Protection Against Tenant Bankruptcy

In many areas, commercial landlords have been hurt by an economic slowdown, overbuilding, a depressed retail sector or other factors.

It's more important than ever for landlords to structure leases to reduce their exposure in the event of a tenant bankruptcy. Increasingly, commercial landlords are requiring letters of credit as protection, which may be used in lieu of the more traditional security deposit.

The Benefits of Using a Letter of Credit Can Be Substantial:

Traditionally, security deposits have been deemed to be the property of a tenant's bankruptcy estate. Accordingly, although a landlord holds a security interest in the deposit, the landlord can't use such funds to cure a tenant's arrears without obtaining relief from the automatic stay. As a result, a landlord may be left without an immediate source of funds to remedy unpaid rent, taxes and other charges.

Letters of credit provide a potential solution. The "independence principle" holds that letters of credit and the proceeds of letters of credit are not property of a bankruptcy estate. Therefore, the automatic bankruptcy stay doesn't impact a landlord's action in drawing upon the letter of credit.

There are certain rules that must be followed in order for the landlord to benefit:

In order to avoid the trap of the automatic stay, the ability to draw on a letter of credit must not be tied to the tenant's cooperation. A properly structured letter of credit allows the landlord to act anytime the tenant is not in compliance with the covenants of the lease.

The use of letters of credit cannot guarantee a favorable outcome. However, a properly structured lease and letter of credit transaction provides commercial landlords with advantages that aren't available through the use of the traditional security deposit.

Definition

The Bankruptcy Code sets forth a broad definition of "property of the estate," which encompasses, "all legal and equitable interests of the debtor in property as of the commencement of the case." (11 U.S.C. §541 (a)(1)) The Code's automatic stay provisions establish extensive protections and stay most actions that may impact property of the estate. (11 U.S.C. 362(a))

We Help You Get to Your Next Level™

Get in touch today and find out how we can help you meet your objectives.

Call Us