Real estate: Substitution and bankruptcy

In the event of bankruptcy of a lessee, lessors are permitted accelerated termination of the lease agreement with the bankrupt party and to look for a different lessor. Will a lessor be confronted with substitution after termination of the lease and thus with an unwanted replacement lessee?

The lessor will have priority in the lessee’s bankruptcy, the rent qualifies as bankrupt’s debts. However, the lessor does not benefit from this if there are no assets. In order not to be stuck with a lessee that cannot pay the rent, the lessor is permitted to terminate the lease agreement with a maximum notice period of three months instead of the usual notice period of at least one year. Especially at A-locations this could be an attractive opportunity for the lessor to get rid of the insolvent lessee quickly and to enter into a lucrative lease agreement with a new lessee. However, the lessor must bear in mind that he cannot control the outcome by himself.

Substitution

After a bankruptcy – but also before, as part of what is referred to as a “pre-pack” (a restart initiated before the bankruptcy) – the liquidator will usually try to find a party that will take over and continue the company. If this is successful, as has recently been the case in the takeover of Perry Sport and Aktiesport by JD Sports, the liquidator is permitted to make use of the substitution scheme.

In the event of substitution, the lessee of shop premises or a catering establishment sells his company or the entire chain to a third party, including ongoing lease agreement(s). The third party will then continue the company in the rented object. If the lessor does not want to cooperate, the lessee can apply for a court order to authorize substitution by the buyer.

Concurrence of substitution and termination pursuant to bankruptcy

In principle, the lease will end after the termination pursuant to bankruptcy and the lessor will be rid of the insolvent lessee. However, the court can order that the liquidator and the estate have such a substantial interest in the sale including substitution, that the lessor is not permitted to exercise his authority to terminate the agreement and has to accept substitution, even if the application is brought out only during the notice period or in the eviction proceedings.

Conclusion

A lessor whose lessee goes bankrupt will terminate the lease if no more rental income can be expected. As soon as the liquidator has found a creditworthy successor, this argument will no longer hold automatically and the court may decide to give priority to substitution.

Action

• As a lessor, be careful to make commitments to new lessees as long as a (partial) restart of the bankrupt retail chain is still possible.
• As a buyer make concrete agreements as quickly as possible after the bankruptcy, otherwise the lessor can claim eviction of the rented object and substitution will become difficult.
• Make sure to carefully check as a lessor or a potential buyer your legal status after bankruptcy. By that, the appropriate decision can be taken in time, which may result in a considerable (financial) advantage.

More information

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