Financial hardship can strike anyone at any time. Especially in the continuing struggle surrounding COVID-19, many landlords may feel the strain of months of unpaid rent or stalled eviction proceedings. When you rely on rent payments to pay your mortgage, what is a landlord to do? Bankruptcy is a last resort, but it is essential to understand the consequences and responsibilities involved when you come to that point. Join us below as we discuss bankruptcy for landlords, how to handle occupied properties, along with types of bankruptcy, and what they mean for you.
Common Types of Bankruptcy for Landlords
Filing for bankruptcy affords individuals a fresh start with their finances. It is a process that one must qualify for in order to have it wipe out most debts all at once. That said, it is a complex process that requires a person to make significant sacrifices in exchange for debt relief. For example, this could include liquidating assets or forfeiting a portion of income. Additionally, your credit will take a hit, which in turn can affect your financial options for several years post-bankruptcy.
Therefore, it is an option to weigh very carefully. Since it is a legal process, it is best to consult an experienced bankruptcy attorney to explain your rights and responsibilities fully. Typically, bankruptcy falls into two categories for businesses and individuals: liquidation or reorganization. Continue reading as we examine these types of bankruptcy for landlords.
Liquidation – Chapter 7 Bankruptcy
Chapter 7, bankruptcy is also known as “liquidation,” is for individuals and businesses who are not a corporation. Therefore, an individual can clear debt via the sale of assets to repay creditors and debts. An assigned bankruptcy trustee will seize and sell your property to offset your debts. So, this is helpful because the court will wipe out unsecured debts. That said, clothing, your car, or your home cannot be sold as part of the debt-clearing process. However, individuals will face a severe hit to their credit rating.
Eligibility requires an individual to meet several different conditions. One of which is a “means test,” which shows that someone cannot sustain the Chapter 13 repayment schedule.
What Does Chapter 7 Bankruptcy Mean for Your Investment Property?
If the investment property has significant value, the court may require you to turn it over. However, if a landlord makes payments on time without being behind, a court might allow you to keep it. That said, the choice to keep or surrender the property must serve an individual’s creditors’ best interest. Filing for bankruptcy allows the trustee to take possession of any non-exempt assets, including rental property. The goal in a liquidation bankruptcy is to sell any eligible assets to repay your debts.
Therefore, if an investment property has significant equity, the court will sell and use that to repay creditors. Additionally, Chapter 7 prevents a landlord from retaining any equity from your rental property when it exceeds the bankruptcy exemption limits.
Reorganization – Chapter 13 Bankruptcy
Unlike Chapter 7, Chapter 13 allows individuals to keep their property, as long as it is profitable. A reorganization bankruptcy is for individuals whose income is both reliable and exceeds the Chapter 7 bankruptcy limits. This option allows landlords to create a plan for repayment of debts gradually. Payment amounts take into account an individual’s income level, and typically repayment is scheduled to take between 3 and 5 years. To qualify, individuals or couples must prove that their debt is below the limits for Chapter 7. So, as long as repayment is on time with no missed payments, creditors will remain at bay, and landlords can retain their assets.
What Does Chapter 13 Bankruptcy Mean for Your Investment Property?
This type of bankruptcy for landlords allows landlords to retain their property under some conditions. Mainly, the property must not be detrimental, and landlords must be able to afford it. If not, the court trustee can seize and liquidate the asset. With reorganization bankruptcy, rental property is separate from a person’s primary residence. Thus, allowing a landlord to take advantage of “cram down.” In other words, readjust the principal owed to reflect the current market value.
Depending on several circumstances, Chapter 13 might be the best bankruptcy for landlords. Whatever payment strategy your lawyer puts forward, a court must approve it. The ability to retain your investment property depends on its cash flow and a landlord’s commitment to using those funds to repay the bankruptcy. So, when a property is profitable, it is in the creditor’s best interest to allow the landlord to keep it. Therefore, the extra income can funnel back into debt repayment.
Tenant Rights Under a Bankruptcy for Landlords
Finding out a landlord is going through bankruptcy raises many questions for a tenant. It is important to realize that bankruptcy does not negate the lease agreement. Below we take a look at some steps in the process when a landlord files for bankruptcy.
- Assignments, Sales, and Auctions
- Security Deposits
When a rental property owner files for bankruptcy, the owner’s assets become part of a “bankruptcy estate.” During the bankruptcy process, the landlord is granted an automatic “stay.” In other words, it prevents a creditor from collecting money from the landlord. Essentially, this first step allows the debtor time to come up with a game plan to get affairs in order and repay debt.
Depending on the type of filing, the landlord or bankruptcy trustee will decide to assume or reject the lease. Regardless, tenants are required to continue submitting rent payments on time. If a landlord can demonstrate to the court that they can uphold their responsibilities under the lease, it can be assumed. Therefore, business would continue as usual for the tenant.
When a landlord cannot uphold their end of the lease, the courts may require a rejection. Therefore, the landlord is free from things such as maintenance and utility responsibilities. So, in this scenario, the tenant has two options –
- Leave the Rental Property Regardless of the Lease-End Date
- Remain in the Rental Property – With this option, the tenant must still pay rent on time. However, they can deduct expenses incurred due to the landlord’s failure to perform maintenance or responsibilities under the lease.
Assignments, Sales, and Auctions
There is a chance that a landlord or court-appointed trustee will opt to sell the property to pay off debts as part of the bankruptcy proceedings. So, when this occurs, it will likely be through an auction. However, the bankruptcy code allows a rental property to be sold free of any commitments. This includes existing leases. Therefore, it is up to the new owners whether they want to honor the existing lease and allow the tenant to stay.
Regarding a tenant’s security deposit, that is essentially the tenant’s money. Therefore, any creditors involved with the landlord’s bankruptcy have no claim over these funds. However, a tenant’s hope of getting their deposit back hinges on whether a landlord has already spent the funds or not. If so, tenants need to contact the court trustee in writing requesting the return of funds. The good news is security deposits are on top of the list compared to other creditors.
When bankruptcy becomes your only option, understanding the consequences and responsibilities is essential. At the end of the day, the financial impacts last far beyond the court proceedings. Bankruptcy for landlords, in particular, can prove complex. So, seek out the advice and representation of a qualified bankruptcy attorney in your area. When you need help managing your rental property portfolio, a professional property management firm is the right choice. Bay Property Management Group is the area’s leading rental consultants. Our diligent staff work to maximize owner return while keeping your tenants safe and happy in your rental home. Call us today for a free no-obligation property evaluation.