There are several important topics for both tenants and landlords to consider from a bankruptcy perspective while negotiating these lease amendments or termination agreements during the COVID-19 pandemic:

Bankruptcy Benefits to Tenant- As a general guideline, while tenants have found themselves in a tough negotiating position given landlord-friendly force majeure clauses in most commercial leases, once a tenant files for bankruptcy protection, the tenant could move into an advantageous position vis-à-vis its lease and its landlord. For example, the tenant's interest in its lease is protected by the automatic stay that goes into effect upon the filing of the tenant's bankruptcy and a landlord would need to get relief from the automatic stay in order to take action against the tenant. Further, if the tenant elects to reject the landlord's lease effective as of the date the bankruptcy case is filed, the landlord's claim for damages will be limited to a pre-petition unsecured claim. In addition, a landlord's claim for damages from a lease rejection is capped under the United States Bankruptcy Code (the "Bankruptcy Code"). Specifically, under Section 502(b)(6) of the Bankruptcy Code, a landlord-creditor is only entitled to a claim for unpaid rent for the greater of one lease year or fifteen (15%) percent, not to exceed three years, of the remaining lease term. The cap operates from the earlier of (i) the petition filing date or (ii) the date on which the landlord repossessed, or the tenant surrendered, the leased property. This capped amount reflects Congress's intent to limit lease termination claims in order to prevent landlords from receiving a windfall over other creditors.
Bankruptcy Benefits to Landlord- There could be benefits to the landlord in not granting rent relief of an early termination and forcing the tenant to file for bankruptcy. For example, all rent that is due to a landlord after the filing of a bankruptcy case is entitled to administrative expense treatment, which means that the landlord's rent claim is entitled to be paid before other types of claims, such as general unsecured claims. Further, if the tenant seeks to assume the lease, the tenant would be required to cure all unpaid rent and provide the landlord with adequate assurance of future performance under the lease.
Awareness of Bankruptcy in the Discussions. Accordingly, both landlord and tenant should make themselves aware of the legal impacts of bankruptcy when considering whether to amend the terms of or terminate the lease. For both parties, a pre-bankruptcy solution could avoid additional expense of an insolvency proceeding. For the landlord, an amendment avoids the lost time during which it could have vacant space and the significant difficulty in finding an income producing tenant during the current pandemic. For the tenant, it might seek to leverage during the negotiations the threat of some of the benefits it could obtain if it would elect to file.
Potential Rent Relief Programs- Since the onset of the COVID-19 pandemic, most landlords have been responding to rent relief requests in several ways, including the following:
- Rent Forgiveness – Some landlords have granted either a full or partial rent abatement for a specified, limited time period. We have seen as much as a 50% rent abatement for a tenant for a three month period (March, April, and May), but we are aware that several landlords have granted abatements to some of their tenants for longer periods of time to help keep them in business and viable as tenants during times when many businesses have been unable to operate at normal capacity as a result of the COVID-19 pandemic or government imposed restrictions resulting therefrom. In this arrangement, the abated rent is forgiven at the expiration of the lease provided there has been no lease termination for an event of default and there has been no bankruptcy filing. This may help the landlord to seek to include the abated rent in its bankruptcy claim if there was a filing and the tenant elects to reject the lease.
- Deferred Rent Program – Instead of the abatement program described above, some landlords could agree to defer rent for a specified number of months, with the rent for those months becoming due at some future period of time or during the term of the lease spread over a specific number of months. The many three or four month deferral deals which have been struck are now coming to fruition, and it is unclear that the tenants have the means to now pay the deferred rent, not to mention meet their current obligations. Landlords may not be willing to agree to any further deferrals. If the tenant files for bankruptcy after the deferred amounts have become due, then the landlord would have a pre-petition unsecured claim for the deferred amounts. If the tenant files for bankruptcy before repaying these deferred amounts which come due post-petition, the landlord may have an administrative claim for these deferred rent payments, provided that the bankruptcy court determines that the obligations to pay arise post-petition.
- Extension of Lease Term ("blend and extend") – Another alternative could be for landlords to defer or abate the rent for a specified period of time in exchange for the tenant extending the term of the lease. The landlord would then blend/amortize the deferred or abated rent into the balance of lease.
Cash Security Deposits – Some rent relief programs we have seen include the application of some or all of the security deposit towards current rental obligations. For example, one of our clients negotiated a 50% rent reduction for a three month period, with the 50% to be paid half in cash and half by application of the funds then being held as a security deposit under its lease. As initially drafted, however, most leases require a prompt replenishment of the security deposit by the tenant in the event of a drawdown. This may prove difficult for a tenant in financial distress and may result in a pre-emptive bankruptcy filing. In addition, once a bankruptcy is filed by a tenant, a landlord would be barred from applying the cash security deposit to its claims by the automatic stay that would go into effect upon the filing of a debtor's bankruptcy, unless and until the bankruptcy court would enter an order allowing the landlord to apply the security deposit.
Letters of Credit – Some tenants provide letters of credit instead of cash as security deposits under their respective leases. Letters of credit are generally not considered to be an asset of a tenant-debtor's bankruptcy estate. Therefore, in most cases a landlord can draw against a letter of credit without obtaining relief from the automatic stay.
Good Guy Guarantees – Many commercial leases were executed together with a "good guy" guaranty being provided to the landlord from either an individual owner of the tenant entity or another credit worthy parent or affiliate of the tenant. While negotiating a lease termination agreement, landlords should be cognizant of the fact that a "good guy" guaranty may be avoidable as a fraudulent transfer and any payment made under that guaranty may be recoverable in the bankruptcy of the guarantor. Further, if the guarantor has not filed for bankruptcy, the bankruptcy of the tenant-debtor does not impact the rights of landlord under the guaranty. Landlords should seek to include in the guaranty language that landlords are not required to first seek payment of the rent from the tenant-debtor before seeking payment from the guarantor, so that a landlord's ability to make a claim against the guarantor is not impacted by the Bankruptcy Code automatic stay if the tenant files for bankruptcy.
Early Termination Agreements – A last resolution for parties to a commercial lease when a tenant is no longer likely to be viable or have an ability to use the leased space is to negotiate an early termination agreement. While negotiating these early termination agreements, the parties should be cognizant of a subsequent bankruptcy filing and negotiate with an eye toward a bankruptcy court's review of the agreement. For example, an early termination agreement should be clear that the tenant is receiving reasonably equivalent value in exchange for agreeing to terminate the lease and vacate the premises in order to withstand a fraudulent transfer analysis. This is especially important if the tenant is paying a termination fee, which is often required in connection with an early lease surrender arrangement.

Jessica K. Bonteque is a partner with Moses & Singer's Reorganization, Bankruptcy and Creditors' Rights practice and Nahum M. Palefski is a partner with the firm's Real Estate practice.

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