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As a landlord, what do you do when your tenant files bankruptcy? Should you:

a. immediately run to the courthouse and file for eviction?
b. lock the tenant out of the property?
c. send the tenant a letter demanding immediate payment?
d. knock on the tenant’s door and inform him or her that the bankruptcy is a violation of the lease agreement, which requires him or her to move out?
e. deliver a formal, written notice requesting that the tenant either pay all amounts owed or move out?

Although it is not listed as an answer, hopefully you are screaming to yourself “none of the above!”, as each of the actions listed could be a serious violation of federal bankruptcy law. If you are a landlord and are not sure why, please save yourself the potential heartache, and possibly significant monetary penalties, and read on.

Bankruptcy is a concept that has been around for centuries, but in the past few decades has, for the most part, increased in frequency and the extent of protections granted to debtors. Simply put, bankruptcy is supposed to give the debtor a “fresh start” by allowing him or her to wipe the slate clean of most debts, or at least to enter into a manageable payment plan. The law also provides the debtor certain additional protections from the collection actions of creditors to provide the debtor with some breathing room while the bankruptcy process moves forward. The most critical of those protections for a landlord to understand is the “automatic stay.”

At the moment a debtor files the petition for bankruptcy, federal bankruptcy law automatically imposes a stay that protects the debtor from almost all collection activities by creditors—including landlords. See 11 U.S.C. § 362. I like to tell clients to think of this law as a brick wall that goes up between the debtor and everyone who wants money from the debtor. That brick wall essentially prevents creditors from demanding money, asking for money, threatening to sue for money, threatening to repossess items in the debtor’s possession, or in the case of a landlord, threatening to evict the tenant if the tenant does not pay rent or other money owed.

So, does this mean that the landlord has to just sit back and watch as the tenant lives in the landlord’s house for free? Not if the landlord knows the right way to climb over the wall.

Because the automatic stay comes from federal bankruptcy law, you must go to the federal bankruptcy court to seek relief from the stay (climb over the wall). This is done by filing a motion for relief from the automatic stay in the federal bankruptcy. In that motion, the landlord asks the bankruptcy court for permission to proceed with evicting the tenant for non-payment, or some other violation of the lease. The bankruptcy court will not issue the actual eviction order. Rather, the bankruptcy court will grant relief from the stay so that the landlord can then move forward with eviction proceedings in state court.

Seeking relief from the automatic stay in bankruptcy court can be a complicated process, much more so than simply seeking an eviction in state court. As such, landlords should seriously consider consulting with an attorney experienced in representing creditors in bankruptcy court. Furthermore, the potential penalties for violating the automatic stay can be very steep—sometimes as high as $10,000 per violation—so it is not wise to take any actions that even come close to looking like collection activities. If you are not sure, consult an attorney.

The good news is, with a little time and patience, the landlord can succeed in obtaining relief from the stay and re-gaining possession of the rental property. While it can be extremely frustrating and somewhat expensive, it may be the only way to get the property back on the rental market.

NOTE: Do not make the mistake of believing that by simply filing a bankruptcy, a tenant is automatically in violation of the lease. As long as a tenant continues to pay rent and is in compliance with the other covenants contained in the lease, he or she is not in default, and should not be in danger of eviction. In other words, a bankruptcy is not automatically a lease violation.

Some landlords even go so far as to include a provision in the lease stating that if the tenant files bankruptcy, it is an automatic lease violation. Such provisions are generally in violation of public policy and, therefore, not enforceable in court. Plus, in today’s market, if you have a tenant who is current on rent and otherwise complying with the lease, why would you want to evict?

Because the facts and circumstances vary for each individual, we encourage you to contact us regarding the facts pertaining to your case to determine how the laws discussed in this article apply to you.

by Josh Deere, Attorney at Hanes Hrbacek & Bartels, LLC