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What Happens When Your Tenant Declares Bankruptcy?

by Editor | ezLandlordForms

Weeks have passed and you have not gotten around to filing that eviction – but you are planning to any day now.  The tenant has provided as many excuses as there are days in the week and you have patiently listened to every one of them.  Finally, when you reach your breaking point and have all of your documents in order, you march down to the courthouse to file the eviction.

What you are unaware of is that while you were patiently waiting for the tenant to stop making excuses and pay the delinquent rent, the tenant had other ideas, and filed bankruptcy.  What do you do now?  You’ve already filed for eviction so it’s just a matter of time before the tenant is out of the home, right?

Wrong.  Filing bankruptcy creates what is known as a ‘stay’ which means all payments to all creditors are immediately halted.

But wait, wasn’t that the rule under the old laws?  Haven’t bankruptcy laws changed in the past few years?

The answer is yes and no.  Under the old bankruptcy laws, tenants who filed bankruptcy after being served an eviction notice, or even immediately after a judgment was rendered, could remain in the property for months under the protection of the ‘stay’.

The Bankruptcy Abuse Prevention and Consumer Protection Act (119 Statute 23, 2005) was enacted in October, 2005 to provide some protection to creditors.  Landlords are especially protected in some areas under the new law.  After October 2005, any landlord who receives an order of eviction or ‘judgment’ before the tenant files for bankruptcy is exempt from the automatic stay and is allowed to proceed with evicting the tenant (under ordinary circumstances).  Tenants are no longer fully protected from eviction, but even with the new rules in place there are still some exceptions.  Landlords should seek the advice of an attorney for all of the specifics of the new rules.

When a tenant files bankruptcy prior to the landlord obtaining a judgment order for eviction, the old bankruptcy rules apply and the stay remains effective.  The landlord is stopped in her tracks and cannot move forward with eviction.  Furthermore, the landlord is prevented from contacting tenant in any way regarding monies owed before the bankruptcy filing.  Dealing with a tenant who has filed bankruptcy is a delicate matter that should only be handled by a skilled attorney experienced in bankruptcy and collections.  While general bankruptcy law is established by federal laws, there are certain nuances which are state-specific.

In addition to the creation of an automatic stay, filing bankruptcy affords tenants several additional options which include the decision to accept or reject the existing lease agreement.  Accepting a lease means that a tenant decides to continue renting the property and agrees to pay all monies due post-bankruptcy filing.  Because the automatic stay allows the tenant to remain in the home, the tenant can remain only if they can prove future rent payments will be made in accordance with the lease agreement.

Alternatively, a tenant may reject the prior lease which means giving up all rights to it and deciding to move out or allow someone else to assume it (assumption will not be covered in detail here).

The most crucial information for landlords and property managers to know when a tenant files bankruptcy is what not to do.  Knowing what not to do keeps the landlord or property manager from losing a great deal more than just a few months’ rent.

Three Actions Landlords Should Avoid:

Avoid Pursuing Eviction – Pursuit of the eviction should cease once a landlord becomes aware the tenant has filed for bankruptcy.  Of course, this information should first be verified by making contact with the tenant’s bankruptcy attorney.  Landlords should also discontinue requesting delinquent rent and inquiring about when to expect it.  Bankruptcy attorneys advise against this practice which could ultimately result in the landlord having to pay the tenant.

Refrain from using the tenant’s security deposit – Using a tenant’s security deposit is considered ‘being paid before all other creditors’ which is not allowed under a bankruptcy.  Landlords must obtain permission to use the security deposit to cover delinquent rent.  Landlords should immediately contact the bankruptcy court for permission to use the tenant’s security deposit.

Abstain from applying new rents to pre-bankruptcy rents – Landlords must resist the urge to use subsequent rental payments towards delinquent rents.  In the event a tenant decides to accept the lease and remain in the property, they must immediately resume paying the rent.  Applying that rent towards the delinquent payments is considered a violation of the stay and could result in hefty fines for the landlord.

So what should landlords do upon learning their delinquent tenant declared bankruptcy?

Immediately seek the advice of a bankruptcy attorney – This is an added expense many landlords feel they cannot afford, but not doing so could result in costly court fines for violations.

Landlords can also buy (or in some cases require tenants to buy) tenant surety bonds, which insure against the risk of tenants defaulting entirely.  And landlords who file for eviction immediately upon rent default may be able to avoid bankruptcy entanglements altogether, by obtaining the judgment order for eviction before the tenant files for bankruptcy.

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