Tenants and Bankruptcy Code: Knowing the Facts - Atlanta Property Management

Many landlords that own rental houses are not millionaire investors. When a tenant files for bankruptcy, that tenant is now dragging the landlord into financial distress.

Mike Nelson
Mike Nelson

It is estimated that there are around 14 million rental houses in the US.  While there has been a recent circumstance where large hedge fund investors have started buying single family homes as rental investments, experts such as Ivy Zelman have data that shows those large investors own less than 5% of all these houses across the country.  Most of these landlords own only the one rental house.  For many of them, it was their personal residence before they had to move and convert it to a rental rather than losing money on the sale or, worse, losing the house to foreclosure.  Many of these “mom & pop” landlords are being abused by tenants that can’t pay the rent and use bankruptcy protection to extend their time in the property, rent free, for months.  This places a huge financial burden on the home owner who now has to borrow money from somewhere to make their mortgage payment or they have to stop making the mortgage payment altogether.

Prior to the 2005 amendment to the current bankruptcy law, a common scenario was that a landlord would begin the eviction process for non-payment of rent.  After the local judge ruled in favor of the landlord one of the adults would file for bankruptcy protection effectively halting the eviction process.  This required the landlord to pay an attorney to file a motion in bankruptcy court to have the Stay lifted so that the landlord could proceed with the eviction.  This would give the tenant an additional 1 – 3 months in the property without paying any rent.  Once the landlord’s attorney got the Stay lifted the other adult, or spouse, would also file for bankruptcy requiring the landlord to go through the process of lifting the Stay all over again.

The bankruptcy code was amended in 2005 and one of the many purposes of the changes was to keep tenants in residential leases from using the bankruptcy code to prolong the eviction process and gain the tenant several more months within their home for free.  Unfortunately these changes did almost nothing to stop the abuses.  The 2005 amendment to the bankruptcy code in §362(b)(22) states that the automatic stay does not apply to the continuation of an eviction action by a landlord involving residential property in which the debtor resides under a lease and with respect to which the landlord has obtained, before the bankruptcy, a judgment for possession of the property. Accordingly, if the landlord obtains a judgment for possession of the property before the debtor files bankruptcy, the automatic stay will not apply. In these cases, the landlord does not need to file a motion to obtain relief from the automatic stay. Instead, the automatic stay does not apply to the landlord, and the landlord is free to continue pursuing its eviction rights under state law.

Unfortunately this “loophole” only applies a small percentage of the time – when the tenant has appeared in court and the local judge has given the landlord a judgment and possession of the property.  The vast majority of the time the tenant does not appear in local Magistrates Court or they file for bankruptcy prior to the court hearing instead of after the local judge has ruled.

Under the current bankruptcy code, lifting of the Stay regarding a residential lease is automatic.  The bankruptcy court will always let the landlord proceed with regaining possession of the property since a residential lease is a usufruct (right to enjoy without owning) and not an asset.  The primary purpose of the bankruptcy is to deal with the debts of the debtor.  However, under current law, when the tenant files for bankruptcy the owner is delayed for several weeks or months in regaining possession.  From a practical standpoint, regaining possession is the primary concern of the landlord.  If the current tenant can’t pay the rent, the landlord needs to regain possession in order to re-rent the property to someone that can pay the rent.  Otherwise that tenant is now dragging the mom & pop landlord into financial distress also.

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