A Chapter 11 debtor is usually is ensnared in one (or more) unmanageable contract or lease that will need to be either redrawn or rejected if the debtor is to get things back to a profitable situation.  Leases for use of equipment or services are common, as well as all types of contractual obligations, employment contracts, collective bargaining agreements, and franchise agreements.  Of course, there are also all types of real estate leases.  As part of a comprehensive plan of reorganization, a debtor can and should consider renegotiating or rejecting such leases as the situation may dictate.

With the exception of leases on nonresidential real property, a debtor in possession is permitted to wait until plan confirmation to assume or reject a lease, but may do it sooner if this is desired.  If an executory contract or unexpired lease is neither accepted nor rejected, it continues in effect and passes with the other property of the debtor to the reorganized debtor.  One of the first steps that must be done is to determine whether the lease or contract in question truly is “executory”, as the Bankruptcy Code does not define this term.

Also important to note is that if there has been any prepetition or postpetition default of a contract or lease, the contract or lease can be assumed as long as (1) the debtor provides adequate assurance that the default will be cured, or (2) compensates the other contractual party for any loss resulting from the default, or (3) provides assurance that such will be forthcoming, or provides adequate assurance of future performance of the lease or contract.  In many situations, the use of the lessor’s property will be necessary to continue the business.

Common examples occur where the business is conducted in the leased premises or with the use of leased equipment.  The expectation is that rent will be paid for the use of the premises.  But the amount of rent for which the debtor will be liable, and the likelihood of that amount being collected, depend on the circumstances.  If the lease is for nonresidential real property, from the time the case is filed the debtor has a statutory obligation to make payments.  Thus deciding whether or not to assume the lease is an important matter.

Some landlord creditors may do the following after entering into a case: (1) view or inspect the premises; (2) demand that the debtor commence the payment of post-petition rent under the Section 365(d)(3) obligation to pay rent or as an expense of administration; (3) file a motion with the court requesting that the debtor begin making rent payments; (4) make suggestions for substituting the property if the debtor is not making economic use of the property; or even (5) ask that the debtor surrender the property if it is not being put to economic use.  Some landlords seem only to rely on their rights to receive administrative rents.

A landlord whose property is being used by the debtor is also likely to request adequate protection payments to protect its interest in the property, pending a decision by the debtor to assume or reject the lease.  Adequate protection payments might be measure by the rent reserved in the lease, by the reasonable rental value of the property, or by the decrease (if any) in the value of the property during the case.  Allowance might also be made for factors such as the possibility of vacancy, the extent and purpose of the debtor’s use, the benefits to the lessor from the debtor’s occupancy of the property, and possible damage to the property from the debtor’s continued possession.

In practice, the handling of leases and contracts in a Chapter 11 case (whether business or personal) can be a complicated matter.  Courts are generally understanding that most debtors enter into a Chapter 11 filing when they are already behind on their lease or contractual payments.  The question of “adequate assurance” is a flexible and fluid one, and will depend on the situation of each debtor.  This is an area where the pre-filing planning with the bankruptcy attorney will need to be thorough, so that potential pitfalls from uncured defaults can be avoided.

If you have questions about a possible Chapter 11 filing, please contact our offices so that we may review the relevant lease or executory contract issues that may affect your case.

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