What To Do When A Tenant Files For Bankruptcy

Owning rental properties can be a rewarding investment, but it also comes with its share of challenges. Responsible tenants who pay rent on time are what every landlord hopes to find. However, dealing with non-payment and the eviction process can be stressful, time-consuming, and costly. While eviction is a potential concern, another situation that can arise is tenant bankruptcy.

If a tenant files for bankruptcy, it can create uncertainty for landlords regarding rent collection. What actions must landlords take when faced with a non-paying renter that files for bankruptcy? How can they prevent themselves from ending up in this situation again?

This blog post will explore what landlords can do in the face of a tenant filing for Chapter 7 bankruptcy. We'll cover relevant actions you can take and steps to potentially avoid similar situations in the future. By understanding your rights and responsibilities, you can be better prepared to manage challenges related to tenant non-payment.

What Is Bankruptcy?

Bankruptcy is a legal process for individuals who have become overwhelmed by debt and are now unable to meet their financial obligations. A declaration of Bankruptcy aims to find a solution that's fair to both the person filing for bankruptcy (the debtor) and their creditors. This might involve liquidation of assets or constructing debt repayment plans.

As a landlord, you might encounter tenant bankruptcies that are either foreseeable or unexpected. Some tenants might prioritize rent payments to stay housed while letting other debts accumulate, eventually leading to a bankruptcy filing. Thorough tenant screening may help you gain insights into a tenant's financial history to be able to discern if bankruptcy has been or may be a problem.

There are a few specific types of bankruptcy that you should familiarize yourself will in order to appropriately handle your tenant filing for bankruptcy.

Types Of Bankruptcy

The two main types of bankruptcy that affect you as a landlord are the most commonly filed by individuals: Chapter 7 and Chapter 13.

Chapter 7

Chapter 7 bankruptcy is a common type where the debtor's assets are liquidated (sold) by a court-appointed trustee to repay creditors. As a landlord, this can impact your ability to collect rent.

1. Current Renters: If a tenant who files Chapter 7 is current on rent payments, they may be able to stay in the property and continue their lease, assuming they comply with the terms of the lease agreement.
2. Delinquent Renters: If a tenant filing Chapter 7 is behind on rent, they will likely be required to vacate the property. The bankruptcy court will typically determine how much, if any, of the rent arrears will be repaid through the liquidation process.

Chapter 7 is also commonly referred to as "straight bankruptcy," and is the typical option for individuals struggling with a large amount of unsecured debt, such as medical bills, credit cards, and utility bills. The goal of this type of bankruptcy is to discharge most unsecured debts, which will provide the debtor with a financial fresh start.

Chapter 13

Chapter 13 bankruptcy focuses on restructuring debt through a court-approved repayment plan, rather than the liquidation of assets. The debtor proposes a plan to repay creditors over a period of three to five years, which allows them to potentially keep their assets.

Chapter 13 is often used when individuals encounter temporary financial hardships, such as job loss or extensive medical bills, that lead to unmanageable debt. The goal of this type of bankruptcy is to create a structured repayment plan that allows the individual to catch up on payments.

My Tenant Filed Chapter 7; What's Next?

Learning that your tenant filed for bankruptcy can be concerning. When a tenant files for bankruptcy, the court will grant them an automatic stay. This legal order temporarily halts debt collection efforts from all creditors, including evictions and back rent. This can be a confusing time for landlords, so here's a breakdown of what it means for you:

1. Automatic Stay: The court will grant an "automatic stay," halting collection efforts while the case progresses through the court system.
2. Lease Status: Your tenant has up to 60 days to either "assume" or "reject" the lease agreement.
3. Rent Payments: Rent payments should continue during this period. However, recouping past-due rent might be delayed until the bankruptcy case is resolved.

Assuming Vs. Rejecting The Lease

When a tenant files for Chapter 7 bankruptcy, they have two options regarding your lease agreement:

1. Assuming the Lease: If the tenant chooses to remain in your property, they must "assume" the lease. This signifies their intention to stay in the property and fulfill the remaining lease term. However, assuming the lease often comes with conditions set by the court. They will likely need to:
2. Catch up on past-due rent: The court might require repayment of any past-due rent within a reasonable time-frame, typically within a year.
3. Demonstrate financial stability: The tenant will need to provide proof of income sufficient to cover current rent payments and past-due balances simultaneously.
4. Rejecting the Lease: The tenant voluntarily chooses to terminate the lease agreement and must move out. They are no longer obligated to fulfill the terms of the lease. The lease will be then treated as part of the bankruptcy estate, potentially liquidated or included in a repayment plan.

Bankruptcy Court

After the tenant's assets and debts are reviewed, a bankruptcy judge will determine whether the case can proceed and how the gathered assets will be used to create a fair repayment plan for all involved creditors. This plan will outline how much, if anything, you can expect to receive for any unpaid rent. It will also address the remaining lease term and the tenant's ongoing residency.

The court-ordered solution is binding for both debtors and creditors. However, if you believe the proposed plan is unfair, you do have the right to challenge it in court.

Move On

Unfortunately, recouping all past-due rent isn't always guaranteed in tenant bankruptcy cases. While the court may indeed order a repayment plan, the timeline and amount can vary.

Focus on the future. This can be an opportune moment to re-evaluate your tenant screening process to better locate financially stable renters and minimize the risk of running into another bankruptcy situation. By implementing stricter screening measures and crystal clear lease agreements, you can increase your chances of finding reliable tenants who prioritize rent payments.

Taking Action

When a tenant files for bankruptcy, it can be a challenging situation for landlords. While empathy for the tenant's circumstances is important, it's also crucial to safeguard your financial interests.

The following guide will equip you with essential knowledge to navigate this complex scenario. We'll explore key aspects to monitor as your tenant's bankruptcy case progresses, including steps you can take to maximize the possibility of recouping owed rent.

Check On The Automatic Stay

A key concept in tenant bankruptcy is the automatic stay. This court order temporarily halts most collection efforts, including rent collection and eviction proceedings, while the bankruptcy case progresses.

What this means for you as a landlord:

1. Rent collection is on hold: You'll be unable to collect past-due or future rent payments until the court decides on the case.
2. Eviction restrictions: New eviction filings are generally prevented by the stay. However, ongoing eviction cases with court rulings in your favor may be allowed to proceed. Additionally, the automatic stay might not apply if the tenant has violated the lease through illegal activity or damage to the property.

Receiving Future Rent Payments

The automatic stay creates a complex situation regarding rent payments. Despite the Automatic Stay, the lease agreement remains in effect, and tenants are legally bound to continue paying rent on time during the bankruptcy case. However, the automatic stay prevents landlords from actively collecting rent payments or enforcing late fees.

It's important to consult with an attorney specializing in landlord-tenant law to understand the specific implications in your jurisdiction. Some courts may interpret the automatic stay in a way that could allow tenants to temporarily withhold rent payments.

It's important to note that even if rent payments are paused during the case, the tenant may still be responsible for the accrued rent. The court will determine the ultimate fate of unpaid rent during the bankruptcy proceedings.

How to Claim Debt

In a tenant bankruptcy case, a "proof of claim" is a document that states the amount of money the tenant owes you and the reason for the debt (lease agreement).

Filing a proof of claim with the bankruptcy court is essential to ensure your owed rent is considered for repayment. This is particularly important if the tenant rejects the lease agreement, as the unpaid rent becomes part of the bankruptcy estate.

By submitting a proof of claim, you increase the chances of recouping at least some of the past-due rent, depending on the court's final decision and the available assets in the bankruptcy case.

If the tenant rejects the lease, you can claim some or all of the following:

1. Past-due payments and related damages
2. Damages caused by the lease rejection (up to one years' rent.)
3. Unpaid rent or fees caused by the bankruptcy filing

To maximize your chances of recovering owed rent and navigate the complexities of tenant bankruptcy, consulting a bankruptcy attorney experienced in landlord-tenant law is highly recommended. These professionals can guide you through the process of filing a claim, represent you in court if necessary, and advise you on strategies to potentially recoup legal expenses.

Pre-Bankruptcy Resolutions

If a tenant is consistently late on rent, open communication is key. While you may not know their exact financial situation, a frank conversation can help you identify potential solutions.

Here's where exploring a pre-bankruptcy resolution can be mutually beneficial:

1. Lease Adjustments: Could modifying the lease terms, such as a temporary rent reduction or a payment plan for past due rent, help them stay current?
2. Lease Termination: Is an amicable lease termination an option? This could involve offering a buy-out for their remaining lease term, allowing them to find more affordable housing and freeing up your unit for a new tenant.
3. Debt Forgiveness: In exchange for a faster move-out or a one-time payment, could you consider forgiving a portion of the debt?

While a pre-bankruptcy resolution may not be possible in all situations, it's definitely worth exploring the possibility. Open communication and a willingness to find common ground can lead to a more positive outcome for everyone involved.

Tenant Bankruptcy - Key Takeaways

While navigating a tenant's bankruptcy filing can be challenging, understanding the process can help you approach the situation strategically. Here are some key takeaways:

1. Proactive Tenant Screening: Implementing a thorough tenant screening process that considers factors like credit history can help identify financially stable renters and minimize the risk of late payments or bankruptcy situations.
2. Open Communication: Maintaining open communication with your tenants allows for early identification of potential financial difficulties. This can open the door to exploring solutions outside of court, such as payment plans or lease modifications.
3. Pre-Bankruptcy Resolutions: If a tenant experiences financial hardship, consider exploring a pre-bankruptcy agreement before a formal filing. This can involve mutually beneficial solutions like lease adjustments or debt forgiveness in exchange for an earlier move-out date.
4. Understanding the Legal Process: Knowing your rights and the steps involved in a tenant bankruptcy case allows you to take appropriate actions, such as filing a claim for owed rent. Consulting with a lawyer experienced in landlord-tenant law can be invaluable in navigating this legal process.
5. Respecting the Automatic Stay: The automatic stay in bankruptcy cases can limit rent collection and prevent eviction proceedings.
6. Calm and Organized Approach: By staying calm and organized, you can effectively manage the situation. Keep detailed records of missed payments and court proceedings. Following the court-ordered solution ensures you comply with the legal requirements.

By implementing these strategies and staying informed, you can be better prepared to address tenant bankruptcy situations and minimize their impact on your rental business.

This blog is for informational and educational purposes only, and does not claim to be legal advice. Always consult with a lawyer to fully understand Landlord-Tenant Law in your area.