The Lien's the Thing

March 1, 2005

10 Min Read
The Lien's the Thing

Your nightmare has come true. The delinquent tenant of unit A36, to whom you sent a preliminary lien notice and a notice of lien saleinforming him that the contents of his unit will be sold at public auction this afternoonjust called and gave you the dreaded news: He is going to file a petition for bankruptcy tomorrow morning. "Neener, neener!" he gloats. "You can't sell my stuff. If you do, I'll sue you. The trustee of my case will, too, and the bankruptcy judge will hit you with a huge fine." Pass the Tylenol and Mylanta.

Fear not, fair self-storage owner. All is not lost. You can rid yourself of that stuff and re-rent the unit to a tenant who is not so payment-challenged. This article presents solutions of a formal nature if you wish to strictly comply with bankruptcy lawsthat is, the conservative, lawyer-recommended approach. It also offers unofficial, practical solutions that, under normal circumstances, will allow you to return a unit to active income production. Of course, these will carry some risk of flouting the pro-debtor bankruptcy laws and incurring the wrath of the tenant, trustee and judge.

For the most part, I'm addressing tenant bankruptcy filed under Chapter 7 of the federal Bankruptcy Act. Although the results might be the same under a Chapter 11 or 13, tenants usually file for liquidation of their assets (if there are any) under Chapter 7. To understand the other filings and how they differ, confer with legal counsel experienced in bankruptcy law.

Automatic Stay Trumps State Laws

The immediate impact of a tenant bankruptcy is an automatic stay goes into effect the moment the petition is filed, regardless of when you are notified. Unfortunately, your state self-storage statute is trumped by federal bankruptcy laws. Therefore, once any employee of your facility learns a tenant has filed bankruptcy, all personnel should cease collection efforts against the tenant. Unless you take action to lift the automatic stay, the following rules apply:

  1. No telephone calls may be made to the tenant for the purpose of attempting to collect on his account, nor can any letters or dunning notices be sent for that purpose.

  2. None of the personal property in the storage space may be sold or otherwise disposed of.

Even after the bankruptcy case is closed, the automatic stay remains in effect, forbidding you from any attempt to collect arrears from the customer. However, the situation is different as it pertains to property inside the unit. Now it's your turn to "neener" the tenant. In our sample scenario, he did not say he had already filed a petitionhe said he would do it tomorrow. Hallelujah! You can sell his stuff at auction this afternoon without fear of reprisal because no automatic stay is yet in effect. However, make sure notices and other steps leading up to the sale, as well as the sale itself, have been done in strict compliance with the laws and requirements in your state.

What if the Tenant Already Filed?

Now, if the tenant informed you he had already filed a bankruptcy petition, you're looking at a different story, as the automatic stay is in effect. You must stop the lien sale. The items in the tenant's unit now belong to the bankruptcy estate and are subject to the right of the bankruptcy trustee (appointed by the court). Only the trustee can take possession of the property. Whether he chooses to do so will depend on:

  1. Whether he has been informed of the existence of the property in the tenant's bankruptcy papers.

  2. Whether he believes that, were the property sold, the proceeds would be substantial enough to contribute meaningfully to the assets of the estatei.e., toward payment of the tenant's debts as well as the trustee's fee.

One exception: If you followed all the mandatory steps of your applicable self-storage statute and created a lien against the tenant's property before the bankruptcy filing, the trustee cannot force you to give up the property unless he satisfies the lien by paying off the debt. The money owed by the tenant is an entirely different animal from the lien attached to the contents of his unit. Whereas the tenant is no longer liable for the debt as a result of his filing, the lien on his property remains until the amount you are owed is satisfied.

Available Options

There are several courses of action you can take to rid yourself of a bankrupt tenant's goods and return your unit to operation. These options vary in cost, result and probability of success, so it's important to consider your ultimate goal. Weigh the amount owed by the tenant and the likelihood of collection against what you are willing to spend.

The alternatives are:

1. Work out an informal resolution, with the trustee's written consent, to have the tenant remove all property from the storage space.

Make sure you secure a written agreement with the tenant that specifies a drop-dead date for removal of the property. It should also include protective provisions to the effect that any items left in the space after the deadline are relinquished by the tenant and released to the facility.

There is one caveat: Technically, in Chapter 7, the tenant has no legal right to take possession of or use the property for the duration of the case, as it belongs to the bankruptcy estate. However, with rare exception, trustees are not interested in the property and do not care if the tenant takes it. The exception is when the property has such substantial resale value the trustee wants to sell it and use the proceeds.

Even then, if you allow the tenant to remove the propertyfor example, you allow him access or fail to over-lock the unityou have not done anything legally wrong and cannot be sued by the trustee.

2. Ask the trustee to formally abandon the personal property back to the tenant.

This is a low-cost option in terms of legal expense and, if successful, allows you to proceed with remedies under your state's self-storage statuteif the trustee acts expediently. Under bankruptcy law, the trustee has 60 days from the date the tenant's filing to affirm or accept the self-storage rental agreement on behalf of the estate. If the trustee does nothing, the agreement is automatically terminated after 60 days as a matter of law. At that point, you are not able to pursue your rights under the Self-Service Storage Facility Act because there is no longer a viable contract to enforce.

If this occurs, your only option is the more expensive (and less effective) remedy of filing an unlawful-detainer action to recover the storage space. After you get a court judgment returning the unit to your possession, you can have the marshal or sheriff sell the contents to raise funds and pay off the lien, or use the personal-property abandonment procedure set forth in some state laws. In either case, it's still simply better to petition the trustee to abandon the goods to the tenant.

A trustee may not respond to your request, as he is not legally required to do so. Furthermore, it's your burden to convince the trustee that sale of the property would not generate substantial proceeds. But if he agrees, he will simply send a notice to all interested parties, notifying them that he intends to relinquish to the tenant all personal property inside the unit. If he gets no objection within the time period specified by the bankruptcy code, the space is officially abandoned. The property is no longer part of the bankruptcy estate or subject to the automatic stay, and you can proceed with standard forms of remedy under your state self-storage statute.

If the trustee declines your appeal, you can file a motion with the bankruptcy court to compel him to cooperate; but it's an expensive procedure, and circumstances rarely warrant it. It might only be worthwhile if the amount owed was substantial, and the property in the unit was expected to bring significant proceeds upon sale.

3. Sit back and wait until the bankruptcy case has been formally closed, and then pursue whatever remedies are available under your state's statute.

Though inaction in the face of a legal quandary usually makes matters worse, waiting out a bankruptcy is not a terrible idea. If you can afford to lose revenue from the unit over the course of several months (i.e., your facility has several other vacancies), it may be best to ride out the storm, especially if you are unable to contact the tenant about removing the property from the space. In addition, a hiatus will give you time to see if the tenant's petition is dismissed by the judge due to some procedural or filing error. It happens often.

Failure to act is contrary to the above advice regarding an appeal to the trustee, so as you can see, each case will need to be handled individually. Examine all aspects of the situation to determine your best strategy. In whatever course of action you choose, enter the space in question and complete a general written inventory, over-lock the unit, and conduct an appraisal of the contents.

Case Closed

After a tenant's bankruptcy case has been formally closed, you should receive a notice from the court. If the trustee has not attempted to take possession of the unit's contents, you may wish to pursue remedies under your state's self-storage statute. But heed this warning: Bankruptcy law does not technically allow you to do that, because even after the case is closed, the property may remain under the jurisdiction of the trustee. In reality, however, it's rare for a trustee to bother with a case after it closes or take action against a storage owner who pursues financial remedies for his losses.

You can file a proof of claim to collect payment for rent that accrued before the bankruptcy was filed. However, this may prove to be a waste of time and energy, as there usually are not sufficient assets in the estate to pay a substantial portion of the tenant's debts. Moreover, the amount of the arrearage is usually too small to warrant the trouble.

By law, you are also legally entitled to be paid out of the bankruptcy estate for the first two months of rent following the tenant's filing. However, if the estate has no assets, you won't get a dime. The same holds true if you attempt to recover rent that accrued after the petition was filed. You can file a motion with the court claiming it as an expense of administering the estate's property, but again, you can't get blood out of a turnip.

In the end, the lien's the thing that makes a facility king. While a tenant bankruptcy can be troublesome, do not despair. On receiving notice of a tenant's Chapter 7 filing, be proactive. Conduct an inventory of the unit's contents, determine a reasonable auction resale value, and consider your options. You can come out of this aliveand return the unit to producing income.

Vin A. Fichter, attorney at law, is based in Woodland Hills, Calif., and has practiced general real estate, business and commercial law, and civil litigation in Arizona, California, Florida and Hawaii for more than 32 years. For the past 10 years, he has devoted a substantial part of his practice to representing owners and operators of self-storage in all types of matters, including act compliance and construction. He has obtained more than 150 judgments for self-storage companies against tenants and successfully defended several companies against lawsuits by tenants. For more information, e-mail [email protected].

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