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What happens to a business if its landlord goes bankrupt?

With all the ups and downs in the real estate market in the last few years, it’s worth thinking about what would happen to a commercial tenant if the landlord were to go bankrupt, or be unable to pay its lenders.

In general (and there are always exceptions), lenders have priority over tenants. So if a lender forecloses on a commercial property, the lender can invalidate the lease and evict the tenant – even if the tenant has faithfully paid the rent and done nothing wrong.

On the other hand, most commercial leases require a tenant to agree that if a foreclosing lender wants to reaffirm the lease instead, and substitute itself as the new landlord, it can do that, too.

This means that most of the time, the lender is in the driver’s seat. If it wants to keep the tenant, it can do so, and if it wants to get rid of the tenant, it can do so. The tenant has no say in the matter.

In actual practice, a foreclosing lender will generally want to keep the tenant, because the tenant is providing steady income. And most of the time a tenant will want to stay put.

However, there are exceptions. If the tenant has a long-term lease at a rent that is now below market value, or if the value of the property has risen and the lender thinks it can sell it at a profit, the lender might be happy to evict the tenant.

So how can a tenant protect itself? In some cases, if the tenant has enough leverage and the issue is important enough to it, it might be able to negotiate a deal now with the landlord and the lender as to what will happen if there’s a future foreclosure.

Restaurants are a good candidate for this type of agreement. That’s because most restaurants have long-term leases (often with options to extend them for even longer), they typically invest a lot of money in kitchen set-up and other non-transferable build-outs, and they’re very dependent on location, such that being forced to move could be disastrous. They have every incentive to make sure a lease will stay in place even if their landlord goes under.

Of course, other businesses could also want to negotiate similar assurances.

The best time to negotiate such a deal is before the tenant signs (or renews) a lease, because once a lease is in place, the lender will have little or no incentive to limit its options.

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