What to Do When Your Tenant Files for Bankruptcy

Eviction is one of the worst-case scenarios for many landlords. It can be a long, taxing process that slowly eats away at your time and money – not to mention the impact it has on an emotional or mental health level. Needless to say, eviction is a situation that most landlords want to avoid whenever possible.

What To Do When Your Tenant Files for Bankruptcy

Unfortunately, eviction isn’t the only situation landlords should be cautious about. Since the pandemic, the economy has been in a state of flux. Not only does this mean instability for investors, but also the job market, leading many citizens to be in worse financial standing than they were a year ago. This increases the chances you may have a tenant file for bankruptcy. If this happens, what actions can you take – and how can you prevent it from happening again?

What is bankruptcy?

Bankruptcy is a legal process that enables someone who cannot repay their debts to gain debt relief assistance while ensuring some form of repayment to creditors. Bankruptcy can include things like the liquidation of assets or other changes to a person’s financial or material wealth to reach a repayment agreement. While bankruptcy allows for a “fresh start” with debt, it can make it more difficult to borrow in the future.

If you encounter bankruptcy with a tenant, there’s a chance you’ll know it’s coming (if you and your tenant keep communication open) but it will more likely come as a surprise. In some cases, your tenant may be paying rent on time, while their other debts grow beyond their means. There are a few specific types of bankruptcy you should be aware of to be able to handle them appropriately. The two most common ones that affect landlords are Chapter 7 and Chapter 13.

Chapter 7

Chapter 7 bankruptcy involved the liquidation of an individual’s assets to pay off debts. The debtor must give all their assets to a trustee, who then administers the assets in a way that satisfies creditors. If the tenant’s rent is paid and up to date, they can continue their lease. If they’re behind on rent, they’ll likely need to move.

Chapter 7 bankruptcy is also known as “straight bankruptcy” because it’s the most direct type. Chapter 7 is typically used for people who have a lot of unsecured debt, like medical bills, utility bills, and credit card debt.

Chapter 13

Chapter 13 bankruptcy is based on creating a debt repayment plan and can be seen more as a type of financial reorganization rather than a fresh start. When someone files for Chapter 13, their debts are reorganized into a payment plan that repays creditors over 3 – 5 years. This type of bankruptcy is typically utilized to resolve short-term financial setbacks, like an illness or job loss.

What Should I do if my Tenant Files Chapter 7?

If your tenant files for bankruptcy, the court will grant an automatic stay, which means all creditors are required to stop debt collection attempts until the case has made its way through the court system. Tenants who are renting will have to assume (continue with their lease and making rent payments) or reject their current lease. Tenants will only be able to assume the lease if they can pay past-due rent quickly, as well as provide assurances that they’ll continue to pay rent on time. They’ll typically have 60 days to make this decision.

The court doesn’t have a strict definition of how quickly back payments must be made, but it’s typically required to be paid back within a year. Your tenant will also be required to show some proof of income to show that they’ll be able to make timely payments without falling behind on their regular rent payments.

If your tenant rejects the lease, the lease becomes part of the assets that are liquidated or put onto a payment plan. Rejection of the lease is considered voluntary termination, so the tenant will be expected to leave the property and will no longer be bound by the terms of the lease.

Once the tenant’s assets and debts have been cataloged, a judge will decide if the bankruptcy can continue and if so, how best to use the assets fairly to pay off creditors. Once the judgment has been made, you’ll be notified of how you can expect to be paid for any back rent that’s owed to you. You’ll also be told what to expect with the remainder of the time the tenant will be at your property. If you find the decision to be unfair, it is possible to challenge the decision.

If the court does order the tenant to make payments through a repayment plan, you’ll eventually get the money owed to you. In some cases, however, the court may not require the tenant to pay you back at all. While this can feel like a huge blow, the best way to handle it is to move on and put your focus into finding a reliable tenant to fill the vacancy.

Steps to take once your tenant files for bankruptcy

Once your tenant has filed for bankruptcy, you’ll need to start making some plans to protect yourself financially. This isn’t to say that you can’t be sympathetic to your tenant – but rather that you should make sure that you’ll be able to sustain your financial wellbeing. Here are a few ways you can be sure that you’re included when it comes time to divvy out creditor repayments:

  • The Automatic Stay:

As previously mentioned, when a tenant is granted an automatic stay, creditors can no longer collect or attempt to collect debts until a ruling has been made for the case. This includes you, as the landlord; you won’t be allowed to collect past-due rent. You also won’t be able to file for eviction, unless it’s an ongoing case that has been ruled on or is allowed to continue. New eviction filings are allowed if the tenant has done something illegal or is endangering your property in some way.

If you have a guarantor named under the lease, you can still pursue and collect back rent from them, even while the tenant is in bankruptcy. In most cases, however, there likely won’t be a guarantor, so as soon as your tenant files for Chapter 7 or Chapter 13, stop trying to collect rent and keep track of what you’re owed for the court proceedings.

The automatic stay only pauses debt and past-due rent collection; your tenant is still legally required to continue paying rent for as long as their lease is active. It doesn’t change anything regarding the amount you’re owed or the date rent is due. If your tenant stops paying their rent on time, you can request the court to begin eviction proceedings and they will decide whether that’s a viable option.

  • Claiming Debt

If your tenant owes you any money for past due rent, you should create a claim outlining how much they owe you and why. This document will be filed with the bankruptcy court if you’d like the debt to be included in the court-decided payment plan or liquidation of assets. It’s recommended that you always file a claim if there’s a bankruptcy case. This ensures you won’t lose out on any money, especially if the tenant decides to reject the lease. If they do reject the lease, your claim can include:

  • Past-due payments and associated damages
  • Unpaid rent or fees caused by the bankruptcy filing
  • Damages from the lease rejection, which can be up to one year’s worth of rent

To make sure you’re getting back as much as possible, it’s recommended to consult with a bankruptcy professional.

Other Actions You Can Take

If you’d prefer not to wait through the bankruptcy process, you can try some alternative options. Although not all these may be possible, they could save you some time and money.

  • Pre-bankruptcy

Depending on your tenant’s financial situation, you may have some warning signs that they may be thinking about bankruptcy. Or, they may have even told you they were considering it. In either case, you may be able to set up a pre-bankruptcy resolution with your tenant before they actually file. Here are some considerations:

  • Are there any changes you could make to the lease that would make it easier for your tenant to continue paying rent?
  • Is there a way you could amicably terminate the lease before the tenant files for bankruptcy?
  • Can you forgive some of their debt or arrange for it to be repaid via early lease termination?

While your tenant may not agree to these options, there’s no harm in exploring them – and in many cases, coming to a pre-bankruptcy agreement will reduce stress for you and your tenant.

  • Bankruptcy history

Do you happen to know that your tenant has a history of filing for bankruptcy? If so, this is something you should bring to the judge’s attention. Make sure you’re only doing this if you don’t believe the bankruptcy was filed in good faith, for example, if the tenant only filed to avoid paying you past-due rent.

No one wants to deal with a bankruptcy filing but if you do encounter one, stay calm and keep organized. Start by trying to set up a pre-bankruptcy resolution. If that isn’t a viable option, file your claim for any debts as soon as possible once the bankruptcy is filed. While you’re waiting for the verdict, be sure to keep track of any additional missed payments. Once the case has a ruling, follow the court-ordered solution.

Preventing Future Issues

Bankruptcy filings, like evictions, can be stressful and time-consuming. Although there’s no way to completely guard against a tenant filing for bankruptcy, you can take an important step in eliminating some of the risk through tenant screening. By running a credit and background check, you can get a better understanding of how an applicant handles their finances, whether they’ve had previous bankruptcies and their overall level of debt and financial wellness.

We recommend our RentalConnect program to help you select the right tenants for your property. You can choose from three different report packages, making it easy to find one that will fit your rental criteria. With RentalConnect, there are no on-site visits, sign-ups, or membership fees, and the cost of the reports is deferred to the applicant. Order yours today or reach out to us for more details!

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