What to Know About Assuming a Lease or Executory Contract During Chapter 11
Existing leases or executory contracts present special issues when one of the parties files for Chapter 11 bankruptcy. Other parties to the lease or contract may wish to end it, fearing the debtor may not be able to fulfill the terms. Some leases and contracts include a clause that automatically terminates the agreement upon a bankruptcy filing. However, these objections and clauses are ineffective, since the debtor in bankruptcy has the right to assume or reject the lease or contract, subject to satisfying certain conditions.
Outstanding leases and contracts are governed by Section 365 of the U.S. bankruptcy code. In a Chapter 7 case, the trustee must assume or reject the lease or contract within 60 days of the petition filing date, or else the agreement is deemed rejected. By contrast, in a Chapter 11 case, the debtor can assume or reject the agreement at any time prior to the court’s confirmation of the debtor’s plan. There is no presumption of rejection if the debtor fails to act. However, the other party to the agreement can file a motion to compel assumption or rejection of the agreement, which can result in the court setting a deadline.
In order to assume a lease or executory contract, the Chapter 11 debtor must cure or provide adequate assurance of curing all defaults under the agreement, together with payment of compensation for monetary losses caused by any default. The debtor must also provide adequate assurances that it will fulfill its future obligations. Creditors wanting to end a lease or contract have an opportunity to challenge the adequacy of the debtor’s assurances.
If the debtor wishes to cancel a lease or executory contract, it files a notice of intent to reject. The other party to the lease or contract becomes a creditor and files a proof of claim, also known as a statement of damages. This includes computation of all future losses projected to be incurred as a result of the lease or contract being canceled. Alternatively, the creditor can file a pre-petition proof of claim for losses the creditor incurred because of a default that occurred prior to the bankruptcy filing.
Whether it is best to assume or reject an unexpired lease or executory contract depends on the overall Chapter 11 strategy. Debtors generally want to continue agreements essential to continued business operations. But assumption becomes problematic when the other party objects on the ground of the debtor’s alleged inability to meet its financial obligation. These impasses are often settled through negotiations with the aid of a qualified Chapter 11 attorney.
The Law Offices of Michael Jay Berger in Beverly Hills is one of Southern California’s most experienced 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.