Legal Corner

What To Do When Your Tenant Declares Bankruptcy

by Ted Kimball and Patricia Tirey

When a residential tenant declares bankruptcy, all attempts at collection of rent are automatically stopped. This includes the serving of notices and/or the filing or maintenance of a court action for unlawful detainer (eviction). If a rental property owner or manager elects to continue with the eviction or attempts to collect rent, he/she could be held in contempt of bankruptcy court, subject to fines, penalties and even imprisonment.

An owner or manager’s decision could also mean the difference between a delay of a few weeks and a delay of several months or even longer. It is therefore important for residential property owners and managers to be aware of the legal ramifications when a tenant files for bankruptcy, especially since the number of bankruptcy filings are on the rise. New bankruptcy filings broke a record during the second quarter of 2001, increasing almost 25 percent over the same period a year ago. In fact, our country may perhaps surpass the all-time bankruptcy filing record of 1998, when more than 1.4 million cases were filed.

A common although improper reason for filing a bankruptcy is to delay an eviction. Typically, once the eviction is completed in state court, the bankruptcy is dismissed instead of discharged. What many tenants fail to realize is that they are perpetrating a fraud on the bankruptcy court by filing the action for delaying purposes only. When the bankruptcy is ultimately dismissed, the tenant still owes his/her back rent, plus attorneys’ fees and court costs and has gained a derogative “black mark” on his or her credit.

Above all, be ready to respond immediately if your tenant files for bankruptcy. This is especially true if the tenant fails to pay rent or is being evicted. Your first action is to request the bankruptcy court’s permission to commence or continue with the eviction process. This is accomplished by filing a Motion for Relief from the Automatic Stay. Some tenants will dismiss their petition and re-file a second bankruptcy petition in an attempt to further delay the process. The motion should be worded so as to make it possible for the eviction to continue, notwithstanding the dismissal and re-filing of a new bankruptcy petition. Most bankruptcy judges will agree to grant the motion with this added protection.

You may have read or heard rumors that if a tenant files for bankruptcy, he/she can live rent free for as long as one year. So long as you are diligent and careful, that kind of a delay should never happen. Under usual circumstances, a bankruptcy filing will delay the eviction process between two and ten weeks. The actual time frame depends on how quickly the motion for relief of stay is filed, the particular bankruptcy court’s local procedural rules and whether the motion can be expedited through an ex parte procedure.

An ex parte motion requests the court to grant you immediate relief in lieu of requiring a formal, noticed motion. One of the primary requirements for the granting of a successful ex parte motion is whether or not the eviction notice declares a forfeiture of the tenant’s lease or rental agreement. Make sure you examine your form notices to see if they contain the correct forfeiture language. All of the California Apartment Association forms have the correct verbiage.

The primary defense to the motion for relief of stay is a claim that the tenant has an ownership interest in the property. This is rarely found in residential rental arrangements. The courts routinely grant the landlord’s motion for relief of stay. However, the result of the tenant’s action is to waste taxpayers’ dollars, expend court time, lose rent for property owners and ruin a tenant’s credit. This, in turn, increases the risk that rents will be raised to cover such losses.

Thanks to legislation sponsored by the CAA, tenants who are being evicted can no longer stop the process by filing for bankruptcy if their petition is filed after the landlord receives a judgment for possession in unlawful detainer. If such a judgment is obtained, the lockout will go forward if the tenant’s bankruptcy petition is filed post-judgment. Although this legislation was passed years ago, sheriffs’ departments throughout the state were skeptical of continuing with the lockout for fear they would be in contempt of the federal bankruptcy court.

Not until the year 2000, when the U.S. Supreme Court upheld this law in Lee v. Baca, did the sheriff’s offices routinely begin doing lockouts if the tenant’s petition was filed post-judgment. The court reasoned that once a judgment has been granted for possession of the leased property, the tenant has lost the leasehold interest as an asset, and the lease could no longer be construed as part of the bankrupt estate. The result is that if a judgment for possession has been rendered, the eviction should continue notwithstanding the tenant’s bankruptcy filing.

In the 2001 U.S. Congressional Session, legislation was introduced to prevent a bankruptcy filing from stopping an eviction if the tenant’s lease had expired or was otherwise forfeited. The favorable language is found in the House version of Section 311 of the Bankruptcy Reform Act of 2001. If this provision becomes part of the Act, the number of frivolous bankruptcy actions will dramatically decrease.

With knowledge of bankruptcy procedure, and by acting in a timely fashion, and hopefully with a little help from Congress, you can minimize your losses when your tenant files for bankruptcy.

The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of the SFAA or the SF Apartment Magazine. The above discussion is general in nature and should not be construed as individualized legal advice. Readers are cautioned to seek individualized legal assistance based on a detailed analysis of their particular facts and circumstances. Ted Kimball and Patricia Tirey are partners of Kimball, Tirey & St. John, a law firm that specializes in landlord/tenant, collections and business and real estate, with offices throughout California. If you have any questions regarding the contents of this article, please call 800-338-6039 or visit their Web site. © Copyright 2002.