Assumption or Assignment of Executory Contracts and Unexpired Leases in Chapter 11

An important aspect of Chapter 11 bankruptcy for debtors and creditors is the treatment of executory contracts and unexpired leases. Chapter 11 gives the debtor in possession, or in some cases the bankruptcy trustee, significant power to decide the fate of such agreements, in which both parties still have unfulfilled obligations. The debtor might assume contracts that it wants to keep or to assign to a third party, while rejecting those it finds unprofitable.

Executory contracts are those in which both parties still have significant remaining performance obligations. Examples are supply contracts, purchase agreements, employment contracts and service contracts. Unexpired leases are those in which the tenant and has remaining occupancy rights and lease payments. The reason for assuming such contracts is to retain valuable relationships or assets, including leaseholds, that may be vital to the business’s emergence from Chapter 11.

U.S. Bankruptcy Code § 365 states that a debtor, subject to court approval, may assume or reject any executory contract or unexpired lease. Court deciding on requests for approval generally apply a business judgment standard, meaning the debtor must show a valid business justification for assuming the agreement.

There are certain conditions for approval of assumption. The trustee or debtor must:

• Cure defaults by paying any amounts outstanding under the agreement and performing any remaining nonmonetary obligations. Alternatively, the debtor must provide “adequate assurance” that the defaults will be promptly cured.
• Compensate or provide adequate assurance of prompt compensation for pecuniary loss from the default.
• Provide adequate assurance of future performance of the contract or lease.

Note that an executory contract or lease must be assumed in its entirety or not at all.

If assumption is approved, the debtor or trustee has the ability to assign the executory contract or unexpired lease as long as the proposed assignee provides adequate assurance of future performance of the debtor’s obligations. The assignment of assets can be a lucrative source of income for the debtor.

There may be situations where the debtor or trustee decides to terminate a contract or lease that is found to be unprofitable or burdensome. This decision must be weighed against the potential negative effects. A rejection might breach the contract, leading to a potential claim by the other party. The debtor may be better off negotiating with the other party to reach agreeable modified terms.

In a Chapter 11 case, most agreements can be assumed or rejected at any time prior to confirmation of a plan. An agreement is not deemed rejected if the debtor fails to assume or reject within this time. An exception is nonresidential leases, which must be assumed or rejected within 210 days of the date of the Chapter 11 petition or any granted extensions. Otherwise, the lease is considered rejected.

The Law Offices of Michael Jay Berger in Beverly Hills represents businesses and individuals in Chapter 11 cases throughout California. Call us at 310-271-6223 or contact me online to schedule a free initial consultation.