By Bernard Fensterwald
At some time, most self-storage operators face a tenant who files for bankruptcy. This article offers a framework for how the bankruptcy system operates and the self-storage operators roles and rights.
Bankruptcy in the United States is as old as the Republic itself. In fact, the U.S. Constitution permits the Congress to establish bankruptcy courts throughout the country. Congress passed the first Bankruptcy Act in 1800.
In 2010, nearly 1.6 million bankruptcy actions were filed in the United States. According to a Harvard University study, roughly 62 percent of bankruptcies are due to excessive medical expenses. In 78 percent of these cases, debtors had insurance. The rising tide of unemployment is also a contributing factor.
Some argue bankruptcy is a way for people to engage in fraud and avoid their debts. In 2007, Congress addressed these issues. Now, many debtors must go through a credit-counseling process prior to declaring bankruptcy.
An important first concept to understand about bankruptcy is the courts established to handle these matters are federal, not state or city. The United States is divided into 94 judicial districts. In each, theres a federal district court and a federal bankruptcy court. For example, the state of Florida has three judicial districts: northern, middle and southern. Courts in these three districts sit, respectively, in Tallahassee, Tampa and Miami.
Its important for self-storage operators to know in which federal judicial district they reside. Its also a good idea for them to familiarize themselves with their local bankruptcy court, its rules, contact points and operating procedures.
How Bankruptcy Works
There are typically three parties to each bankruptcy case. The debtor is the person who files the petition seeking a discharge of debts. The creditor is the one to whom a debt is owed. The trustee is the individual whos entrusted to hold the debtor's assets in trust while the bankruptcy court sorts out who has a priority for a return of some or all money owed. In some business-related bankruptcy proceedings, called Chapter 11, the debtor is permitted to control its own assets as a debtor in possession. Self-storage operators are typically creditors.
Bankruptcy proceedings arise when a debtor files a petition with the bankruptcy court seeking a discharge from his debts. These proceedings are normally filed as either a Chapter 7 (complete discharge) or a Chapter 13 (individual-debt adjustment). In the first instance, a debtor seeks total relief from debts; in the second, the debtor seeks to reorganize his finances and pay all or a part of whats owed under a court-approved plan. Theres a separate Chapter 11 proceeding for businesses seeking to reorganize and stay in business.
An important concept to understand in bankruptcy is whats referred to as the automatic stay. Once a debtor files a bankruptcy petition, any and all action by creditors to collect a debt must cease immediately or severe penalties may apply.
What this means for self-storage operators is simple: If youre in the process of using your state's self-storage lien law to enforce your lien, i.e., auction process, and youre notified a tenant has filed a bankruptcy petition, you should immediately freeze the process at whatever stage its in. If youve filed an action in state court to collect money from a tenant whos filed a bankruptcy petition, your attorney must notify the state court.
As a creditor, youll normally receive written notice from the bankruptcy court that a petition has been filed. Of course, this assumes the tenant has listed you as a creditor in the petition. Whether youve been listed as a creditor or not, if the tenant tells you he has filed a petition or you receive notice via a third party, you should stop any proceedings to collect the debt. At this point, its a good idea for you to contact your local bankruptcy court, either by phone or online, to determine whether the tenant actually filed a petition, when it was filed, the file number, the schedule of hearings, etc.
The purpose of a bankruptcy petition is for the debtor to obtain a discharge of debt. Meanwhile, the debtor is happy to leave goods stored at the facility for an indefinite period. This can result in a continuing burden for the self-storage operator.
What You Can Do
As a self-storage operator, your goal in bankruptcy proceedings may be two-fold. First, you hope to recover all or at least a portion of the rent previously owed for storage used prior to the filing, called the pre-petition debt. Second, you want to remove the debtor's property from the storage unit so the space can be leased to a new customer.
As to the recovery of pre-petition debt, it maybe painfully obvious the debtor has little or no assets from which an operator can hope to receive a full or partial recovery of unpaid rent. If thats the case, your focus should be on the second goal. This can go one of two ways, depending on the relative value of the property held at your facility. Also remember you have a lien on the property stored in your facility. This lien may give you a priority over other creditors seeking a recovery from a shortage of assets.
If the property is relatively valueless or the debtor seeks a complete discharge, you may want to contact the trustee and see if its possible for him to abandon the stored property. If the trustee agrees and the abandonment is approved by the bankruptcy court, you may be able to proceed to auction and clear the unit. You should notify the trustee of any funds you receive at the auction to determine how they should be distributed.
If the property in the storage unit has value or the debtor seeks to reorganize his finances, the trustee may wish to hang onto it to pay creditors as a part of the discharge process. In this instance, you may want to contact the trustee to determine if the storage charges that occur after the petition is filed can be paid ongoing out of funds held by the trustee as administrative expenses of the bankruptcy estate. This process may take time, but it may be worth it to keep a paying tenant in your facility.
Its important to note that storage charges that accrue after a petition is filed are not part of the bankruptcy itself. While operators are still bound by the automatic stay, these storage charges are not discharged as a part of the bankruptcy and may be pursued after the bankruptcy process is complete.
Other Key Considerations
Here are some more things to consider when dealing with a tenant bankruptcy.
Know the process. Prior to the start of any bankruptcy proceeding, familiarize yourself with the process and your local bankruptcy court. Know where the court is located and how you can contact it. Helpful information can be found at www.uscourts.gov.
Stop collections. If youre notified a tenant is "filing for bankruptcy," stop any collection actions immediately. Contact the bankruptcy court to confirm a petition has been filed, the file number, when it was filed, a schedule of hearings and other important matters. In these cases, knowledge is a good thing.
Get listed as a creditor. Do not assume the tenant will remember to list you as a creditor. If thats the case and you want to participate in the bankruptcy proceedings, youll need to notify the bankruptcy court. Remember, however, that even if you arent listed as a creditor, youre still bound by the automatic stay once you have knowledge a petition has been filed.
File the claim. If you receive notice from the court that you are a creditor, complete and file the claim form included in the notice. Since you have a lien on the property stored, you may have a priority over other creditors. Be sure to complete and file the claim form on time. Plus, keep a copy for your records.
Attend hearings. There will be a series of hearings during the bankruptcy proceeding. One of these is the creditor's meeting normally held at an early stage with the trustee. Be proactive and attend. Many creditors write off the debt owed them and dont participate in the bankruptcy process. However, because self-storage operators have ongoing relationships with debtors, youll want to determine whether the trustee may be willing to abandon the stored property or be able to pay ongoing storage charges as administrative expenses. Introduce yourself to the trustee and explain your situation to him.
Know military status. Individual debtors serving in the military pose a separate problem. Not only does the bankruptcy process govern them, there are separate considerations due to the Servicemembers Civil Relief Act. You should use extra caution when dealing with these types of cases.
Retain a lawyer. Depending on the situation and amount of funds at stake, you may want to retain a bankruptcy attorney to represent you. Its always good practice to know one upon whom you can call. Remember, however, that you will be unlikely to recover any attorney's fees that you incur from the debtor.
The purpose of bankruptcy proceedings is to give people in financial distress a "fresh start." While it often appears to be unfair, its an accepted part of our financial world. By understanding the processand your role and rightsyoull be in a good position to make the best of a bad situation.
This article is for the purpose of providing general legal insight into the self-storage field and should not be substituted for the advice of your own attorney.
Bernard Fensterwald III is a consulting attorney with 25-plus years of experience. Hes licensed to practice law in Maryland, Virginia and Washington, D.C. Hes also a principal in U-Store Management, a Washington, D.C.-based self-storage company, and a past president of the Washington Area Self Storage Association. To reach him, e-mail [email protected]; visit www.fensterwald.weebly.com.