The Tenant in the Middle: What Happens When Your Landlord Files Bankruptcy?

Across the country, homeowners are being pushed out of their primary residences by a combination of escrow shock, rising insurance premiums, inflation, and fuel‑driven cost spikes. Unable to sell in a cooling real estate market, homeowners are becoming Accidental Landlords, renting out their homes to keep up with the mortgage.

To survive, households are turning to credit cards and HELOCs not for improvements, but to stay afloat, quietly draining their home equity in the process. But the real danger is hidden: the moment a homeowner moves out, the property loses its homestead exemption in bankruptcy.

What began as a temporary survival strategy can quickly become a legal and financial trap, putting both the home and the tenant at risk if a bankruptcy filing becomes necessary.

By Alexander Hernandez, J.D., Professor, and Author of Consumer Bankruptcy Law (Routledge).

Key Takeaways: The Tenant’s Rights in a Landlord’s Bankruptcy

• The Automatic Stay: The moment a landlord files for bankruptcy, the “Automatic Stay” goes into effect. This prevents the landlord from taking immediate action against a tenant, such as changing the locks or starting an eviction, without court permission.
• The Power of Section 365(h): If the landlord or trustee decides to “reject” your lease, essentially trying to cancel the contract, you have a special right under the Bankruptcy Code to stay in the property for the remainder of your lease term, even if the landlord doesn’t want you there.
• The “Service” Offset: If the landlord stops providing essential services like water, trash, or repairs, because of their financial situation, Section 365(h) typically allows you to pay for those repairs yourself and deduct those costs from your monthly rent.
• Keep Paying Rent: This is the most critical rule. Bankruptcy does not give you a “rent holiday.” You must continue to pay your rent on time.
• Security Deposits are Protected: Legally, your security deposit is your property, not the landlord’s. While you may need a court order to get it back if the landlord spent it, it is not considered part of the landlord’s “bankruptcy estate” for the creditors to take.

The Rise of the Accidental Landlord and Escrow Shock

In a prior article, I discussed the rise of the “Accidental Landlord,” homeowners who move out because they can no longer afford their home, but rent the property out to cover the mortgage, since they were unable to sell it. This has become a common survival tactic in a market where, for the first time in years, we are seeing more homes for sale than buyers.

A primary driver of this trend is “escrow shock.” Rapidly rising property taxes and homeowners’ insurance premiums have forced monthly payments to skyrocket. For example, I recently consulted with a client in Orlando, Florida, whose escrow increased by over $2,000 for the year.

When you combine an escrow increase with persistent inflation and the recent spike in fuel prices driven by the Iran War, household budgets are at a breaking point. Credit card debt is at an all-time high, and there has been an increase in Home Equity Line of Credit (HELOC) applications not to remodel or improve homes, but to pay off debt.

This is a sign of households struggling and looking to buy time, as the debt hasn’t disappeared, just moved, while eating away at a home’s equity. But an unexpected escrow shortage of several hundred dollars a month is often the “last straw” that pushes a homeowner toward a filing.

However, the hidden danger for these accidental landlords is that once they move out, their former primary residence loses its homestead exemption protection in bankruptcy. This puts the property and tenant at risk.

But what happens if you are the tenant and your landlord files for bankruptcy?

If you are a tenant and your landlord files for bankruptcy, you might wake up wondering if there will be a “For Sale” sign in your yard by noon or if the locks will be changed. The good news? You have more rights than you think. The bad news? Your landlord isn’t likely to fix the leaky faucet.

The Automatic Stay: It Works Both Ways

Just as the landlord gets protection from creditors, the Automatic Stay prevents the landlord or the bankruptcy trustee from simply tossing you out. The bankruptcy filing doesn’t dissolve your lease. You still have a right to live there, provided you keep paying rent.

Section 365(h): The Tenant’s Shield

In a Chapter 7 or Chapter 13 case, a “Debtor-Landlord” or their Trustee, has a choice regarding “executory contracts,” which are leases. They can either Assume the lease (keep it) or Reject it. You can read more about assuming or rejecting leases on the bankruptcy petition in this prior article and YouTube video.

If the landlord or trustee decides to reject your lease, often because they want to sell the house, you have two choices under 11 U.S. Code §365(h):

1. Treat the lease as terminated: You can move out and file a claim in the bankruptcy court for damages like moving costs.
2. Stay put: You can choose to remain in the property for the remainder of your lease term. The bankruptcy court cannot kick you out just because the landlord filed.

The Landlord’s Obligations

If the landlord rejects the lease but you choose to stay, the landlord is no longer legally obligated to provide services. This means the landlord could stop paying for:

• Water/Utilities (if included in rent).
• Lawn maintenance
• Pool cleaning
• General repairs

The Workaround: Section 365(h) allows you to offset the cost of these missing services against your rent. If you have to pay $100 to fix a broken pipe that the landlord ignores, you can typically deduct that from your next rent check.

Who Collects the Rent Payment?

The biggest danger for a tenant is paying the wrong person.

• In a Chapter 13, you usually keep paying the landlord since the intent of the landlord is to keep the property.
• In a Chapter 7, if the Bankruptcy Trustee is selling the property, the payments are typically made to the Trustee, who is collecting the rent on behalf of the Bankruptcy Estate.

The Professor’s Conclusion

If your landlord files for bankruptcy, do not panic and do not stop paying rent. If you stop paying, you lose your rights under Section 365 and can be evicted just like any other defaulting tenant.

Make sure to register with PACER.gov to receive notifications on your Landlord’s bankruptcy filing. You can learn how to register with PACER in this prior article and video.

Colleges and universities can purchase my bankruptcy law textbook directly from Routledge Publishing. Paralegals and students who are buying single copies can do so via Amazon Books. To access my YouTube channel, click this link.

You can learn more about filing for bankruptcy and the bankruptcy petition via this link. Information on the bankruptcy court system, contact information for trustees, and your state’s exemptions can be found here. The federal bankruptcy exemptions are listed here. The latest version of the 341 Meeting of the Creditors can be found here.

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Please note that the information on this site does not constitute legal advice and should be considered for informational purposes only.