As of Sunday, May 2^nd, 2010, Movie Gallery, along with Hollywood Video and GameCrazy, will close all of the company’s 2,415 U.S. locations under Chapter 7 liquidation.  Less than two months prior, half of the stores were closed based on Chapter 22 reorganization, which offered Movie Gallery the opportunity to sell assets outside of bankruptcy.  Upon initial bankruptcy filing, the company employed over 19,000 in the US and Canada.

More than half of the Houston stores that have been, or will become affected, are located in the Northwest Quadrant of Houston.  All in all, this liquidation is the largest of its kind and it brings our readership to an interesting topic.  What happens to a landlord when a tenant declares bankruptcy?

First, the differences between reorganization and liquidation cases:

Most commercial tenants end up filing under chapter 11 for their reorganization cases because the business is an entity – a corporation, a limited liability company, or a partnership. Where the debtor is an individual or couple, and the debts do not exceed certain limits set by Congress, the debtor(s) may reorganize under chapter 13. Under either chapter, in every reorganization case, it is the debtor that the landlord must negotiate with or assert rights and remedies against. In liquidation cases under chapter 7, the landlord must deal with the tenant’s bankruptcy trustee who is charged with maximizing the tenant’s assets for the benefit of all general creditors of the tenant. Based on the value of the leasehold, the trustee will decide whether to assert the tenant’s rights against the landlord granted by the bankruptcy code.

The first and foremost question the landlord faces in every case is “will the bankrupt tenant remain in the property?” Of course, the landlord may want the tenant out, which is, in part, a function of the breach issues discussed in the next section. There are five basic scenarios:

1. The lease has expired by its terms or by operation of law due to an uncured default before the tenant filed the bankruptcy case. Here, the lease is terminated and none of the tenant’s bankruptcy rights come in to play. The landlord may evict the tenant after obtaining relief from the automatic stay by filing a motion in the bankruptcy court, or the landlord may choose to enter a new lease with the tenant on entirely new terms.
2. The lease is current and the tenant wants to stay. If the tenant is reorganizing, all the tenant has to do is make the rent and associated payments, give the landlord “adequate assurance of future performance under the lease and obtain bankruptcy court approval to assume the lease within 60 days after the date the bankruptcy case was filed.
3. The lease is in default and the tenant wants to stay. Again, assuming the tenant is reorganizing, all the tenant has to do is cure the default, make the payments, give the landlord adequate assurance of future performance under the lease and obtain bankruptcy court approval to assume the lease within 60 days after the date the bankruptcy case was filed.
4. A chapter 7 bankruptcy trustee is involved. The trustee has exactly the same rights as the tenant under scenarios 2 and 3 above. In most cases, however, the trustee will not want to run the tenant’s business for the long run. If the lease has value (it is a below market lease), the trustee, after filing a motion and giving the landlord an opportunity for a hearing, will assume the lease and assign it to a third party in exchange for a payment to the tenant’s bankruptcy estate. The trustee must cure any defaults, the new tenant must (on behalf of the trustee) provide adequate assurances of future performance, and the trustee must accomplish the assumption and assignment within the 60 day period after the date the bankruptcy was filed. The landlord’s objections, if any, to the new tenant’s assurances of future performance will be heard by the bankruptcy court.  Note that the magic 60 day period for assumption and assignment may be extended for cause if a motion to extend the period is filed by the tenant or the bankruptcy trustee before the original 60 day period expires. If the original 60 day period expires without a proper extension or an assumption approved by the bankruptcy court, the lease is deemed rejected and may not be resurrected by anyone (unless the landlord consents).
5. As in the case of Movie Gallery, neither the tenant, nor the trustee in a liquidation case, wish to retain the leasehold. The property is either surrendered to the landlord immediately, or, because the trustee must first investigate the potential value of the lease, after the investigation period. In this case, the trustee must pay at least the administrative rent for each day the trustee fails to surrender the leasehold after the bankruptcy filing date.

Nothing contained herein is to be considered legal advice.  Always seek legal advice when evaluating any legal document.