In This Article
Chapter 11 vs. Chapter 7 – what’s at stake?
Even with robust early-warning systems in place, a tenant’s bankruptcy can still come as a surprise. For owners of commercial real estate, particularly net lease investors, the immediate concerns are practical. Will rent continue? What can be recovered? Will the tenant stay, and if not, when can the space be relet?
The answers depend on both the lease and bankruptcy law. This article explains the key differences between Chapter 11 and Chapter 7, then examines provisions addressing security deposits, early marketing, and the tenant’s ability to meet future lease obligations. Understanding these protections before they are needed can help landlords assess their options when every cent on the dollar counts.
Stronger lease protections can help to reduce a landlord’s risk, but market conditions influence both the ability to negotiate them and their practical value. Demand for comparable space and the availability of alternatives shape how much bargaining power each party has.
In both Chapter 11 and Chapter 7, rent owed for the period after the bankruptcy filing and before the lease is assumed (retained) or rejected is generally treated as an administrative expense. This gives the landlord’s claim for that rent priority over general unsecured claims, improving its prospects for recovery without guaranteeing payment. How landlords can exercise their rights during bankruptcy proceedings depends on statutory requirements and how courts interpret them. Local bankruptcy courts also have their own rules and procedures for submitting documents and conducting hearings. An attorney familiar with the relevant court can help landlords navigate these requirements.
Chapter 11 – reorganization. The tenant usually remains in control of its business as the ‘debtor-in-possession’ and continues operating while seeking to reorganize. The court may appoint a trustee to take over management for reasons such as fraud, dishonesty, incompetence, or gross mismanagement, or when doing so serves the interests of creditors and the estate. For an unexpired commercial real estate lease, the tenant has 120 days after the order for relief (which occurs upon filing in a voluntary bankruptcy – filed by the tenant itself) to assume or reject the lease, unless a plan is confirmed sooner. For cause, the court can grant a 90-day extension, bringing the period to 210 days without the landlord’s approval. Further extensions require the landlord’s prior written consent (11 U.S.C. / U.S. Bankruptcy Code, Section 365(d)(4)).
To assume the lease, the tenant generally must address existing defaults, including unpaid rent, by curing them or providing adequate assurance of prompt remedy (‘curing’ the defaults). It must also provide adequate assurance that it can meet its future lease obligations – meaning, credible evidence of its ability to perform, which the bankruptcy court evaluates. If the lease is rejected, the landlord recovers possession and can retenant. Claims for unpaid pre-filing rent and rejection damages (such as lost future rent and certain reletting costs) are generally unsecured, with lease-termination damages subject to a statutory cap. Actual recovery for unsecured claims may be only a fraction of the amount owed.
Chapter 7 – liquidation. A trustee (usually, but not necessarily a lawyer who specializes in bankruptcy law) is appointed to oversee the liquidation of the tenant’s bankruptcy estate (the assets and legal interests available for administration in the bankruptcy case) and may seek prompt rejection of the lease. For an unexpired commercial real estate lease, the trustee generally has up to 120 days after the order for relief to assume or reject it, subject to the extension rules described above.
Upon rejection, a landlord is generally left with unsecured claims for unpaid pre-filing rent and rejection damages, with lease-termination damages subject to a cap under the Bankruptcy Code. A cash security deposit may reduce the loss, but its application is subject to bankruptcy restrictions. In this scenario, the landlord may regain possession of the vacant premises but face limited recovery, without the cure of defaults generally required when a lease is assumed.
In both Chapter 7 and Chapter 11, landlords face the automatic stay, a legal restriction that takes effect immediately upon a tenant filing a bankruptcy petition. It prohibits or limits landlords from initiating or continuing eviction proceedings, applying cash security deposits, collecting pre-filing past-due rent, or taking other action to enforce lease defaults without prior permission from the bankruptcy court.
The stay is designed to give debtors breathing room, but it can catch landlords off guard, limiting their ability to act when they need flexibility most. That’s why protective provisions on financial reporting, performance triggers, and lease remedies are best established before distress escalates, while the landlord has greater flexibility to act. Alongside these protections, regular communication with tenants, especially during periods of economic turmoil, can help both parties identify emerging difficulties early and explore practical solutions.
Key lease provisions to prepare for tenant bankruptcy
The following lease provisions can help protect landlords and are best considered when the lease is first negotiated. Rent relief discussions with a distressed tenant may offer another opportunity to introduce them, prior to bankruptcy. However, pre-petition changes (made prior to bankruptcy filing) may be challenged and unwound if they improperly favor the landlord over other creditors or involve transfers or obligations intended to hinder, delay, or defraud creditors. Such challenges depend on specific requirements under bankruptcy law, rather than simply whether a change disadvantages another creditor. Building appropriate protections into standard leases from the outset can reduce reliance on last-minute changes.
1. Security Deposit - Cash vs Letter of Credit
Best practice:
- When negotiating the lease, consider an i-LOC from a reputable bank with a strong credit profile instead of a cash security deposit.
- Ensure the lease and i-LOC work together, with clear draw conditions for tenant defaults and, where legally enforceable, a tenant’s bankruptcy filing, supported by documentation requirements the landlord can readily satisfy.
- Address expiry, renewal, and draw rights if the bank gives notice of non-renewal.
- Review any conversion from cash security carefully if the tenant is already distressed, as pre-petition arrangements may be challenged under bankruptcy law.
2. Early Access and Discreet Marketing
Best practice:
- Define the breaches that permit early marketing, such as unpaid rent, failure to deliver required financial statements, or cessation of operations in breach of the lease. Specify the relevant deadlines, notice requirements, and cure periods, and tailor the triggers to the tenant’s business.
- Provide for reasonable access on advance notice, with safeguards to minimize disruption to the tenant’s operations.
- Allow confidential outreach without signage or public listings, and specify when broader marketing becomes permissible, taking account of any applicable notice and cure periods.
3. Tenant's Ability to Meet Future Lease Obligations
Best practice:
- Establish clear financial reporting requirements, such as a rolling 12-month budget and cash-flow forecast for the landlord’s review.
- Define the agreed security requirements in the lease. If additional security is needed during bankruptcy, consider seeking an i-LOC (e.g. covering three months’ rent) as part of the proposed assurance package, rather than assuming it is automatically required.
- Request evidence that defaults requiring cure, including unpaid rent, have been addressed or that adequate assurance of prompt cure has been provided.
Because adequate assurance involves a case-specific assessment, landlords should seek commercially reasonable protections tied to identifiable risks and supported by financial evidence. Requirements that reflect the tenant’s business, the property, and relevant market conditions give the court a stronger basis to accept the landlord’s proposals. Excessive or poorly supported demands are more vulnerable to challenge or rejection.
Additional considerations
- Documenting Potential Claims
Clearly address responsibility for potential losses in the lease, including unamortized tenant improvements, broker commissions, and vacancy-related expenses such as marketing and reletting costs, to the extent permitted by the state law governing the lease. Keep records supporting the amounts claimed. If the lease is rejected, this documentation can help substantiate the landlord’s claim, but it does not override the statutory cap on lease-termination damages or guarantee recovery (Section 502(b)(6)).
- Tenant Improvement Recovery
If tenant improvement allowances are provided, consider an agreed amortization schedule and clawback provisions requiring repayment of the unamortized balance following specified defaults or early termination. These provisions can establish a basis for seeking repayment, but bankruptcy may limit recovery, including through the cap on lease-termination damages.
- Payment Clawback Risk
Under Section 547 of the Bankruptcy Code, a bankruptcy trustee, or the tenant acting as debtor-in-possession in Chapter 11, may seek to recover certain payments received by the landlord within 90 days before filing as preferential transfers. This does not mean landlords should stop accepting rent. Section 547(c) provides defenses that may protect some or all of a payment, including ordinary-course payments and qualifying new value subsequently provided by the landlord, such as further unpaid use of the premises. Keep clear payment records and obtain advice before agreeing to unusual catch-up payments or new security for overdue rent.
- Shopping Center Leases
Section 365(b)(3) provides additional protections for leases in qualifying shopping centers – e.g. a strip center under common ownership with shared parking and coordinated lease provisions governing permitted uses and tenant mix. A tenant may also seek to assume the lease and then assign it to a replacement tenant – e.g. as part of a sale of its business. The replacement tenant takes over the lease obligations, subject to court approval and applicable bankruptcy requirements. For an assignment of a qualifying shopping-center lease, the financial condition and operating performance of the proposed replacement tenant and its guarantors must be similar to those of the original tenant and its guarantors when the original tenant entered into the lease.
The landlord should also assess whether the proposed arrangement:
Preserves the tenant mix and respects permitted-use restrictions and other tenants’ exclusive-use rights.
Respects applicable co-tenancy and anchor-tenant provisions, including requirements tied to the presence or operation of specified tenants.
Provides adequate assurance that the replacement tenant can meet maintenance, common area maintenance (“CAM”), and percentage rent obligations, and that percentage rent will not decline substantially.
Clearly document use restrictions, co-tenancy and anchor-tenant arrangements, and payment obligations in the lease. These provisions help establish what the landlord can seek to protect under Section 365(b)(3), although their enforcement remains subject to the court’s assessment.
Conclusion - shape the narrative before bankruptcy does
A tenant’s bankruptcy can be disruptive, but preparation can help bring order to a potentially chaotic process. Thoughtfully drafted leases, clear financial records, and early attention to warning signs help landlords present a well-supported position when their rights and recovery are at stake. Whether you’re a private investor, family office, or REIT, preparing before distress escalates can help preserve your options, mitigate losses, and improve the prospects for recovery. The best time to strengthen your position is while you still have room to act.
How can we help?
Johannes Schmidt, Founder of Alphaporting, brings deep financial and credit risk expertise to help landlords assess tenant viability, detect early signs of financial distress, and negotiate practical, performance-based lease terms, particularly during rent relief discussions.
Katie Goodman, Managing Partner at GGG Partners, brings extensive restructuring and turnaround experience to help stakeholders navigate distressed situations, evaluate restructuring alternatives, and implement practical solutions, including Chapter 11 reorganizations and asset sales, when financial distress escalates.
