Real Estate Interests and the New Bankruptcy Legislation

On April 20, 2005, President Bush signed into law significant amendments to the U.S. Bankruptcy Code made by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.  Most of these provisions become effective eighteen months after the date of enactment.  In the interim, there is a lot to learn because the revisions are substantial and far-reaching.  One point is immediately clear—landlords and real estate lenders are big winners.

Assumption/Rejection of Leases

The new legislation provides a limit to the court's power to extend the time frame for a debtor's assumption or rejection of an unexpired lease of nonresidential real property.  Previously, the Bankruptcy Code required the debtor to make a decision to assume or reject such leases within 60 days after the commencement of the case.  This same provision, however, gave the bankruptcy court discretion to extend that deadline indefinitely.  This discretion was commonly applied and in large cases subjected the landlord to uncertainty for many years.

The new legislation doubles the initial time for a debtor to assume or reject unexpired leases to 120 days after the commencement of the case, but more importantly, sets a finite period of 90 days for the court to extend this initial period.  No further extensions are allowed without the prior written consent of the landlord.  Thus without the landlord's consent, the maximum period that the debtor has to occupy leased premises without assuming the lease is 7 months.

If the debtor is forced by the time limit to assume a nonresidential real property lease and subsequently decides to reject the lease, the landlord's rejection claim will be equal to all monetary obligations due for a period of two years following the later of the rejection of the lease or the turnover of the property.   This claim will not be reduced by amounts payable by a third party guaranty or letter of credit and the landlord may assert an unsecured claim for the unpaid rent due for the remaining term of the lease that is otherwise allowed under Code § 502(b)(6). 

Finally, the 2005 Amendments attempt to make it clear that the debtor may assume a lease without having to cure nonmonetary defaults that are impossible to cure.  One exception, however, is when the default is based on the debtor's failure to operate in accordance with the lease, such as a "going-dark" provision.  In that instance, the debtor must comply with the nonmonetary provision after the assumption and pay to the landlord any pecuniary loss resulting from the default.

Exceptions to the Automatic Stay

The new legislation adds four exceptions to the automatic stay relating to real property—two for landlords and two for mortgage lienholders.   First, a landlord of residential real property may now continue a pending eviction, unlawful detainer or similar proceeding against a debtor/tenant occupying residential premises under a lease or rental agreement when the lessor has obtained, before the filing of the bankruptcy, a judgment for possession of the property.  This exception may have limited application because in most instances the tenant files bankruptcy before the judgment is obtained. 

Second, the landlord may commence an eviction action that seeks possession of residential real property when the eviction action is based on endangerment of the property or illegal use of controlled substances on the property.   The lessor is obligated to file with the court and serve upon the debtor a verified certification stating that an eviction action had been filed pre-petition or that the debtor has endangered the property, illegally used a controlled substance on the property, or allowed such controlled substance to be used on the property during a 30 day period preceding the date of the filing of the bankruptcy. 

These two new exceptions to the automatic stay have limitation provisions that affect their enforceability.  For example, an eviction based on a judgment is not effective until 30 days after the date of the filing of the bankruptcy petition.  This 30 day period may be further extended if the debtor files a certification under penalty of perjury with the petition and serves upon the lessor a statement that under non-bankruptcy law applicable in the jurisdiction there are circumstances under which the debtor would be permitted to cure the entire monetary default that gave rise to the judgment and the debtor has deposited with the clerk any rent that would become due during the 30 day period after the filing of the petition.  The court must act quickly on this motion by holding a hearing within 10 days after its filing and service to determine if the certification filed by the debtor is true.

In the case of the property endangerment section, stay relief is automatically granted 15 days after the date upon which a certification is filed and served stating that the eviction action is justified.   The stay will be extended if within the 15 day period the debtor files with the court an objection to the truth or legal sufficiency of the certification.  The court must hold a hearing within 10 days after the debtor's filing and service of the objection to determine if the lessor's certification should stand.  If the debtor can demonstrate to the satisfaction of the court that the situation giving rise to the lessor's certification did not exist or has been remedied, the stay shall remain in effect. 

Mortgage lienholders will also get automatic relief from the stay in a single asset real estate case for any act to enforce a lien when the debtor’s bankruptcy filing occurred within two years after the entry of an order granting the creditor relief from the stay in a prior case, provided, however, the debtor will have the right to reinstate the stay by showing to the court that the new filing has occurred after changed circumstances or other good cause.

Finally, mortgage lienholders will get automatic relief from the stay when the debtor is ineligible to file a second bankruptcy case or the second case was filed in violation of a bankruptcy court order prohibiting the debtor from filing again.

Relief from Stay

There are now two special provisions under which a creditor with a lien on real estate can get relief from the automatic stay.  First, with respect to an act against single asset real estate, the creditor will be entitled to relief from stay if the debtor fails to file a reasonable plan within 90 days after the filing of the case, or fails to make interest payments (based on the value of the real estate) in an amount accruing at the nondefault contract rate.  Second, stay relief may be granted if the court finds that prior to the filing, the debtor had transferred all or part ownership in real property without the consent of the secured creditor or had previously filed multiple bankruptcy filings affecting the real property, and the latest bankruptcy filing was part of a scheme to delay, hinder, and defraud creditors.

Homestead Exemption

The new legislation also addressed perceived abuses of the unlimited homestead exemption that exists in some states such as Florida and Texas.   The exemption may be limited under certain circumstances.  First, to take advantage of a certain state’s exemption, the debtor must have been domicile in that state for two years preceding the date of the filing of the petition.  If the debtor has not been in the state that long, the court will apply the law of the state where the debtor's domicile was located for the better part of 180 days immediately preceding the two year period. 

Second, the new legislation reduces the amount available for the homestead exemption if the debtor has attempted to take advantage of the homestead exemption by purchasing assets under certain circumstances.  The new law states that the debtor may not exempt any amount of interest in (i) the debtor's residence, (ii) a cooperative that owns the property where the debtor resides, (iii) a burial plot for the debtor or a dependent, or (iv) real or personal property that the debtor claims is a homestead that was acquired by the debtor during the 1,215 day (40 months) period preceding the filing of the petition when the acquisition exceeded the aggregate value of $125,000.  This reduction does not apply to the principal residence of a family farmer.  Additionally, the homestead exemption is limited to $125,000 if any of the following circumstances exist: (a) the debtor has been convicted of a felony and the circumstances are such that the court concludes that the filing was an abuse of the Bankruptcy Code, or (b) the debtor owes a debt arising from (i) violation of federal securities laws, (ii) fraud, deceit, or manipulation in a fiduciary capacity in connection with the purchase or sale of any registered security, (iii) any civil remedy under the federal criminal code, or (iv) any criminal act, intentional tort, or willful or reckless misconduct that caused serious physical injury or death to another individual in the preceding 5 years.

Finally, the value of the homestead exemption may be reduced by the value of non-exempt property that the debtor sold in the 10 year period before the filing of the petition when the property was sold with intent to hinder, delay, or defraud a creditor.

Homeowners Associations

Any fee or assessment accruing post-petition to a membership association with respect to a debtor’s interest in a condominium, cooperative or homeowners association is non-dischargeable even though the debtor became obligated to the association prepetition.  This resolves a legal issue that was troubling the courts since the nature of the homeowner association fee was ongoing but it arguably was dischargeable because it related back to a period prior to the filing of a debtor's case.

Conclusion

The above described amendments will become effective for cases filed on or after October 17, 2005.  Since the language of the amendments are new, undoubtedly there will be uncertainty in the courts as to the application of these provisions to a particular set of facts.  Thus, you should consult counsel to be sure you understand your rights, particularly if the action you desire to take involves actions against the debtor or the leased premises that may be subject to the automatic stay.  If you have any issues that involve these matters and need any assistance, please let us know.