy petition or during the pendency of the bankruptcy case. Otherwise, to evict a commercial tenant and obtain possession of the property, a commercial landlord must seek relief from the automatic stay by filing a motion in the bankruptcy case. Under 11 U.S.C. § 362(d), the bankruptcy court shall grant relief from stay where the debtor has no equity in the property and the property is not necessary for an effective reorganization by the debtor, and where the landlord lacks adequate protection of its interest in the property. In the case of residential property, the automatic stay applies to eviction proceedings, unless: (i) the landlord had already obtained an order for possession of the leased property prior to the tenant filing the bankruptcy petition. 11 U.S.C. § 362(b)(22); or (ii) the eviction action seeks possession of the residential property based on endangerment of the property or the illegal use of controlled substances on the property, and the landlord files with the court, and serves on the debtor, a certification that such eviction action has been filed, or that the debtor, during the 30-day period preceding the date of the filing of the certification, has endangered the property or illegally used or allowed to be used a controlled substance on the property. 11 U.S.C. § 362(b)(23). Can the landlord retain any portion of the tenant’s security deposit? Recently, the U.S. Bankruptcy Court for the District of Colorado addressed whether the landlord’s retention of a tenant’s security deposit violated the automatic stay. In In re Baetz, 493 B.R. 228 (Bkrtcy.D.Colo., 2013), during the pendency of a residential tenant’s bankruptcy case, the tenant’s landlord sent a Notice of Deposit Withholding advising the tenant of the landlord’s intent to withhold his deposit for pre-petition and post petition unpaid rent. The court noted that while the automatic stay mostly applied to actions related to pre-petition debt, the setoff provisions applied to any debt. Accordingly, the court determined that a landlord violates the automatic stay by offsetting or otherwise retaining any portion of a tenant’s security deposit, even if the offset is only applied against the tenant’s post-petition rent obligations.

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