Tenants in financial difficulties: our views and practical tips for landlords 

It has been a year since the COVID-19 pandemic became part of our lives, affecting not only individuals but also businesses, especially those in the retail and services sectors. These businesses are very restricted (if operating at all), but their obligations under agreements, in particular lease agreements, continue despite the current restrictions preventing them from operating in the leased premises. To overcome these difficulties, tenants use any available government subsidy programs and stimuli, and also ask landlords to reduce their rent, rent free periods or to defer payments.

Warning signs

Continuously outstanding overdue invoices might be a warning that a tenant’s insolvency is inevitable. Tenants do not usually wait for creditors to enforce their claims through the courts, but very often initiate insolvency proceedings themselves. Once there are enough signs that the tenant’s insolvency is imminent, landlords should not wait long. If no turning point in restructuring the tenant is expected, the relationship with the tenant should be terminated. This is because once the tenant is officially declared bankrupt, the landlord’s options are much more limited.

The sooner the lease is terminated, the better

The most common reason for the landlord to terminate a lease is the tenant’s failure to pay the rent or any other obligation under the lease when due. To terminate a lease, the lease agreement usually requires the landlord to give a default notice to the tenant and provide them with a period to redress the default. Only after the ineffective expiry of such period can the landlord terminate the lease. In our experience, landlords sometimes hesitate to serve a default notice for some time or simply forget to do so. And when the tenant becomes officially insolvent, they lose the flexibility in handling the lease termination.

Landlords should also pay attention to the formal requirements on a default or termination notice stipulated in the lease agreement and closely follow them. Otherwise, the landlord may not be able to terminate the lease before all of the protective measures of insolvency law step in. Alternatively, tenant or insolvency trustee might object to the termination, which at a later stage of the insolvency might cause trouble if the premises have been rented to another tenant.

The declaration of bankruptcy materially limits the landlord’s rights

Until the moment the tenant is declared bankrupt, the landlord can terminate the lease for whatever contractual or statutory reason (as the case may be), such as default in the payment of the rent or filing for insolvency. Landlords should be aware that the declaration of the tenant’s bankruptcy could follow very soon after filing for insolvency. It is no exception that it occurs within one or two days, especially if the tenant’s filing is accompanied by all necessary documents and information from which bankruptcy is certain.

What are the drawbacks to proceeding only after the tenant has been declared bankrupt?

On the declaration of bankruptcy, the lease becomes protected by Czech insolvency law. As a result, the landlord cannot terminate or withdraw from the lease due to a default which occurred before the declaration of bankruptcy or due to a deterioration in the tenant’s financial situation, including the very fact of the tenant’s insolvency. This does not prevent the landlord from terminating the lease due to a new payment default occurring after the declaration of bankruptcy. However, it creates another unnecessary time gap in which the landlord is limited in leasing the premises to another solvent tenant and thus recovering the rent or potential leakage in operating costs from the insolvent tenant. Should such situation occur, it is advisable to agree with the tenant, or the insolvency trustee, on the termination of the lease agreement on mutual agreement. A reasonable tenant should be willing to terminate the lease to prevent a further increase in the debt and claims being raised.

On the tenant’s declaration of bankruptcy, limitations may also apply to the landlord’s right to use the deposit under the lease, and therefore we recommend using the deposit as soon as the landlord is allowed to do so, in any case before the declaration of bankruptcy, if possible. This is because the use of the deposit can be considered as a set-off of receivables, which has a number of limitations. The good news is that the calling of a bank or parent guarantee (when available) is not affected by the tenant’s bankruptcy and can be used as an instrument to recover the landlord’s receivables, at least partially, even after the declaration of bankruptcy.

The law provides tenants with other protection against their creditors: a moratorium. Tenants can ask the court to declare a moratorium before the commencement of insolvency proceedings. Some of the effects of a moratorium are similar to those related to the declaration of bankruptcy, such as offset restrictions affecting a right to use a deposit or limitation in lease termination.

To sum up, we recommend that landlords take any steps which are available to them at the time, in particular:

• serving a default notice immediately after a default occurs;
• paying attention to formal requirements in notices;
• using a deposit when the lease allows so; and
• delivering a termination notice once insolvency is known to be imminent.

Finally, it is worth monitoring the tenant’s situation in the Insolvency Register. All of these actions provide the landlord with more flexibility in coping with the tenant’s insolvency.