When a commercial tenant files Chapter 11 bankruptcy, the federal Bankruptcy Code governs whether the lease will be assumed, assigned, or rejected. Understanding Section 365 timelines, the automatic stay, Section 502(b)(6) statutory rent claim caps, and lender DSCR covenant impacts is essential for commercial underwriters and asset managers.
Key Financing Parameters & Standards
Institutional Market Reference
Governing LawTitle 11, United States Bankruptcy Code (11 U.S.C. §§ 362, 365, 502)
Initial Assumption/Rejection Window120 days from bankruptcy filing (extendable once up to 90 days)
Post-Petition Rent ObligationDebtor must pay timely rent under Section 365(d)(3)
Cure Standard for AssumptionDebtor must cure all monetary defaults and provide adequate assurance
Statutory Claim Cap (Section 502(b)(6))Greater of 1 year rent or 15% of remaining lease term (capped at 3 years)
Lender Credit TreatmentBankrupt tenant excluded from underwritten NOI unless lease is formally assumed
* Bankruptcy court procedures, lease assignment rights, and claim recoveries depend on bankruptcy court jurisdiction and debtor estate solvency.
The Impact of the Automatic Stay on Commercial Leases
The instant a commercial tenant files a bankruptcy petition under Chapter 7 or Chapter 11, the Automatic Stay of 11 U.S.C. Section 362 immediately takes effect. The stay halts all pending eviction actions, rent collection lawsuits, lockouts, and draws on cash security deposits without prior bankruptcy court relief.
However, under Bankruptcy Code Section 365(d)(3), the debtor-in-possession or trustee is legally obligated to timely perform all post-petition lease obligations—meaning regular monthly rent must continue to be paid while the tenant decides whether to keep the lease.
Section 365 Mechanics: Assumption vs. Rejection of the Lease
Under Section 365(d)(4), the debtor has an initial 120-day window to evaluate unexpired non-residential commercial leases.
Lease Assumption and Assignment
Assumption: To assume the lease, the debtor must cure all pre-petition monetary arrears, compensate the landlord for pecuniary losses, and provide "adequate assurance of future performance."
Assignment: Debtors can assume and assign leases to third-party purchasers even over landlord objections, provided the new assignee demonstrates comparable financial capability.
Shopping Center Protections: Section 365(b)(3) provides specialized protections for shopping centers, preserving tenant mixes, radius restrictions, and co-tenancy covenants.
Lease Rejection and Damages Caps
If the debtor rejects the lease, it is deemed a pre-petition breach. The tenant must immediately vacate. The landlord claim for future unpaid rent is subject to the statutory ceiling of Section 502(b)(6): capped at the greater of one year rent or 15% of the remaining lease term (not to exceed three years).
Lender Underwriting Protections During Tenant Insolvency
Mortgage underwriters adjust property cash flows during active tenant bankruptcies. Underwritten net operating income immediately excludes revenue from the bankrupt tenant, and debt sizing is stress-tested against the revised DSCR. If debt service coverage drops below covenant minimums, lenders evaluate letters of credit or corporate parent guaranties to bridge shortfalls.
Frequently Answered Questions
Common Questions About Commercial Tenant Bankruptcy: Section 365 Assumption & Rejection
Direct, transparent answers regarding underwriting standards, documentation, and process.
Underwriting Credit Risk
What is Section 365 in commercial tenant bankruptcy?
Direct Answer
Section 365 of the U.S. Bankruptcy Code governs unexpired commercial real estate leases. It grants the bankrupt tenant the power to assume (retain), assume and assign to a third party, or reject (terminate) the lease within statutory deadlines.
Section 365 of the U.S. Bankruptcy Code governs unexpired commercial real estate leases. It grants the bankrupt tenant the power to assume (retain), assume and assign to a third party, or reject (terminate) the lease within statutory deadlines.
Underwriting Credit Risk
How long does a bankrupt tenant have to decide on a commercial lease?
Direct Answer
Under Section 365(d)(4), a debtor has an initial 120 days from filing to assume or reject a nonresidential commercial lease. The bankruptcy court may extend this window once for up to 90 days for cause. Further extensions require written landlord consent.
Under Section 365(d)(4), a debtor has an initial 120 days from filing to assume or reject a nonresidential commercial lease. The bankruptcy court may extend this window once for up to 90 days for cause. Further extensions require written landlord consent.
Underwriting Credit Risk
How are commercial landlord claims capped in tenant bankruptcy?
Direct Answer
Under Bankruptcy Code Section 502(b)(6), a landlord claim for lease rejection damages is capped at the greater of one year rent or 15% of the remaining lease term, with a maximum cap of three years rent, plus any unpaid pre-petition rent.
Under Bankruptcy Code Section 502(b)(6), a landlord claim for lease rejection damages is capped at the greater of one year rent or 15% of the remaining lease term, with a maximum cap of three years rent, plus any unpaid pre-petition rent.
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