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June 2, 2020 | Category: Asset Protection, Corporate and Taxation, Estate Planning and Probate, News

This is the fourth in a series of articles on Bankruptcy. Feel free to review Part 1, Part 2 and Part 3.  

Sometimes it takes a catastrophic event to shake up the status quo. COVID-19 is such an event.  For years, telecommuting or working from home has been increasing, and eventually the culture would have changed.  After this forced experiment, many of us who do not need to be physically present in an office some or most of the time will probably not do so.

This puts great pressure on the commercial office space industry. Those businesses that can maintain their workforce, but use less office space, will be at a competitive advantage. Those businesses who retain fewer employees will need even less space. 

This brings us to today’s topic.  In our example, Professional Pension Consultants, Inc. (the “Company”) is a 40-year-old business that designs and administers pension and profit sharing plans for primarily professional, mid-size businesses. They have 20 employees, six of whom are actuaries, CPAs, attorneys or managers. They have a 5,000 square foot office and pay $200,000 a year in rent.

When the Plague of 2020-2021 was over, they lost a third of their business, six employees were no longer there, and had little cash.  Clients were not paying well and many demanded a discount.  But the lease was still there for another 5 years, along with increasing rents and pass-throughs. The Company believes that many of the employees could work from home most of the time and everyone else at least some time. Their real need is about 1,500 square feet or 70% less than they have.  

The landlord played hardball by offering no concessions.  And so did the Company. The Company filed under Chapter 11 of the Bankruptcy Code.

Under bankruptcy, unexpired commercial leases may be either assumed by the debtor or rejected.  This assumes that we are dealing with a real lease and not one that is really a sale with financing disguised as a lease (e.g., the tenant has a right to buy the property for $1 at the end of the lease.) This also assumes that the commercial lease has not expired (i.e., there is a length of time left on the lease) or terminated (e.g., tenant is in default under the lease and without right to cure the default at time of filing for bankruptcy).

In bankruptcy, the Trustee in Chapter 7 (Liquidation) or usually the debtor-in-possession under Chapter 11 (Reorganization), has 120 days to accept or reject the lease. Court approval is usually required either way.  If the lease is accepted, the arrearages must be brought current or the landlord given “adequate assurance” of prompt compensation, “non-monetary” defaults must be cured (e.g., non-permitted signage under the lease must be removed), and the landlord must be given adequate assurance that the lease going forward will be honored.

Adequate assurance is a function of the projected profitability of business, guarantees under the lease, deposits under the lease, etc.

If the lease is rejected by the Trustee or debtor-in-possession, the bankruptcy estate is liable for the greater of (i) rent for one year; and (ii) 15% of future rents under lease, but not to exceed 3 years’ rent.  In our example, since the lease has another 5 years, there is a claim for 1 year’s rent.

More complicated rules apply for shopping center leases.

Why would the Trustee assume the lease if the business is being liquidated under Chapter 7?  This may occur when the rent is below fair market value and the Trustee can assume and then assign the lease to a third party and make a profit.

In our example, the Company reorganized under Chapter 11, rejected the lease, and continued on with a reduced work force with a much smaller office with an affordable lease.  The landlord got their property back and 1 year’s rent. 

We wish the Company good luck.

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