Assuming or Rejecting Leases and Executory Contracts in Chapter 11
A company in Chapter 11 needs flexibility to manage its obligations, including leases and executory contracts, in order to control costs, improve cash flow and enhance its prospects of emerging solvent after debt reorganization. As such, the U.S. Bankruptcy Code allows a debtor in possession to assume, reject or assign executory contracts and unexpired leases subject to court scrutiny.
Courts apply the business judgment rule to debtors’ decisions regarding the assumption, rejection, or renegotiation of contracts under Bankruptcy Code Section 365. The rule calls for deference to the debtor’s management decisions provided they are made in good faith and within the scope of authority, they are reasonably justified and they promote support the overall restructuring plan.
Courts look at several factors in reviewing decisions about executory contracts and unexpired leases meet the business judgment rule. One consideration is whether the decision to assume or reject a contract is likely to maximize the return to creditors or minimize their losses. This involves evaluating whether the continuation or termination of a contract would better serve the creditors’ interests, potentially leading to higher recoveries on their claims against the bankruptcy estate.
Courts also consider whether the debtor’s decision regarding a contract facilitates the broader goal of successful reorganization and whether it contributes to the viability of the debtor’s post-bankruptcy operations. This includes examining how essential the contract is to the debtor’s business operations and whether renegotiating its terms could lead to more favorable conditions that enhance the business’s ability to recover and maintain sustainable operations.
Additionally, courts consider the nature and extent of outstanding contractual obligations. To assume a lease or contract, the debtor must cure any existing defaults by catching up on missed lease payments or curing pre-existing breaches of contract and providing compensation for the other party’s losses. The debtor also must provide adequate assurance of fulfilling future obligations, such as by demonstrating sufficient financial resources or a solid business plan.
Section 365 sets different rules depending on whether a lease or a contract is involved. For executory contracts, under which both parties have ongoing performance obligations that neither has fully performed, Section 365 allows the debtor to assume or reject such contracts subject to court approval.
For unexpired leases of nonresidential real property, a decision must be made within 120 days, or within a granted 90-day extension. If the debtor does not make a timely decision, the lease is deemed rejected, and the property must be surrendered to the lessor. This provision aims to protect commercial landlords from prolonged uncertainty regarding the status of their properties and potential income losses.
A Chapter 11 bankruptcy attorney with experience handling leases and executory contracts can provide invaluable support by assisting in decision-making, devising workable solutions and representing the debtor effectively throughout the process.
The Law Offices of Michael Jay Berger in Beverly Hills is one of Southern California’s most experienced Chapter 11 bankruptcy law firms, with 12 locations across the region. If your company is struggling with debt, call as at 310-271-6223 or contact us online to schedule a consultation.
