It is crucial a self- storage owner take all the appropriate steps when advised a tenant is bankrupt. Handling this matter properly will ensure the owner is not in violation of bankruptcy law and can proceed in his efforts to collect the secured debt.

Types of Bankruptcy

Chapter 7 is a liquidation. In a Chapter 7 case, where the debtor can be an individual or a corporation, a trustee under supervision of the bankruptcy court collects the debtor's property, converts it to cash, and distributes the cash to the creditors.

Chapter 11 is a reorganization. In a Chapter 11 case, where the debtor is likely a corporation, the debtor creates--again under supervision of the bankruptcy court--a plan to pay off the creditors, usually from post-petition (after the bankruptcy filing) earnings.

Chapter 13 is also a reorganization, but is limited only to individuals who meet certain requirements. Here, the individual files with the court a plan to pay off his debts over time with a so-called "wage earner" plan.

The Bankruptcy Process

What follows are the steps a self-storage owner should take upon notification of a tenant's bankruptcy. Also included are possible strategies to recover the debt or simply make the occupied unit available for rent.

Step 1: Stop the sale.

If the facility is contemplating or in the process of a foreclosure sale, all sale efforts must cease immediately. This includes any preforeclosure notices, placing any ads and, of course, selling the tenant's property.

Step 2: File proof of claim.

The proof of claim is a document that may be obtained from the bankruptcy court. It is imperative to check the document to determine whether it is filed with the court or the trustee. This often is determined by the type of bankruptcy. The document identifies all the debt that occurred up to the time the petition for bankruptcy was filed (the "prepetition" debt). It will serve to identify the storage facility as a creditor against the debtor. Because most rental agreements provide for a lien against the tenant's property and a possessory interest in it, an owner can identify himself as a secured creditor. Because these proofs of claim often have deadlines, the storage facility must file this document with the appropriate entity as soon as possible.

Step 3: Continue to charge rent and other fees after the date of the petition.

Depending on the strategy used to proceed in the storage facility's collection efforts, it is important to continue charging the tenant for use of the space. One remedy for recouping the post-petition rental fees is requesting rent be paid as "administrative costs" of maintaining the property. Additionally, a debtor or trustee may assume the rental contact, as clarified below.

The owner must also review the tenant's debt by examining the amounts owed and, more specifically, payments received in the 90 days prior to the filing of the bankruptcy. The concern about payments in the 90-day period relates to "preferential claims." A nonaffiliated creditor cannot accept more than $600 payment toward debt within 90 days prior to filing of the bankruptcy. If money is paid in excess of the $600, the trustee will demand the funds be returned to the debtor's estate as a preferential claim, and the funds will be distributed among all the creditors. Failure to respond to the trustee's demand will result in a suit against the facility owner to recapture those funds.

Step 4: Contact the debtor's attorney and bankruptcy trustee.

The contact information for the debtor's attorney and trustee is listed on the bankruptcy petition. The objective of this contact is to determine the intent of the tenant.

Possible Courses of Action

The actions a storage facility may take after a tenant files bankruptcy are:

Assumption of the contract. The debtor can ask the bankruptcy court to allow it to assume the contract. This is called assuming an "executory contract." If the debtor assumes the contract, the monthly rent gets paid while the case is pending, and the outstanding past-due rent must be paid to the debtor out of default. This situation moves the self-storage owner to the front line of priorities. Nonetheless, if the trustee does not believe it will benefit the debtor to keep the property in storage, he will reject the contract. If the trustee takes no action to accept or reject the lease within 60 days after the date of the order for relief, the lease is deemed rejected and the automatic stay is terminated under 11 U.S.C. sec. 365 (d)(4).

Relief from stay or adequate protection. A creditor may request a "relief from the stay" that, if granted, allows the facility operator to enforce his lien rights to foreclose on the property. A request for relief from the stay is filed in the form of a motion with the court, requesting that the court "lift the stay."

Alternatively, a motion for adequate protection may be filed. Whether a secured creditor is entitled to adequate protection depends on whether he is oversecured or undersecured. An oversecured creditor has collateral worth more than the debt. An undersecured creditor has debt greater than the worth of the collateral. Adequate protection can come in the form of post-petition interest on its claim for an undersecured creditor and payment of principal and interest for an oversecured creditor.

When a secured creditor has interest in property to be used, sold or leased by the trustee or debtor, the court may prohibit or condition such use, sale or lease as is necessary to provide him adequate protection. Under 11 U.S.C. ß 363(o), the bankruptcy trustee or debtor-in-possession has the burden of proof on the issue of adequate protection, and the secured creditor who has asserted a lien on the property to be sold has the burden of proof on the validity, priority or extent of the lien.

Apply for administrative costs. In a Chapter 11 or 13, the storage owner can request the trustee or debtor pay the costs to maintain the property in the storage facility. The bankruptcy court can make the determination that certain costs are required to proceed with the bankruptcy, and the maintenance of the debtor's property in the storage facility could be considered such a cost.

Turnover. Certain creditors may be required to "turn over" property of the debtor to the bankruptcy trustee. This allows the bankruptcy court to collect the assets of the debtor to distribute to all of the creditors. If the bankruptcy court requires the storage facility turn over the stored property to the trustee, the facility will receive a notice of the request in the form of a motion for turnover, which will require the facility's response. However, turnover may not be required by the court unless the debtor can provide sufficient collateral to the creditor to ensure its claim is protected. The bankruptcy court will not require a secured creditor to give up its possessory interest if by doing so it will lose its security rights.

Abandonment. Another approach under a bankruptcy is to file a motion with the bankruptcy court requesting it order the trustee to "abandon" the tenant's property. The motion must demonstrate to the court that this property is burdensome and of "inconsequential value and benefit" to the debtor. If the trustee is ordered or chooses to abandon the property, it will be released to the storage facility as the secured creditor, the stay will be lifted, and the property can be sold in an effort to recoup monies owed on the storage facility's claim. If nothing else, an abandonment would allow the storage facility to remove the property from the unit.

Statutory liens. Whether the storage facility's tenant files a Chapter 7, 11 or 13, it should be assumed that if the facility is holding the tenant's property and has a signed rental agreement providing for a statutory lien, it is a secured creditor. This fact provides it additional priority over other creditors who are unsecured, and will entitle it to faster payment for the outstanding debt.

Conclusion

Tenant bankruptcy is a difficult process for self-storage operators made worse by tenants who remain on the property after the bankruptcy and continue to default on payment. By following these step-by-step procedures, an operator can act to establish priority on his secured claim against the tenant. At a minimum, the operator can turn over the property to the trustee and open up the space to generate further revenue for the facility.

Scott Zucker is a partner and Lisa Cohen is an associate in the Atlanta-based law firm of Weissmann & Zucker P.C., which specializes in business litigation with an emphasis on real estate, landlord-tenant and construction law. For more information, call 404.364.2300 or visit www.wzlegal.com.