What to do if your tenant enters into a business reorganization process?

Law 1116 enacted on December 27, 2006, sets forth the corporate insolvency regime applicable to both individuals and legal entities conducting ongoing business activities within  the national territory, unless they are specifically exempted. This law applies to both private and mixed companies.

The primary goal of this law is to revitalize companies, with a secondary aim of facilitating the orderly liquidation of their assets. Thus, when a company enters insolvency, it doesn’t necessarily mean liquidation; the law’s main objective is to preserve viable companies and normalize their commercial and credit relationships through an agreement that allows for the operational and administrative restructuring of their assets and liabilities.

However, this regime only applies if the admissibility conditions stipulated in Article 9 of this Law are met. These conditions include imminent inability to pay, which refers to situations where the debtor demonstrates circumstances in the relevant market or within their organization that significantly affect or could reasonably affect the normal fulfillment of their obligations within a term of one year or less.

The Law also establishes the scenario of cessation of payments. This occurs when the debtor defaults on two or more obligations to two or more creditors for more than 90 days, or when at least two enforcement actions have been filed by two or more creditors for payment of their obligations.

In this context, this article aims to answer the following question: What are the implications for a diligent landlord if the tenant is undergoing a business reorganization process?

Firstly, one of the effects of filing a petition for admission to the reorganization process is that the debtor’s administrators are prohibited from selling assets or conducting transactions outside the ordinary course of the debtor’s business.

Secondly, Article 21 of Law 1116 stipulates that initiating a reorganization process prevents the unilateral termination of any contract to which the debtor is a party. Therefore, as a general rule, the compliant party in a lease agreement cannot terminate the contract simply because the other party is undergoing a business reorganization process, thereby allowing the tenant-debtor’s business to continue operating.

However, every general rule has its exceptions. The second paragraph of Article 21 of the Insolvency Law provides that, despite being in a business reorganization process, it is possible to terminate ongoing contracts when: (i) there are contractual breaches that occur after the commencement of the reorganization process or that involve obligations unrelated to its purpose; or (ii) in long-term contracts, it is not possible to renegotiate their terms by mutual agreement, in which case authorization must be requested from the bankruptcy judge.

In this regard, the Constitutional Court has examined the second paragraph of Article 21, concluding that this provision does not prevent the termination of the debtor’s contracts for reasons other than the initiation of the reorganization process, such as serious breaches of contractual obligations.

Regarding the first situation and applying it to lease agreements, it can be concluded that if a tenant undergoing a reorganization process fails to fulfill any of their obligations under the lease (including non-payment of rent accrued after the commencement of the reorganization), the landlord has the right to terminate the contract, unless the breach involves non-payment of rent that was accrued before the reorganization process began.

Regarding the second scenario, the Superintendency of Companies  has clearly established that, while the debtor is undergoing a reorganization process, the contracting creditor cannot terminate any contract to which the debtor is a party by citing the initiation of the reorganization process. However, ongoing contracts—including lease agreements—may be renegotiated by the parties through mutual agreement, or authorization may be requested from the bankruptcy judge for their termination.

Lastly, in the third scenario, in the case  case of successive performance contracts where the obligations of the debtor become excessive, the debtor may seek a renegotiation of the contract terms by mutual agreement. If this is not possible, the debtor may request judicial authorization to terminate the contract, in compliance with all the conditions set forth in Article 21 of the Insolvency Law.

In light of the above, here are some recommendations to consider if the tenant in a lease agreement is undergoing a business reorganization process:

1.The breach of obligations under the lease agreement that occurred before the commencement of the reorganization process does not entitle the complying party to terminate the contract. However, it is advisable to seek a renegotiation of the contract terms by mutual agreement with the defaulting party to keep the contract in force under conditions favorable to both parties.

2.If, after renegotiating the terms of the lease agreement, the breach by the party undergoing the reorganization process persists (with breaches occurring after the commencement of the process), the complying party may enforce the contractual consequences, including, but not limited to, the termination of the contract.