Commercial property often involves complex leasing arrangements. One such arrangement is when a tenant becomes a sublandlord by subleasing their space to a subtenant.
While this arrangement can surely offer benefits to the parties involved, it can also create certain challenges. In this client alert, we will address some of the challenges that arise when a sublandlord files for bankruptcy.
Notification Of Bankruptcy Proceedings
When a sublandlord files for bankruptcy or is otherwise subject to bankruptcy proceedings, both the primary landlord and the subtenant are at risk. Landlords should receive a formal notification from the bankruptcy court if their tenant is subject to bankruptcy. The notice will provide a summary of the case and indicate any actions potential creditors must take in response.
Upon receiving notice or otherwise learning of a sublandlord’s bankruptcy, primary landlords and subtenants should seek legal counsel to determine the best course of action.
The primary landlord and subtenant should review their obligations under the bankruptcy law in conjunction with relevant state laws and the terms of the lease, the sublease, the Subordination Non-Disturbance and Attornment (SNDA), the consent, and any other agreement governing occupancy of the space that may contain provisions in the event of bankruptcy or insolvency.
What Happens To The Sublease?
Generally, a debtor in bankruptcy has the right to either assume or reject a lease they are a party to. If the debtor assumes the lease, the lease continues mostly unchanged, but if the debtor rejects a lease, the primary landlord may assert a general unsecured claim for damages against the bankruptcy estate for breach of the lease, though general unsecured claims are the lowest priority in a bankruptcy case.
If the debtor is a primary landlord who rejects the lease, the tenant may then elect to terminate the lease or to remain in possession of property. In the case of a rejected sublease, however, a subtenant may not be given the option to remain in the premises absent an SNDA or another agreement with the primary landlord, which may be the sublease consent. The primary landlord and subtenant may be able to protect their positions by dealing with each other directly. If the subtenant is willing to remain in the premises and fulfill their sublease obligations, the subtenant may agree to assume the position of the sublandlord as the original tenant under the overlease, or they may have the opportunity to negotiate directly with the primary landlord for a new lease.
If the Sublease Is Terminated, What Happens To The Security Deposit?
Rights to any security deposit will be governed by the relevant provisions of the bankruptcy code and any bankruptcy provisions in the applicable leases or license agreements. Under the bankruptcy code, only lease deposits on properties for personal, family, or household use of individuals will be treated as unsecured priority claims.
In New York, pursuant to NY GOL 7-103, any money deposited or advanced for use or rental of real property shall be held in trust and continue to be the money of the person making such deposit or advance (i.e., the tenant) until refunded or applied pursuant to the terms of the agreement. Therefore, when a tenant or subtenant is in bankruptcy, security deposits are generally considered property of the bankruptcy estate and must be returned to the tenant, unless the landlord is permitted by the court to set off their claim against the tenant with the security deposit. When a landlord is in bankruptcy, however, the security deposit does not become part of the landlord’s bankruptcy estate property and should be returned to the tenant pursuant to the terms of the lease. However, unless the landlord agrees otherwise, the tenant will need to obtain a bankruptcy court order requiring the landlord to return the security deposit.
Subtenants should also ensure that they have a security deposit that is required by law to be held in a segregated account, which is typical for a standard lease. However, in shared office space environments, for example, “services agreements” may be used rather than a lease which creates an interest in real estate. In this scenario, such deposit is likely to be deemed a general unsecured claim in bankruptcy.
Legal Counsel In These Cases Is Essential
Sublandlord bankruptcies entail many legal intricacies. Enlisting the help of an attorney is essential in navigating this difficult situation. They can provide valuable insights into your rights and obligations as a landlord or tenant and help you evaluate your options.
The foregoing is not intended to be comprehensive nor constitute legal advice. If you would like to address your specific circumstances or would like more information, feel free to call us at (212) 625-8505