What to Do With a Bankrupt Tenant

As a landlord, one of the most challenging situations you may face is dealing with a tenant’s bankruptcy. It can complicate the eviction process, affect your income, and leave you navigating a complex legal landscape. 

Understanding the nuances of bankruptcy and its impact on landlord-tenant relations is crucial for effective property management. This guide aims to demystify the process of dealing with tenant bankruptcy and highlight how leveraging tenant screening can serve as a crucial preventive measure.

Please note that this is for informational purposes only and is not intended as legal advice. Laws may vary depending on your location. 

Understanding Bankruptcy and Its Implications for Landlords

Bankruptcy is a legal declaration by an individual or entity that they cannot meet their financial obligations. It signals to creditors, as well as landlords, that the tenant needs legal intervention to manage their debts.

Bankruptcy claims can be categorized into secured, unsecured, and administrative claims. Each type has different implications for landlords:

  • Unsecured Claims: Debts that aren’t secured by an asset, like pre-bankruptcy rent, are less likely to be recovered.
  • Secured Claims: Debts that are backed by physical assets and have a higher recovery priority.
  • Administrative Claims: Debts accrued post-bankruptcy filing, such as ongoing rent, are prioritized for payment.

When a tenant files for bankruptcy, landlords find themselves in a precarious position. They cannot initiate eviction proceedings due to automatic stays issued by the bankruptcy court. These stays protect the tenant from all collection efforts while their case is being processed, which can take anywhere from 4 to 6 months on average, depending on the bankruptcy chapter filed.

Chapter 7 and Chapter 13 Bankruptcy

The two most common types of bankruptcy that affect landlords are Chapter 7 and Chapter 13, and each has distinct implications for the rental relationship. 

Chapter 7 

 Also known as “straight bankruptcy,” Chapter 7 involves the liquidation of an individual’s assets to pay off debts. In this process, the debtor must surrender their assets to a trustee, who then distributes the proceeds to creditors. This type of bankruptcy is typically pursued by individuals with a significant amount of unsecured debt, such as medical bills, utility bills, and credit card debt. 

For landlords, a tenant’s Chapter 7 filing can have immediate consequences. If the tenant’s rent is current, they may continue their lease without interruption. However, if they are behind on rent, the bankruptcy filing will likely mean that they need to vacate the property, as their assets will be liquidated to satisfy outstanding debts.

Chapter 13

Chapter 13 bankruptcy, on the other hand, focuses on financial reorganization rather than asset liquidation. It allows individuals who are facing short-term financial setbacks, such as illness or job loss, to create a debt repayment plan. Under Chapter 13, debts are restructured into a manageable payment plan that spans 3 to 5 years, which offers a path for debtors to gradually clear their financial obligations while retaining their assets. 

For landlords, a tenant filing for Chapter 13 can offer a more stable outcome. Since the tenant is working to repay their debts (including any back rent) through a court-approved plan, landlords may eventually recoup the rent they’re owed. This process, however, can take several years, so it requires patience and cooperation with the bankruptcy proceedings.

In both scenarios, the automatic stay issued by the bankruptcy court temporarily shields the tenant from eviction and other collection efforts, so it’s important for landlords to understand the nuances of each type of bankruptcy. 

How Can Landlords Navigate Tenant Bankruptcy?

Navigating tenant bankruptcy requires a proactive approach; understanding a tenant’s financial history through thorough tenant screening is the first line of defense. This enables landlords to make informed rental decisions and potentially sidestep future complications linked to tenant bankruptcies. 

However, if you’re faced with an ongoing eviction or if a tenant declares bankruptcy, it’s important to adopt strategic measures to protect your financial interests while staying legally compliant. 

Immediate Steps Following Tenant Bankruptcy

Under the automatic stay, actions such as collecting past-due rent or initiating eviction proceedings are prohibited unless specific conditions are met. These conditions include ongoing cases that have been ruled on or are permitted to continue and new eviction filings in instances of illegal activities or endangerment to the property by the tenant.

If there’s a guarantor under the lease, you can still pursue rent from them. Following a tenant’s filing of Chapter 7 or Chapter 13 bankruptcy, you should cease rent collection efforts and meticulously document any owed amounts for court proceedings. It’s crucial to note that the automatic stay does not relieve tenants of their obligation to pay current rent; if they fail to do so, you can petition the court for eviction proceedings.

Claiming Debt

You’re entitled to file a claim with the bankruptcy court for any outstanding rent or associated debts. This claim should detail the amounts you’re owed and the basis for each to ensure they’re included in the debtor’s payment plan or asset liquidation. 

Filing a claim is a critical step in safeguarding your rights to potential repayment, particularly if the tenant decides to reject the lease. Claims can encompass past-due payments, damages, unpaid rent or fees resulting from the bankruptcy filing, and damages from lease rejection—and potentially up to a year’s worth of rent.

Consulting with a Bankruptcy Professional

To maximize recovery and navigate the complexities of bankruptcy law, it’s highly recommended to consult with a bankruptcy professional. This will ensure that your claims are properly filed and that you take appropriate steps within the legal framework to recover what you’re owed. A bankruptcy professional can provide invaluable guidance on the intricacies of bankruptcy proceedings and the best course of action for protecting your investment.

Tenant Screening: Your First Line of Defense

Like evictions, bankruptcy filings 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 risks 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.  

Our RentalConnect service is ideal for helping you select the right tenants for your property. With three different reporting levels, we make it easy to find a package that perfectly fits 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 contact Tenant Screening Center at 1-800-523-2381 for more information. 

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