Bankruptcy
What Happens Next?
By Michael E. Hickey
Typically, bankruptcy issues arise the day of or shortly before a lien sale, causing a fervor of questions:
- What happens to the money owed to the storage facility?
- How does the bankruptcy affect the self-storage lien?
- How long can the tenant continue to use the storage unit and not pay?
- What do I do next?
Make no mistake, bankruptcy issues are complicated "land mines" for the unsuspecting and ill-advised storage facility owner or manager.
The recurring situation involves a non-paying tenant who arrives at or telephones the facility prior to a lien sale and states (in an unfriendly manner): "I have filed bankruptcy, and your sale is stayed, and there's nothing you can do about it." Unfortunately, the tenant does speak a partial truth here: The sale is stayed and cannot go forward. However, you can help alleviate the potential for rent losses caused by bankruptcies.
The Chapters
It's first important to point out that bankruptcy law is federal law, which is generally uniform throughout the United States. This is in sharp contrast to self-storage statutes, which vary from state to state. In addition, you should know that there are several types of bankruptcy or, as federal law categorizes them, "Chapters of Bankruptcy," which the storage facility owner or manager will encounter.
The most common form of bankruptcy is known as Chapter 7 bankruptcy. In this proceeding, a debtor seeks to "discharge" (get rid of) all their pre-bankruptcy debts. In a Chapter 7 case, a bankruptcy trustee is appointed to collect and liquidate (sell) the debtor's non-exempt assets. In theory, as part of a Chapter 7, debtor's assets are liquidated and the proceeds distributed among the debtor's creditors. Unfortunately, 99 percent of all Chapter 7 cases have no non-exempt assets to liquidate and, therefore, collecting back rent owed to a self-storage facility from the trustee is next to impossible.
Another type of bankruptcy is a Chapter 11 "Reorganization Plan," which can be filed by an individual or corporation. In this proceeding, a trustee is generally not appointed and the debtor continues to operate his business. A Chapter 12 ("Family Farmer") and Chapter 13 ("Wage Earner Proceedings") usually allow a debtor three to five years to repay all or a portion of his debts.
All chapters are designed to protect a legitimate debtor and have many useful purposes. Occasionally a debtor files a Chapter 11, 12 or 13 proceeding, not to reorganize his debts and finances, but instead to stall creditors. This type of debtor has no intention or ability to reorganize and these cases are commonly dismissed or changed by the court to Chapter 7 within one year of filing. That's why some creditors refer to cases under these chapters as "Chapter 7s waiting to happen."
Sticking to a Stay
Regardless of the chapter, the filing of any bankruptcy creates a stay that automatically prohibits any person or company who is a creditor from collecting debts owed to them by the debtor and further prohibits a creditor from proceeding against the property of the debtor. Although the code does not define "stay," it clearly includes "stopping a lien sale" or acts to perfect a lien, including the mailing of pre-lien letter or notices of lien sales. One judge has defined the scope of the "stay" to prohibit any act which would "put a smile" on a creditor's face.
The most important things to remember about the stay are that it exists regardless of whether the facility has knowledge of the filing of the bankruptcy and the intentional violation of the stay is a contempt of court. Violations of the stay are a basis for sanctions against storage facility owners and their managers and attorneys. The amount of the sanction includes all damages caused by the violation plus out-of-pocket costs, including recovery of the debtor's attorney's fees and associated costs. Plus, in egregious intentional cases, this could include six-figure punitive damages awards that certainly pale any amount sought to be recovered from a lien sale.
When a bankruptcy is filed, a tenant's "post-petition rent" (rent which becomes due after filing the bankruptcy) should be monitored to assure the debtor does not continue to default after filing. This is important because bankruptcy courts will generally not allow a tenant to hide behind the stay and occupy a space without paying rent. In the event a tenant ignores his obligation to pay rent after filing, the owner should file a motion in the bankruptcy court for permission to go forward with lien sale in accordance with state laws. Always remember: Until the stay is formally modified by the bankruptcy court, a creditor cannot proceed against the debtor in any manner.
Upon completion of a bankruptcy, a final discharge is entered extinguishing the tenant's obligation to pay for pre-filing rental defaults; however, the entry of a discharge does not, by itself, effect a self-storage lien that was validly perfected prior to the bankruptcy filing. The existence of a valid pre-petition self-storage lien is crucial to collecting all or at lease some of the delinquent rent. The amount of delinquent rent that may be collected after entry of a discharge is limited to the amount collected from completion of a lien sale. Any rent owed after completion of the lien sale and crediting the tenant's account is discharged and cannot be collected.
Occasionally, a facility may be contacted by a Chapter 7 trustee appointed in the bankruptcy proceeding to liquidate the tenant's (debtor's) assets. After filing, the trustee is in possession (constructive) of all of debtor's assets including those stored at the facility. Trustees are often unaware of the contents or value of the contents stored in the facility. Therefore, the trustee has the right to inspect the property to aid them in their decision to sell or abandon the contents. Lastly, unless the facility receives written permission from the trustee or the trustee abandons the stored contents, the facility should not release the property to the tenant--even if the rent is current.
Regardless of contact by a trustee and promises that all rent will be paid, post-petition rent should not be allowed to increase. Remember, as delinquent rent continues to increase, the facility's ability to collect "rent due" diminishes. Continued default by the debtor or trustee gives an owner a basis to hire an attorney to prepare and file a formal motion with the bankruptcy court for relief from stay, allowing the owner to complete a lien sale. Under some circumstances, the court may order payment of rent by the debtor or trustee as a condition of allowing the property to remain in the facility.
Receipt of a notice entry of discharge or order for relief from automatic stay removes the stay. Assuming a valid self-storage lien existed prior to the filing, the owner may proceed with the lien sale in accordance with state law. Prior to conducting a lien sale, advice from an experienced attorney who has specialized knowledge of both lien and federal bankruptcy laws should be considered.
In Summary
Immediately after receiving notice of a bankruptcy, ask the tenant for the case number, filing date, chapter and the court in which the case is filed. It is also convenient to obtain a copy of the petition from the debtor. If rent is not paid, consider a formal federal court motion for relief of stay. Remember, after the debtor files the bankruptcy, all lien activities are stayed until after entry of a notice of discharge by the court or until the owner has received an order for relief of stay allowing the self-storage owner to proceed.
As a final thought, the best way to protect the storage facility from loss of rent is to immediately and properly perfect a self-storage lien. In the event a bankruptcy is filed and the tenant continues to default in post-petition rent, then the self-storage owner should in file a formal motion with the court for permission to proceed with a sale before the amount of rent increases significantly.
Michael E. Hickey is an attorney and partner in the law firm of Corrons-Hickey & Hickey. He is a member of the California State Bar representing clients in self-storage evictions, unlawful detainers, construction lawsuits and debtor and creditor rights in bankruptcy. Mr. Hickey may be reached at Corrons-Hickey & Hickey, 930 W. 17th St., Suite A, Santa Ana, CA 92706; (714) 550-9211; fax (714) 550-9819.