Bankruptcy & Lease Rejection

By Beverly Bird

Leases form a legal agreement between two parties, both of whom agree to do something under the terms of the contract. The lessor provides property for the lessee's use, and in exchange, the lessee makes periodic payments. In personal bankruptcy, the property is typically real estate or an automobile, and special rules determine what becomes of the contract when you file for Chapter 7 or Chapter 13.

The Automatic Stay

If you're behind with your lease payments at the time you file for bankruptcy, the lessor generally cannot do anything about it, at least for a limited period of time. An automatic stay goes into effect as soon as you file for bankruptcy, preventing creditors – including lessors – from taking any action to collect from you. They can't repossess your leased auto or evict you from a rented dwelling. If your landlord already began a legal action to evict you or repossess before you filed, the stay lasts only 30 days. You have the right to ask the bankruptcy judge to continue the stay beyond this point, but you must deposit with the court the amount of back payments you owe. If you can do so, this gives you a little more time to decide whether you want to reject the lease or assume it.

Making Payments

Another condition of the automatic stay is that you must make timely lease payments going forward, beginning with the date you file your bankruptcy petition. If you don't, the lessor can ask the court to lift the stay so it can take its leased property back. If you know you want to reject the lease and you don't want the property, this may not concern you. If you think you might want to assume the lease, you may continue to make payments so you can keep the property.

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Rejection vs. Assumption

If you file for Chapter 7 bankruptcy, which means the trustee takes control of your non-exempt assets and sells them to raise money for your creditors, you have 60 days after you file to decide whether you want to keep or relinquish the leased property. This assumes you've paid all arrears and you're current with your payments. If you file for Chapter 13 bankruptcy, which involves giving your extra income to the trustee each month to pay to your creditors, you have until the court date when your proposed repayment plan is confirmed. If you don’t make a decision before these deadlines, your lease is automatically rejected. If you decide to assume a lease, your contract with the lessor proceeds just as though you had not filed for bankruptcy protection. You remain responsible for the entire balance due under the lease's terms.

Effect of Rejection

If you reject the lease, the lessor can immediately reclaim the property, either by repossession or eviction. State law takes over at this point, so the lessor must follow the state's rules and procedure. He might be entitled to damages as the result of your stalled lease, particularly if you haven't made payments for a while, but damages – along with all other payments due under the lease's terms – become unsecured debts in your bankruptcy proceedings. They're discharged in Chapter 7 – you're off the hook for paying them. If you filed for Chapter 13, the lessor may or may not receive all of what you owe under the terms of your repayment plan. If he doesn't, the balance is discharged as an unsecured debt.

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