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Can a tenant break a lease after filing a chapter 7 bankruptcy?

Posted by attorney James Cole

If a consumer tenant files a chapter 7 bankruptcy without telling the landlord, then fails to pay rent while living there and moves out only after a notice of default is given, does the bankruptcy allow the tenant to break the lease and leave without paying what is owed for past rent due and for the remainder of the lease?

This answer addresses chapter 7 consumer debtors only. Chapter 13 invokes different considerations because it lasts for several years and the debtor does not obtain a discharge until the end. The short answer is "yes, the consumer tenant can do that," but the landlord may be able to obtain a judgment for rents due for the period of actual occupancy after the bankruptcy was filed, depending on state law.

In chapter 7 bankruptcy, a residential lease is "rejected" 60 days after the date of bankruptcy filing unless the trustee "assumes" it with court approval. (Bankruptcy Code sec. 365(d)(1).) The Bankruptcy Code defines "rejection" as a breach of the lease as of immediately before the filing of the petition. (Code sec. 365(g)(1).) This means that all amounts due under the lease because of the breach, including damages for the unexpired portion of the lease contract, are discharged. They cannot be collected unless an exception to discharge is proved. (See below for possible alternative remedies.)

It is disputed around the country whether a discharge is good against a creditor who is not notified of the bankruptcy filing. (See Code sec. 523(b)(3).) It depends, among other things, on the type of debt that is involved--a debt that may be held nondischargeable for certain other reasons (e.g., fraud, malicious personal injury), or a debt that is not within those other reasons but could be partially paid if a proof of claim were timely filed. A landlord's claim will usually not be among the "certain other reasons," but will be an ordinary claim that could be paid if a proof of claim were filed. However, in some areas of the country, such as in the seven states of the Eighth Circuit Court of Appeals, the courts have held that if no assets were liquidated or distributed in the chapter 7 case (as in over 95% of chapter 7 cases), then a creditor would not have received any distribution anyway if a proof of claim had been timely filed. Therefore, in a “no asset" case, the creditor has not suffered any harm under the bankruptcy law from not being notified of the bankruptcy, and the discharge is good against the creditor. In other words, "no harm, no foul."

This rationale ignores real-world consequences of lack of notice of a bankruptcy that are unrelated to filing a proof of claim, such as those facing a landlord who is stuck with a tenant who breaks a lease, but such consequences have not swayed the courts who have adopted the "no harm, no foul" rule.

The landlord may not be completely without remedies, however. Let me make a standard disclaimer here: This article does not attempt to give anyone legal advice for specific circumstances. All general rules stated here are subject to exceptions. Anyone in this situation should consult with an attorney to find out what laws apply, what exceptions to general rules there may be, and what is the best thing to do in a particular case.

Having stated the disclaimer, here are possible remedies. First, nonpayment of rent generally allows a landlord to recover possession of the premises separate and apart from an award of monetary damages. During the course of the chapter 7 bankruptcy, in order to obtain possession from a consumer tenant, the landlord must obtain relief from the automatic stay from the bankruptcy judge under sec. 362(d). After the tenant receives a chapter 7 discharge, this part of the automatic stay is terminated under sec. 362(c)(2)(C), and the landlord can seek possession without first obtaining relief in the bankruptcy court.

Second, if the lease damages are discharged, there may still be equitable or other remedies under state law for collecting the amount of rent that should have been paid for the tenant's occupation of the premises after the bankruptcy filing. Only pre-petition debts are discharged by bankruptcy under sec. 523. (As pointed out above, all damages for breach of the lease are artificially deemed to accrue just before the bankruptcy is filed under sec. 365(g), but the equitable or other remedies for actual post-petition occupancy may be distinguished from damages for breach of the lease.) This type of relief will depend entirely on state law. Some states may consider the tenant to have been "holding over" after the breach of the lease occasioned by bankruptcy "rejection." Others may may make common law remedies available analogous to "quantum meruit." A landlord with sufficient unpaid post-petition rentals to collect should consult with a lawyer to see what might be possible in the applicable state. It is likely that the recoverable amount, if any, will be governed by what is "reasonable" rent, and it will be recoverable only for the period of occupancy that transpired after the bankruptcy filing. (Any equitable remedies due for pre-bankruptcy occupancy are discharged because they arose pre-petition.)

The situation is difficult for landlords, but not completely free of remedies. On the other hand, tenants and their attorneys in judicial circuits that have not adopted the "no harm, no foul" rule on discharges would be well-advised to include landlords as creditors on the tenant's bankruptcy schedules, so that landlords are precluded from suing later for all the damages under the lease under the claim that there was no discharge due to a lack of notice. While a lack of actual knowledge of the bankruptcy is required for the landlord to prevail, that is not a far-fetched factual situation if no notice from the bankruptcy clerk was given.

Jim Cole

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