Your Legal Obligations and How to Recoup Debt When Your Self-Storage Tenant Files for Bankruptcy

Most self-storage tenants abide by all the terms of their rental agreement and pay their rent on time. Nevertheless, every operator has a few customers who default. In these instances, the state’s lien law outlines a legal procedure so the stored goods can be sold at auction and the space reclaimed. However, every so often, you’ll receive notice that a delinquent renter has filed for bankruptcy. The question then quickly becomes how to proceed, particularly if there’s a lien sale already scheduled.

Once you’ve been advised that a tenant has filed for bankruptcy, it's crucial that you take all the appropriate steps. Handling this matter properly will ensure you aren’t in violation of bankruptcy law and can proceed in your efforts to collect the debt owed.

Types of Bankruptcy

First, let’s define each type of bankruptcy and what’s involved:

Chapter 7 is a “liquidation” in which the debtor can be an individual or corporation. In this scenario, a trustee under supervision of the bankruptcy court collects the debtor's property, converts it to cash and distributes it to the creditors. The trustee will sell all the assets to pay as many creditors as possible. However, in most Chapter 7 filings, there are little or no assets to sell.

Chapter 11 is a “reorganization.” In this case, the debtor is likely a corporation. They’ll create a plan under bankruptcy-court supervision to pay off the creditors, usually from post-petition (after the bankruptcy filing) earnings.

Chapter 13 is also a reorganization but is limited to individuals who meet certain requirements. Here, the debtor files a proposal with the court to pay off the debt over time with a “wage earner” plan. This allows them to keep possession of all the property, however, the court will appoint an impartial or standing trustee who’ll evaluate the plan and distribution of payments.

The Initial Bankruptcy Process

Following are the steps you should take upon notification of a self-storage tenant’s bankruptcy. It includes possible strategies to recover the debt or simply make the occupied unit available for rent.

Step 1: Stop the sale. As soon as the bankruptcy petition is filed by a tenant, an automatic stay puts an immediate halt to all collection activities, sale efforts, foreclosures and repossessions of all property. This includes any pre-foreclosure notices, ad placements and, of course, selling the stored goods. This also involves overlocking the unit if it wasn’t already done when the petition was originally filed.

Step 2: File a proof of claim. This document may be obtained from the court. It’s imperative to check the bankruptcy notice to determine if it was filed with the bankruptcy court or the trustee. This is often determined by the type of bankruptcy.

The proof of claim identifies all the pre-petition debt, that is, the debt that occurred up to the time the petition for bankruptcy was filed. It’ll identify your self-storage facility as a creditor against the debtor. Because most self-storage rental agreements provide for a lien against the tenant’s property and a possessory interest in it, you can identify yourself as a secured creditor. These proofs of claim often have deadlines, so you must file the document with the appropriate entity as soon as possible.

Step 3: Continue to charge rent and other fees. Depending on the strategy used to proceed in the storage facility’s collection efforts, it’s important to continue charging the monthly rent. One remedy for recouping the post-petition rental fees is requesting that rent be paid as “administrative costs” of maintaining the property. I’ll discuss this further below. Additionally, a debtor or trustee may assume the rental contract (also clarified below).

You must also review the tenant’s debt by examining the amount owed, more specifically the payments received in the 90 days prior to the bankruptcy filing. The concern about payments within this period relates to “preferential claims.” A non-affiliated creditor can’t accept more than $600 payment toward debt within 90 days before the filing.

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. They will then be distributed among all the creditors. Failure to respond to the trustee’s demand will result in a suit against you to recapture those funds.

Step 4: Contact the debtor’s attorney and bankruptcy trustee. Their contact information is listed on the bankruptcy petition. The objective of this communication is to determine the intent of the tenant.

What Can Happen Next

The actions that may be taken in regard to the delinquent self-storage unit following a bankruptcy petition by a tenant include the following. Note: Whether the tenant files a Chapter 7, 11 or 13 bankruptcy action, it should be assumed that if your facility is holding the tenant's property and has a signed rental agreement providing for a statutory lien, your business is a secured creditor. This fact provides you with additional priority over other creditors who are unsecured and entitles you to faster payment for outstanding debt.

Relief from stay or adequate protection. You can request a “relief from the stay,” which, if granted, would allow you to enforce your lien rights to foreclose on the tenant’s property and sell it. The request is filed in the form of a motion with the court to lift the automatic stay that goes into effect when a bankruptcy petition is filed.

Alternatively, you can file a motion for adequate protection, which provides compensation to a secured creditor for the loss in value they may suffer due to the automatic stay. Whether you’re entitled to this protection depends on whether you’re oversecured, meaning you have collateral that’s worth more than the debt owed, or undersecured, whereby the debt owed is greater than the worth of the collateral. If you’re oversecured, adequate protection can come in the form of payment of principal and interest. If you’re undersecured, it can come in the form of post-petition interest on your claim.

When a secured creditor has interest in property to be used, sold or leased by the trustee or debtor, the court may either prohibit or condition this as necessary to provide adequate protection. The bankruptcy trustee or debtor-in-possession has the burden of proof on the issue of adequate protection, while the 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.

Assumption of the contract. The tenant can ask the bankruptcy court if they can assume the self-storage lease as an “executory contract.” If this happens, the monthly rent continues to be paid while the case is pending. The past-due rent must also get paid to pull the tenant out of default.

This moves you as the self-storage operator to the front line of priorities. Nonetheless, if the trustee doesn’t believe that it’ll benefit the tenant to keep the property in storage, they’ll reject the contract. If they take no action to accept or reject the contract within 60 days after the date of the order for relief, it is deemed rejected and the automatic stay is terminated.

Apply for administrative costs. In a Chapter 11 or 13, you can request that the trustee or debtor pays the costs to maintain the property in your self-storage facility. The court can make the determination that certain costs are required to proceed with the bankruptcy, and the maintenance of the debtor’s property in your facility could be considered as such.

Turnover. Sometimes the bankruptcy court will opt to collect all the debtor assets and distribute them among the creditors. In this case, you may be required to turn over any property in your possession to the trustee. If this happens, you’ll receive a notice of the request in the form of a motion for turnover, which will require your 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 court won’t require a secured creditor to give up its possessory interest if by doing so they’ll lose their security rights.

Abandonment. Another approach is to file a motion requesting the bankruptcy court to order the trustee to “abandon” the tenant's property. This request must demonstrate that the property is burdensome and of “inconsequential value and benefit” to the debtor. If the trustee is ordered or chooses to this option, the stay will be lifted, and the property will be released to you for sale or disposal. If nothing else, an abandonment allows you to remove the goods from the unit so it can be rented to another customer.

You can also directly contact the debtor’s attorney or trustee to see if the tenant is willing to sign an abandonment form, thus giving up all rights to the property. It would have the same effect as filing such a motion with the court.

Move out. There is one other method that doesn’t involve filing anything with the bankruptcy court: You can simply contact the debtor’s attorney or trustee and see if the tenant is willing to move out of the storage unit. You might also sweeten the pot by waiving any past-due amounts.

Final Solutions

Bankruptcies can be confusing because of the various laws involved. Generally, a bankruptcy is filed because the self-storage tenant is unable to pay their ongoing bills. If they can’t pay the past-due storage rent, it’s unlikely they’ll be able to pay the ongoing rent. It’s often the best-case scenario to simply allow the customer to remove their property from the space, then submit the claim for payment to the bankruptcy court.

At the end of the day, if neither the tenant nor the trustee is cooperating to resolve the status of the stored goods and you continue to not get paid, even though the tenant still has their property in the space, you have the right to file a “motion to lift stay.” This allows the court to grant you permission to proceed on your lien rights, even though the tenant is still in bankruptcy.

The best approach on a bankruptcy is to be proactive. You can still discuss the situation with your self-storage tenant, you just can’t threaten a lien sale to collect the debt. The tenant can move out, which removes your rights over the collateral property, but frees the unit to be rented to a paying customer.

Ashley Oblinger is an attorney with the Atlanta law firm of Weissmann Zucker Euster Morochnik & Garber, P.C., where he specializes in business and self-storage law, advising operators nationwide on all legal matters, including lease preparation, lien enforcement, tenant issues, tenant-claims defense, and employment policies. To reach them, call 404.760.7434 or email [email protected].