How Leases and Executory Contracts Are Handled in Chapter 11
For a business in Chapter 11 bankruptcy, leases and executory contracts can represent valuable assets or burdensome obligations. An executory contract is one where both parties have unperformed obligations. Leases, where rent payments remain outstanding and the landlord has obligations to maintain the property, fall under this category. Here are some key points a Chapter 11 debtor should keep in mind.
The Bankruptcy Code affords a debtor company in Chapter 11 the ability to choose between assuming or rejecting leases or executory contracts. Assumption allows the business to continue fulfilling its obligations under the agreement. Rejection, on the other hand, terminates the agreement, potentially freeing up resources but also risking the loss of valuable property or services.
Assuming a valuable lease or contract can offer several benefits. It allows the business to retain essential property or services needed for its ongoing operations. It also demonstrates the debtor’s commitment to upholding its obligations, potentially fostering trust with creditors and partners. However, assuming a burdensome agreement can hinder the reorganization process. Careful analysis of the lease’s or contract’s long-term financial impact is essential.
To assume a lease or contract, the debtor must first cure any existing defaults. This could involve catching up on missed lease payments or addressing breaches of contract and providing compensation for the other party’s losses. Additionally, the debtor needs to provide “adequate assurance” of fulfilling future obligations. This assurance can take various forms, like demonstrating sufficient financial resources or a solid business plan.
Since landlords and other contracting parties have a stake in the outcome, negotiations often are necessary. The debtor might propose modified lease terms, like extending the lease period or securing a rent reduction. The other party might counter with other proposals and/or seek further assurances.
Even after reaching an agreement with the other party, the assumption process requires court approval. The court will scrutinize the debtor’s ability to perform under the agreement and ensure the assumption benefits the overall reorganization plan.
While Chapter 11 offers flexibility in assumption decisions, there are deadlines to observe. Chapter 11 allows for assumption any time before the court confirms the reorganization plan. However, for non-residential leases, a stricter deadline applies. The debtor must assume or reject them within 210 days of filing the Chapter 11 petition, or risk automatic rejection.
The complexities of assuming or rejecting leases and contracts necessitate seeking professional guidance. A Chapter 11 bankruptcy attorney with experience handling these transactions can provide invaluable support by weighing the relative advantages and drawbacks, 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, contact us online or call 310-271-6223 to schedule a consultation.
