Bankruptcy
What Happens Next?

By Michael E. Hickey

Typically, bankruptcy issues arise the day of or shortly before a lien sale, causing afervor of questions:

Make no mistake, bankruptcy issues are complicated "land mines" for theunsuspecting and ill-advised storage facility owner or manager.

The recurring situation involves a non-paying tenant who arrives at or telephones thefacility prior to a lien sale and states (in an unfriendly manner): "I have filedbankruptcy, and your sale is stayed, and there's nothing you can do about it."Unfortunately, the tenant does speak a partial truth here: The sale is stayed and cannotgo forward. However, you can help alleviate the potential for rent losses caused bybankruptcies.

The Chapters

It's first important to point out that bankruptcy law is federal law, which isgenerally uniform throughout the United States. This is in sharp contrast to self-storagestatutes, which vary from state to state. In addition, you should know that there areseveral types of bankruptcy or, as federal law categorizes them, "Chapters ofBankruptcy," which the storage facility owner or manager will encounter.

The most common form of bankruptcy is known as Chapter 7 bankruptcy. In thisproceeding, a debtor seeks to "discharge" (get rid of) all their pre-bankruptcydebts. In a Chapter 7 case, a bankruptcy trustee is appointed to collect and liquidate(sell) the debtor's non-exempt assets. In theory, as part of a Chapter 7, debtor's assetsare liquidated and the proceeds distributed among the debtor's creditors. Unfortunately,99 percent of all Chapter 7 cases have no non-exempt assets to liquidate and, therefore,collecting back rent owed to a self-storage facility from the trustee is next toimpossible.

Another type of bankruptcy is a Chapter 11 "Reorganization Plan," which canbe filed by an individual or corporation. In this proceeding, a trustee is generally notappointed and the debtor continues to operate his business. A Chapter 12 ("FamilyFarmer") and Chapter 13 ("Wage Earner Proceedings") usually allow a debtorthree to five years to repay all or a portion of his debts.

All chapters are designed to protect a legitimate debtor and have many useful purposes.Occasionally a debtor files a Chapter 11, 12 or 13 proceeding, not to reorganize his debtsand finances, but instead to stall creditors. This type of debtor has no intention orability to reorganize and these cases are commonly dismissed or changed by the court toChapter 7 within one year of filing. That's why some creditors refer to cases under thesechapters as "Chapter 7s waiting to happen."

Sticking to a Stay

Regardless of the chapter, the filing of any bankruptcy creates a stay thatautomatically prohibits any person or company who is a creditor from collecting debts owedto them by the debtor and further prohibits a creditor from proceeding against theproperty of the debtor. Although the code does not define "stay," it clearlyincludes "stopping a lien sale" or acts to perfect a lien, including the mailingof pre-lien letter or notices of lien sales. One judge has defined the scope of the"stay" to prohibit any act which would "put a smile" on a creditor'sface.

The most important things to remember about the stay are that it exists regardlessof whether the facility has knowledge of the filing of the bankruptcy and the intentionalviolation of the stay is a contempt of court. Violations of the stay are a basis forsanctions against storage facility owners and their managers and attorneys. The amount ofthe sanction includes all damages caused by the violation plus out-of-pocket costs,including recovery of the debtor's attorney's fees and associated costs. Plus, inegregious intentional cases, this could include six-figure punitive damages awards thatcertainly pale any amount sought to be recovered from a lien sale.

When a bankruptcy is filed, a tenant's "post-petition rent" (rent whichbecomes due after filing the bankruptcy) should be monitored to assure the debtor does notcontinue to default after filing. This is important because bankruptcy courts willgenerally not allow a tenant to hide behind the stay and occupy a space without payingrent. In the event a tenant ignores his obligation to pay rent after filing, the ownershould file a motion in the bankruptcy court for permission to go forward with lien salein accordance with state laws. Always remember: Until the stay is formally modified by thebankruptcy court, a creditor cannot proceed against the debtor in any manner.

Upon completion of a bankruptcy, a final discharge is entered extinguishing thetenant's obligation to pay for pre-filing rental defaults; however, the entry of adischarge does not, by itself, effect a self-storage lien that was validly perfected priorto the bankruptcy filing. The existence of a valid pre-petition self-storage lien iscrucial to collecting all or at lease some of the delinquent rent. The amount ofdelinquent rent that may be collected after entry of a discharge is limited to the amountcollected from completion of a lien sale. Any rent owed after completion of the lien saleand crediting the tenant's account is discharged and cannot be collected.

Occasionally, a facility may be contacted by a Chapter 7 trustee appointed in thebankruptcy proceeding to liquidate the tenant's (debtor's) assets. After filing, thetrustee is in possession (constructive) of all of debtor's assets including those storedat the facility. Trustees are often unaware of the contents or value of the contentsstored in the facility. Therefore, the trustee has the right to inspect the property toaid them in their decision to sell or abandon the contents. Lastly, unless the facilityreceives written permission from the trustee or the trustee abandons the stored contents,the facility should not release the property to the tenant--even if the rent is current.

Regardless of contact by a trustee and promises that all rent will be paid,post-petition rent should not be allowed to increase. Remember, as delinquent rentcontinues to increase, the facility's ability to collect "rent due" diminishes.Continued default by the debtor or trustee gives an owner a basis to hire an attorney toprepare and file a formal motion with the bankruptcy court for relief from stay, allowingthe owner to complete a lien sale. Under some circumstances, the court may order paymentof rent by the debtor or trustee as a condition of allowing the property to remain in thefacility.

Receipt of a notice entry of discharge or order for relief from automatic stay removesthe stay. Assuming a valid self-storage lien existed prior to the filing, the owner mayproceed with the lien sale in accordance with state law. Prior to conducting a lien sale,advice from an experienced attorney who has specialized knowledge of both lien and federalbankruptcy laws should be considered.

In Summary

Immediately after receiving notice of a bankruptcy, ask the tenant for the case number,filing date, chapter and the court in which the case is filed. It is also convenient toobtain a copy of the petition from the debtor. If rent is not paid, consider a formalfederal court motion for relief of stay. Remember, after the debtor files the bankruptcy,all lien activities are stayed until after entry of a notice of discharge by the court oruntil the owner has received an order for relief of stay allowing the self-storage ownerto proceed.

As a final thought, the best way to protect the storage facility from loss of rent isto immediately and properly perfect a self-storage lien. In the event a bankruptcy isfiled and the tenant continues to default in post-petition rent, then the self-storageowner should in file a formal motion with the court for permission to proceed with a salebefore the amount of rent increases significantly.  

Michael E. Hickey is an attorney and partner in the law firm of Corrons-Hickey& Hickey. He is a member of the California State Bar representing clients inself-storage evictions, unlawful detainers, construction lawsuits and debtor and creditorrights in bankruptcy. Mr. Hickey may be reached at Corrons-Hickey & Hickey, 930 W.17th St., Suite A, Santa Ana, CA 92706; (714) 550-9211; fax (714) 550-9819.