TREATMENT OF EXECUTORY CONTRACTS AND
UNEXPIRED LEASES IN BANKRUPTCY
A.
GENERALLY
Section 365 (unless otherwise noted, all statutory references are to the United
States Bankruptcy Code, Title 11 U.S.C.) contains the Bankruptcy Code’s principal
provisions governing the treatment of executory contracts and unexpired leases. It
authorizes a debtor, subject to the approval of the bankruptcy court, to assume or reject
executory contracts and unexpired leases. This power is grounded in the principle that
debtors should have the ability to abandon burdensome property and retain beneficial
property. Although the term "executory contract" is not defined in the Bankruptcy Code,
it has meant “on which performance is due to some extent on both sides”. Mason v. FBI
Distribution Corp. (In re FBI Distribution Corp.), 330 F. 3d 36, 40 (1st Cir. 2003). Most
courts have adopted the definition proposed by Professor Countryman:
[a] contract under which the obligation of both the bankrupt and
the other party to the contract are so far unperformed that the
failure of either to complete performance would constitute a
material breach excusing the performance of the other.
Countryman, Executory Contracts in Bankruptcy, 57 Minn. L. Rev., 439, 460 (1973);
That definition has been adopted by the Ninth Circuit Court of Appeals. In re Coast
Trading Company, Inc., 744 F.2d 686, 692 (9th Cir. 1984). See also In re Riodizio, Inc.,
204 B.R. 417, 420-422 (1997); In re Spectrum, 190 B.R. 741, 746-747 (1996).1 If the
offsetting obligations are solely for the payment of money, the contract is not executory.
In re Chateaugay Corporation, 102 B.R. 335, 347 (Bankr. S.D.N.Y. 1989). See also In
re Spectrum at 747.
Note that an unexpired lease need not be executory in order to be covered by § 365.
Phoenix Grain, Inc. v. Estate of Hipp, Inc. (In re Estate of Hipp, Inc.), 96 Bankr. 656,
659 n.4 (Bankr. N.D. Tex. 1988).
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The courts have held a wide variety of contracts to be executory contracts within
the meaning of § 365.2 On the other hand, certain types of contracts which would appear
to fall within the Countryman definition have been held not to be executory contracts or
unexpired leases under § 365, especially where they are essentially financing devices. In
re McDaniel, 89 B.R. 861 (Bankr. E.D. Wash. 1988) (real estate installment sales
contract under which debtor is vendee is not an executory contract); In re PCH
Associates, 804 F.2d 193 (2d Cir. 1986) (a financing lease is not an unexpired lease
within the meaning of Section 365); In re Cox, 28 B.R. 588 (Bankr. D. Idaho 1983). (A
real estate contract where seller’s only remaining action is to transfer title to the debtors
on completion of payments is not an executory contract.) See also In re Lykes Bros.
Steamship Co., Inc., 196 B.R. 574, 585 (Bankr. M.D. Fla. 1996) (a financing lease is not
an unexpired lease within the meaning of § 365).
In general, the correct time as of which to determine whether a contract is
executory is the date on which the bankruptcy petition was filed. In re Cochise College
Park, Inc., 703 F.2d 1339, 1348 (9th Cir. 1983); In re Norquist, 43 B.R. 224, 230 (Bankr.
E.D. Wash. 1984). See also In re Riodizio, Inc. at 421; In re Spectrum at 747. But see In
re Government Securities Corp., 101 B.R. 343, 349 (Bankr. S.D. Fla. 1989) and In re
Gloria Manufacturing Corp., 734 F.2d 1020 (4th Cir. 1984) (where contract which is
executory on date of petition is later rendered non-executory, nature of contract is
For example, the following cases have held various types of contracts to be executory: In
re McLean Industries, Inc., 96 B.R. 440, 447 (Bankr. S.D.N.Y. 1989) (option). But see
In re Giesing, 96 Bankr. 229, 232 (Bankr. W.D. Mo. 1989) (option for which option price
has been paid in full is not executory contract); In re Coordinated Financial Planning
Corp., 65 B.R. 711 (Bankr. 9th Cir. 1986) (right of first refusal); In re Newcomb, 744
F.2d 621 (8th Cir. 1984) (escrow contract); Jensen v. Continental Financial Corp., 591
F.2d 477, 481072 (9th Cir. 1979) (settlement agreement); In re Norquist, 43 B.R. 224
Bankr. E.D. Wash. 1984) (partnership agreement); In re The Record Co., Inc., 8 B.R. 57
(Bankr. S.D. Ind. 1981) (agreement for sale of business); In re Rovine Corp., 6 B.R. 661
(Bankr. W.D. Tenn. 1980) (franchise agreement); NLRB v. Bildisco & Bildisco, 465 U.S.
513 (1984) (collection bargaining agreement).
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considered as of date of hearing on motion to assume or reject).
B.
LEASES AND EXECUTORY CONTRACTS TERMINATED PRIOR TO
BANKRUPTCY
Section 365 applies only to contracts and leases which have not expired or been
effectively terminated prior to the filing of the bankruptcy petition. Once an agreement
has been validly terminated, it is no longer executory and the debtor has no interest which
can be assumed. In re B-K of Kansas, Inc., 69 B.R. 812, 816 (Bankr. D. Kan. 1987); In
re Crabb, 48 B.R. 165 (Bankr. D. Mass. 1985). See also In re Memphis - Friday’s
Associates, 88 B.R. 830 (Bankr. W.D. Tenn., Western Div. 1988).
If the nonresidential lease is terminated prior to entry of the order for relief, the
trustee may not assume the lease. 11 U.S.C. § 365(c)(3). Conceptually, section
365(c)(3)’s limitations on assumption of terminated lease makes sense, because there are
simply no legal rights left following termination of the lease for the debtor or trustee to
assume.
The Code distinguishes between termination and default, and expressly allows
assumption after a default has occurred. 11 U.S.C. § 365(b)(1). Thus, if there has been a
default in payment of rent, without more, there is no termination and the trustee may still
assume the lease.
For an agreement to be terminated and not subject to assumption under Section
365(a) the agreement must be fully terminated in accordance with state law and there
must be no provision in the agreement or applicable law which would allow the debtor to
reinstate. In re Waterkist Corp., 775 F.2d 1089 (9th Cir. 1985). See also In re Boll
Weevil, Inc., 202 B.R. 762, 764-765 (Bankr. S.D. Cal. 1996); Stalter v. 700 South Peters
Street Partnership, 696 So.2d 586, 589 (La. App. 4th Cir. 1997); In re Windmill Farms,
Inc., 841 F.2d 1467, 1469 (9th Cir. 1988); In re Windmill Farms Management Company,
116 B.R. 755, 765 (Bankr. S.D. Cal. 1990). If the debtor retains any right to avoid the
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termination under state law, then the bankruptcy court should protect that interest for the
benefit of the estate. Consistent with the bankruptcy court’s policy of preventing
forfeitures, it will not find that an executory contract has been terminated if it is possible
to infer a waiver of termination by the other party. In re Hub of Military Circle, Inc., 13
B.R. 288 (Bankr. E.D. Va. 1981); In re Belize Airways Ltd., 5 B.R. 152 (Bankr. S.D. Fla.
1980). See also In re Royal Yarn Dyeing Corp., 114 B.R. 852, 858 (Bankr. E.D.N.Y.
1990).
In an appropriate case, termination of a contract or lease can be avoided as a
preference or fraudulent conveyance. In re Edward Harvey Co., Inc., 68 B.R. 851
(Bankr. D. Mass. 1987). See also In re Metro Water and Coffee Services, Inc., 157 B.R.
742, 745-746 (Bankr. W.D.N.Y. 1993); In re Egyptian Brothers Donut, Inc., 190 B.R. 26,
28; Goodman, Avoidance of Lease Terminations as Fraudulent Transfers, 43 Bus. Law.
807 (1988).
C.
IMPACT OF AUTOMATIC STAY ON LEASES AND EXECUTORY
CONTRACTS.
1.
The Automatic Stay Generally
Upon the filing of the petition, the debtor’s executory contracts and unexpired
leases are in limbo. Truck Drivers Local Union No. 807 v. Bohack Corp., 541 F.2d 312,
320 (2d Cir. 1976). Nonetheless, the lessee is constrained by the provisions of 11 U.S.C.
§ 362, which automatically provides for a stay of certain activity upon the filing of a
bankruptcy case. The lessor may not commence or continue any legal proceeding (such
as an eviction action) which existed at the time of the bankruptcy filing or which could
have been commenced prior to the bankruptcy. See 11 U.S.C. §362(a)(1). Any act to
enforce a judgment obtained prior to the bankruptcy is likewise prohibited under
11 U.S.C. §362 (a)(2). Thus, if the lessor/creditor has obtained a judgment evicting the
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tenant or requiring payment of the debt, that creditor may not act upon that judgment.
To balance the prohibitions of the automatic stay, the creditor/lessor may request
the bankruptcy court to grant permission for that creditor to proceed with its legal action
against the debtor. Typically, the creditor requests the Court to grant permission to
proceed with a specific action (such as commencing an unlawful detainer action or
proceeding with a foreclosure). To be granted by the Bankruptcy Judge, the creditor’s
request for relief from the automatic stay must meet one of three bases under 11 U.S.C.
§ 362(d). B.R. 4001(a)(3) provides that relief from stay orders themselves are stayed for
10 days after entry of the order unless the court orders otherwise.
First, the Court may grant the creditor relief from the stay for cause, such as a lack
of adequate protection of that creditor’s interest. See 11 U.S.C. § 362(d)(1). In the
second instance, the Court may grant the creditor permission to proceed against property
of the debtor if there is no equity and the property is not necessary for the debtor’s
reorganization. See 11 U.S.C. § 362(d)(2). The third avenue for a creditor to obtain
permission to proceed with his or her action against the debtor applies only in those cases
which may be termed “single asset real estate cases.” A single asset real estate case is
defined generally as real property constituting a single property or project generating
substantially all the gross income of the debtor who is not a family farmer. See 11 U.S.C.
§ 101(51B). The property may not include residential real property with fewer than four
units. Id. In this type of case, relief from stay will be granted to the creditor who is
secured in the property if the debtor fails to either file a plan of reorganization or begin
monthly payments within ninety days from the time of the bankruptcy filing or thirty
days after the court determines that the debtor is subject to §362(d)(3), whichever is later.
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See 11 U.S.C. § 362(d)(3). The amount of these payments must be equal to the interest
on the secured property at the applicable non-default contract rate. Under the Bankruptcy
Abuse and Consumer Protection Act of 2005 (BACPA), fully secured creditors will at
least be guaranteed their contractual bargained for interest rate. The single asset real
estate provision was added to the Bankruptcy Code in October 1994 as a part of the
Bankruptcy Reform Act of 1994 because creditors felt that their legitimate collection
rights were being unduly delayed. With the recent Bankruptcy Abuse and Consumer
Protection Act of 2005, the $4 million cap in the §101(51B) definition has been
eliminated as it is now deemed unreasonably low.
BACPA
Change
Old Law
New Law
Single
Asset Case
definition
Limited to $4 million in secured
debts. Section 362(d)(3) provides
that the stay may be lifted in a
single asset case unless the debtor
files a plan within 90 days or has
commenced making monthly
interest payments at a current fair
market rate to secured creditors.
Removes the limit.
Therefore, more single
asset cases will be
subject to § 362(d)(3).
Changes the rate to the
then applicable nondefault contract interest
rate.
However once the court has granted relief from stay (and no appeal is taken), the
creditor may proceed with the action for which permission has been granted.
a. Changes for Automatic Stay under the Bankruptcy Abuse and
Consumer Protection Act of 2005
There has been a change under the Bankruptcy and Consumer Protection Act of
2005 that has increased successful motions for relief from the automatic stay. Bankruptcy
and Consumer Protection Act of 2005, Sections 311 and 320. Before the change under
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the BACPA, certain debtors were abusing the bankruptcy system by, among other things,
filing multiple bankruptcies using different corporate entities for the same real estate. The
BACPA now includes new provisions that provide relief for the automatic stay in such
circumstances. Normally an automatic stay is effective immediately when a bankruptcy
petition is filed. 11 U.S.C. § 362(a). Now the court must grant relief from stay to a
secured creditor where the debtor’s use of bankruptcy filing was part of a scheme to
delay, hinder or defraud creditors through either (i) a transfer of ownership or other
interest in the real estate without the consent of the secured creditor or without court
approval or (ii) there have been multiple bankruptcy filings with respect to the same real
estate. If a debtor files a case under any chapter (other than Chapters 12 or 15) within one
year of the dismissal of a preceding case filed by the same debtor (other than a Chapter
11 or 13 case filed after dismissal under 11 U.S.C. § 707(b)), the automatic stay in the
second case will terminate 30 days after the filing. 11 U.S.C. § 362 (c)(3). However the
automatic stay may be continued if, after a hearing on motion, the court finds that the
second filing was made in good faith with respect to the creditors to whom the stay was
intended to apply. If a third case is filed within one year, then no automatic stay goes into
effect unless the court actually imposes the stay after holding a hearing and making a
finding that the filing was made in good faith. The legislators’ hope is to decrease debtor
abuse by granting more stay relief to creditors.
Recently there has been a distinction for relief from stay of personal property.
Bankruptcy Abuse and Consumer Protection Act of 2005, Section 304. If a lease of
personal property is rejected, or not timely assumed by the trustee under 11 U.S.C.
§ 365(d), the lease property is no longer property of the estate and the stay under Section
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362(a) is automatically terminated. See 11 U.S.C. § 365(p)(1). In a Chapter 7, the
individual debtor may notify the creditor in writing that it desires to assume the lease.
Upon notification, the creditor has the option to notify the debtor that it is willing to have
the lease assumed and may condition that assumption on the cure of any outstanding
default on terms set by the contract. See 11 U.S.C. § 365(p)(2)(A). If, after 30 days, the
debtor notifies the lessor in writing that the lease is assumed, the liability of the lease will
be assumed by the debtor and not the estate. See 11 U.S.C. § 365(p)(2)(B). Any stay
under § 362 and injunction under § 524(a)(2) shall not be violated by notification of the
debtor and negotiation of a cure.
In a Chapter 11, the individual debtor, and in a Chapter 13, where the individual
debtor is the lessee with respect to personal property and the lease is not assumed in the
plan confirmation by the court, the lease is deemed rejected at the conclusion of the
confirmation hearing. If the lease is rejected, the stay under § 362 and any stay under
§ 1301 is automatically terminated with respect to the property under the lease.
2.
Prohibition Against Bankruptcy Termination Clauses
Section 365(e)(1) invalidates ipso facto bankruptcy termination clauses, which
make the filing of a bankruptcy case a default. In re Texaco Inc., 73 B.R. 960, 965
(Bankr. S.D.N.Y. 1987). See also In re Prime Motor Inns, Inc., 123 B.R. 104, 108
(Bankr. S.D. Fla. 1990). That provision covers clauses which permit termination because
of the insolvency or financial condition of the debtor as well as those making the filing of
a bankruptcy case a default. Section 365(e)(1) does not make ipso facto clauses
completely invalid; it merely makes them unenforceable during the pendency of the case.
The clauses are enforceable if used to validly terminate the contract or lease under state
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law prior to the filing of the petition. See In re Gordon Car & Truck Rental, Inc., 59
B.R. 956, 960 (Bankr. N.D.N.Y. 1985); In re LIP, Inc., 22 B.R. 556, 558 (Bankr. S.D.
Fla. 1982). See also Phillips Petroleum Co. v. Rexene Corp., 1997 WL 781856, 11-12
(D. Del.). Similarly, such clauses may be enforceable after the bankruptcy. In re
Schweitzer, 19 B.R. 860, 867 (Bankr. E.D.N.Y. 1982). See also In re Solocolowski, 227
B.R. 16, 18-19 (Bankr. D. Conn. 1998); In re Mitchell, 85 B.R. 564 (Bankr. D. Nev.
1988). But see In re Ballance, 33 B.R. 89, 90 (Bankr. E.D. Va. 1983).
D.
ASSUMPTION AND ASSIGNMENT OF EXECUTORY CONTRACTS
AND UNEXPIRED LEASES
Where relief from the automatic stay is not possible, or not desired, the
Bankruptcy Code provides for both the assumption and assignment of unexpired leases
and executory contracts. The decision to assume a contract merely allows the contract to
continue to operate and does not change the obligations of the parties, except as provided
explicitly in the Code. See In re Washington Capital Aviation & Leasing, 156 B.R. 167,
173 (Bankr. E.D. Va. 1993); In re Drexel Burnham Lambert Group, Inc., 138 B.R. 687,
706 (Bankr. S.D.N.Y. 1992); In re Allen, 135 B.R. 856, 864 (Bankr. N.D. Iowa 1992)
(assuming a contract under § 365 only allows the debtor to carry on with the contract
according to its terms); In re LeRoux, 167 B.R. 318 (Bankr. D. Mass. 1994), aff'd, 1995
WL 447800 (D. Mass. Oct. 20, 1995).
1.
Standards for Assumption
Section 365 requires court approval for the assumption of an executory contract or
unexpired lease. See 11 U.S.C. § 365(a). Because damages for breach of an assumed
contract or lease have priority, creditors will generally want assumption to be deferred
until confirmation. A contract or lease cannot be assumed by implication through the
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debtor’s conduct in continuing to observe its terms. In re Treat Fitness Center, Inc., 60
B.R. 878, 879 (9th Cir. B.A.P, 1986). See also In re Revco D.S., Inc., 109 B.R. 264, 267
(Bankr. N.D. Ohio 1989); In re Golden Triangle Film Labs, Inc., 176 B.R. 608, 609
(Bankr. M.D. Fla. 1994). But see In re The Casual Male Corp., 120 B.R. 256, 260-262
(Bankr. D. Mass. 1990). The Bankruptcy Code does not specify any showing that a
debtor must make to assume a contract or unexpired lease that is not in default. In re
Perretta, 7 B.R. 103, 105 (Bankr. N.D. Ill. 1980). The “standard” generally applied is the
“business judgment rule” which basically requires that assumption be advantageous to
the estate and that the estate will be able to perform. In re Orion Pictures Corp., 4 F.3d
1095 (2nd Cir. 1993). If there has been a default, the debtor may not assume the contract
or lease unless it (a) cures or provides adequate assurance that it will promptly cure the
default; other than a default that is a breach of a provision relating to the satisfaction of
any provision (other than a penalty rate of penalty provision) relating to a default arising
from any failure to perform nonmonetary obligations under an unexpired lease of real
property. If it is impossible for the trustee to cure such default by performing
nonmonetary acts at and after the time of assumption, except that if such default arises
from a failure to operate in accordance with a nonresidential real property lease, then
such default shall be cured by performance at and after the time of assumption in
accordance with such lease, and pecuniary losses resulting from such default shall be
compensated in accordance with the provisions; (b) compensates the other party for any
pecuniary loss resulting from the default or provides adequate assurance that it will
promptly do so, and (c) gives adequate assurance of future performance. 11 U.S.C. § 365
(b)(1).3 See Bankruptcy and Consumer Protection Act of 2005, Section 328.
3
If a court discerns two contracts in one document, it may allow assumption of one and rejection of the
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BACPA
Change
Old Law
New Law
NonMonetary
Defaults
There was a split in the case law
on how non-monetary defaults in
unexpired leases (e.g. covenant
defaults) are treated and whether
such non-monetary defaults must
be cured in order for the debtor to
assume the agreement.
The new Law clarifies that
most non-monetary
obligations in unexpired
leases of real property need
not be cured in order for the
debtor or trustee to assume
the contract.
When a contract or lease is assumed, it is assumed with all of its benefits as well
as all of its burdens. NLRB v. Bildisco and Bildisco, 465 U.S. 513 (1984). See also In re
Plitt Amusement Co. Of Washington, Inc., 233 B.R. 837, 840 (Bankr. C.D. Cal. 1999); In
re The J. Peterman Company, 232 B.R. 366, 369 (Bankr. E.D. Ky. 1999). If the trustee
elects to assume a contract, the entire contract must be assumed. In re Caravansary, Inc.,
67 B.R. 469, 473 (9th Cir. B.A.P. 1986); In re Reda, Inc., 54 B.R. 871, 882 n.25 (Bankr.
N.D. Ill. 1985). See also In re Cafe Partners/Washington 1983, 90 B.R. 1, 6 (Bankr.
D.C. 1988); In re Emerald Forest Construction, Inc., 226 B.R. 659, 664 (Bankr. D. Mont.
1998).
2.
Prompt Cure and Adequate Assurance
The Bankruptcy Code does not provide a general definition of the terms "prompt
cure" and “adequate assurance of future performance.” The courts have considerable
discretion in interpreting and applying them. See, e.g., In re Belize Airways Limited, 5
B.R. 152, 156 (Bankr. S.D. Fla. 1980) (debtor required to cure within 15 days); General
Motors Acceptance Corp. v. Lawrence, 11 B.R. 44 (Bankr. N.D. Ga. 1981) (prompt cure
other. See In re Pacific Express, Inc., 780 F.2d 1482 (9th Cir. 1986); In re Steffen, 181 B.R. 981 (Bankr.
W.D. WA 1995).
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must be less than 1 year); In re Coors of North Mississippi, Inc., 27 B.R. 918, 922
(Bankr. N.D. Miss. 1983) (3 years is prompt cure). See also In re Allison, 1995 WL
930889, 3 (Bankr. E.D. Va.) (prompt cure must be less than 1 year); In re Yokley, 99 B.R.
394 (Bankr. M.D. Tenn. 1989) (2 years to cure defaults in a residential lease not prompt);
In re Reed, 226 B.R. 1, 2 (Bankr. W.D. Ky. 1998) (prompt cure generally less than 6
months).
The concept of adequate assurance of future performance is derived from Section
2-609 of the Uniform Commercial Code and does not require an absolute guarantee of
performance. See In re Luce lndus., 14 B.R. 529, 531 (S.D.N.Y. 1981). See also In re
Westview 74th Street Drug Corp., 59 B.R. 747, 754 (Bankr. S.D.N.Y. 1986). If there are
defaults under the contract or lease at the time of assumption, the contracting party is
granted the right to demand adequate assurance of future performance. 11 U.S.C.
§ 365(b)(1)(C). See also In re Sapolin Paints, Inc., 5 B.R. 412, 417 (Bankr. E.D.N.Y.
1980); In re Rachels Industries, Inc., 109 B.R. 797, 802 (Bankr. W.D. Tenn. 1990); In re
Washington Capital Aviation & Leasing, 156 B.R. 167, 173 (Bankr. E.D. Va. 1993).
Poor prospects for a successful rehabilitation or precarious financial condition have been
taken to indicate an inability to provide adequate assurance of future performance. In re
General Oil Distributors, Inc., 18 B.R. 654, 658 (Bankr. E.D.N.Y. 1982). See also In re
Great Northwest Recreation Center, Inc., 74 B.R. 846, 853-854 (Bankr. D. Mont. 1987);
In re PRK Enterprises, Inc., 235 B.R. 597, 603 (Bankr. E.D. Tex. 1999).
As discussed above, adequate assurance of future performance generally does not
have to be provided if there have been no defaults. If, however, the other party to the
contract affirmatively demonstrates reasonable concern that the bankruptcy estate will not
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timely perform its obligations, assurances may be required notwithstanding the absence
of defaults. In re Currivan’s Chapel of the Sunset, 51 B.R. 217, 218-219 (N.D. Cal.
1985). Adequate assurance can be provided in a number of ways. In re Westview 74th S.
Drug Corp., 59 B.R. 747, 755 (Bankr. S.D.N.Y. 1986) (security deposit); In re Alipat,
Inc., 36 B.R. 274 (Bankr. ED. Mo. 1984) (financial resources of assignee); In re
Petersons Ltd., 31 B.R. 524, 527-28 (Bankr. S.D.N.Y. 1983) (certificate of deposit). See
also In re Vitanza, 1998 WL 808629, 29 (Bankr. E.D. Pa. 1998) (provide certification
with supporting documentation).
3.
Assignment of Executory Contracts and Leases
The Bankruptcy Code renders unenforceable certain anti-assignment clauses and
enables the debtor to sell and assign certain valuable executory contracts or leases
otherwise unassignable under nonbankruptcy law. 11 U.S.C. § 365(f); In re Old South
Coors, Inc., 27 B.R. 923, 925 (Bankr. N.D. Miss. 1983). See also In re I&M Acquisition
Corp., 1995 WL 606353, 4 (S.D.N.Y.); Robb v. Schindler, 142 B.R. 589, 591 (D. Mass.
1992). Also, bankruptcy courts can refuse to enforce contractual provisions, such as
overly restrictive use clauses in leases, which have the practical effect of precluding
assignment even though they do not expressly prohibit it. See, e.g., Matter of U.L. Ratho
Corp., 19 B.R. 537 (S.D.N.Y. 1982). See also Robb v. Schindler, supra.
The debtor may assign a contract or lease only if (a) it first assumes the contract
or lease in accordance with the provisions of Section 365, and (b) adequate assurance of
future performance by the assignee is provided, whether or not there has been a default
on the contract or lease. 11 U.S.C. § 365(f)(2). Upon assignment, the debtor is released
from all liability on the contract or lease. 11 U.S.C. § 365(k).
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4.
Contracts Not Subject to Assumption and Assignment
Section 365(c) prohibits a debtor from assuming or assigning an executory
contract if applicable law excuses the other party from accepting performance from, or
rendering performance to, an entity other than the debtor, and the other party does not
consent to such assumption or assignment.4 This generally applies to personal service
contracts. See, e.g., Matter of Tonry, 724 F.2d 467 (5th Cir. 1984) (contingent fee
contract with attorney is non-assignable personal service contract). See also Turner v.
Avery, 947 F.2d 772, 774 (5th Cir. 1991).
Contracts to make a loan or extend other financial accommodations to the debtor
similarly may not be assumed or assigned. 11 U.S.C. § 365(c). In re Swift Aire Lines,
Inc., 30 B.R. 490 (9th Cir. B.A.P. 1983). See also In re Stanton, 239 B.R. 222, 230
(Bankr. E.D. Wash. 1999). But see In re TS Industries, Inc., 117 B.R. 682, 686-687
(Bankr. D. Utah 1990). This provision does not apply to contracts to furnish goods or
services which only incidentally involve the extension of credit. In re Charrington
Worldwide Enterprises, Inc., 98 B.R. 65 (Bankr. M.D. Fla. 1989). See also In the Matter
of Thomas B. Hamilton Company, Inc., 115 B.R. 384, 386 (Bankr. N.D. Ga. 1990).
Some courts have held that a general partner in a limited partnership cannot
assume the partnership agreement as an executory contract. In re Sunset Developers, 69
B.R. 710 (Bankr. D. Idaho 1987); In re Harms, 10 B.R. 817 (Bankr. D. Colo. 1981). See
also Finkelstein v. Security Properties, Inc., 76 Wn. App. 733, 736-737, 888 P.2d 161
(1995). But see In re Norquist, 43 B.R. 224 (Bankr. E.D. Wash. 1984); In re LeRoux,
There may be a conflict between § 365(c)(1), which allows “applicable law” to block an assignment, and
Section 365(f)(1) which permits assignment despite “applicable law.” See In re Braniff Airways, Inc., 700
F.2d 935 (5th Cir. 1983); but see In re Magness, 972 F.2d 689 (6th Cir. 1992) which attempts to harmonize
the sections.
4
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167 B.R. 318, 320-321 (Bankr. D. Mass 1994).
Even if a contract is not assumable under § 365, the non-debtor party may not
terminate it without first obtaining relief from the automatic stay. In re Computer
Communications, Inc., 824 F.2d 725, 739 (9th Cir. 1987). See also In re Hutchins, 216
B.R. 1, 7-8 (Bankr. E.D. Ark. 1997). But see Watts v. Penn. Housing Finance Co., 876
F.2d 1090, 1096-1097 (3rd Cir. 1989).
E.
REJECTION OF EXECUTORY CONTRACTS AND UNEXPIRED
LEASES
Among the provisions of the Bankruptcy Code which are of particular concern to
both debtors and lessees are the provisions for rejections of executory contracts and
unexpired leases. The practical effects of a rejection of these types of contracts can be
quite dramatic.
1.
Standards for Rejection
The Bankruptcy Code provides no specific standard governing the debtor’s
rejection of an executory contract or unexpired lease. Under prior law, a debtor had to
prove that a contract was onerous to the estate before it could be rejected, but that
requirement has largely been rejected in favor of the “business judgment” test under
which the debtor is given wide discretion in the rejection of executory contracts and
unexpired leases. See In re Midwest Polychem, Ltd., 61 B.R. 559, 562 (Bankr. N.D. Ill.
1986). See also In re Albrechts Ohio Inns, Inc., 152 B.R. 496, 501-502 (Bankr. S.D.
Ohio 1993); In re Jr. Food Mart of Arkansas, Inc., 131 B.R. 116, 118 (Bankr. E.D. Ark.
1991). The debtor may reject an executory contract through a motion to reject under §
365(a) or through a provision in the plan of reorganization pursuant to § 1123(b)(2). In re
Parkwood Realty Corp., 157 B.R. 687, 690 (Bankr. W.D. Wash. 1993). However,
TREATMENT OF EXECUTORY CONTRACTS AND
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boilerplate terms in a plan which reject all contracts not assumed, without further
specificity, may not always be effective. Parkwood, 157 B.R. at 690-91.
In some cases, courts have refused to allow a debtor to reject a contract where it
appeared the debtor had an improper purpose or that the harm to the other party would
greatly exceed the benefit to the debtor’s estate. See, e.g., In re Waldron, 785 F.2d 936
(11th Cir. 1986) (debtor, who was a bankruptcy attorney, filed Chapter 13 case for the
sole purpose of rejecting a real property option which was not as profitable as it could
be); In re Noco, Inc., 76 B.R. 839 (Bankr. N.D. Fla. 1987) (solvent debtors filed case in
order to reject a covenant not to compete entered into in connection with sale of
business); In re Petur U.S.A. Instrument Co., Inc., 35 B.R. 561 (Bankr. W.D. Wash.
1983) (rejection would destroy business of non-debtor party to contract and harm would
be disproportionate to benefit to debtor). See also In re Monarch Tool & Mfg. Co., 114
B.R. 134, 136-138 (Bankr. S.D. Ohio 1990) (rejection of exclusive distributorship
contract not allowed where distributor will be ruined, fortunes of debtor will not be
helped, and general creditors will not be helped); In re Hirschhorn, 156 B.R. 379, 388389 (Bankr. E.D.N.Y. 1993) (cannot use Bankruptcy Code to defeat non-compete
clause); In re Innkeepers of New Castle, Inc., 671 F.2d 221 (7th Cir. 1982); cert. denied,
103 S.Ct. 212 (1982) (cannot reject or assume if lease is no longer executory).
2.
Effect of Rejection
In general, the non-debtor party to an executory contract or unexpired lease is left
with a bankruptcy claim against the debtor for the damages it suffers as a result of the
rejection. Where the rejected contract is subject to enforcement by injunctive relief, the
question arises whether that relief remains available despite the rejection. This question
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has most often been dealt with in connection with covenants not to compete contained in
rejected contracts. In In re Register, 95 B.R. 73, 75 (Bankr. M.D. Tenn. 1989), affirmed,
100 B.R. 360 (M.D. Tenn. 1989), the court held that a covenant not to compete contained
in a franchise agreement was rejected when the franchisor simply had a general
unsecured claim under § 502(g) for any damages it suffered. The court refused to hold
that the covenant not to compete could be enforced by injunction after rejection of the
contract. See also In the Matter of JRT, Inc., 121 B.R. 314, 323 (Bankr. W.D. Mich.
1990). Contra, In re Don & Lin Trucking Co., Inc., 110 B.R. 562, 567-568 (Bankr. N.D.
Ala. 1990).
3.
Evicting the Debtor After the Bankruptcy Petition Is Filed
The automatic bankruptcy stay of § 362(a) generally precludes actions against a
debtor following the filing of the bankruptcy petition. However, specifically excepted
from the stay is
any act by a lessor to the debtor under a lease of nonresidential real
property that has terminated by the expiration of the stated term of
the lease before the commencement of or during a case under this
title to obtain possession of such property . . .
11 U.S.C. § 362(b)(10). Thus, if the leasehold interest expires pursuant to the lease
terms, the lessor may commence unlawful detainer proceedings if necessary to evict the
tenant/debtor, without first obtaining an order from the bankruptcy court granting relief
from stay. However, unless the case fits squarely within the exception of § 362(b)(10), a
motion for relief from stay should be filed and an order entered authorizing eviction
before the lessor takes steps to evict the tenant.
F.
TIME FOR ASSUMPTION OR REJECTION
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1.
In General
The debtor in Chapters 9, 11, 12, or 13 may reject or assume an executory
contract or unexpired lease, except for leases of nonresidential real property, at any time
before the confirmation of a reorganization plan; but a party to the executory contract or
unexpired lease may request the bankruptcy court, for cause, to order the debtor to
assume or reject within a specified earlier period of time. 11 U.S.C. § 365(d)(2). In a
Chapter 7 case, all executory contracts and unexpired leases are deemed rejected if they
are not assumed within 60 days after the entry of the order for relief, subject to the court’s
power to extend that time period. 11 U.S.C. § 365(d)(1). Any motion for an order
extending the 60-day period must be made within that period. In re Tompkins, 95 B.R.
722, 724 (9th Cir. B.A.P. 1989). See also In re Vecchitto, 235 B.R. 231, 236 (Bankr. D.
Conn. 1999).
It has been held that a court may permit a debtor to defer its decision to assume or
reject an executory contract until after the confirmation of a Chapter 11 plan of
reorganization. In re Gunter Hotel Associates, 96 B.R. 696, 699 (Bankr. W.D. Texas
1988), cf., In re Adams, 94 B.R. 838, 849 (Bankr. E.D. Pa. 1989) (executory contract can
only be assumed before confirmation of plan in Chapter 13 case).
2.
Leases of Nonresidential Real Estate
Section 365(d)(4)(A) establishes a different rule for leases of nonresidential real
property. Recently there has been a change in the BACPA that will assist creditors of
nonresidential real property. It provides that,
an unexpired lease of a nonresidential real property under which
the debtor is the lessee shall be deemed rejected, and the trustee
shall immediately surrender that nonresidential real property to the
lessor, if the trustee does not assume or reject the unexpired lease
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by the earlier of a) the date that is 120 days after the date of the
order of relief, or b) the date of the entry of an order confirming a
plan.
BACPA
Change
Old Law
New Law
Nonresidential
real
property
leases
The debtor had 60 days from the
petition date to assume or reject
non-residential real property
leases, and the Bankruptcy Court
could extend that 60-day deadline
for cause. Debtors often obtained
extensions through plan
confirmation to make
assumption/rejection decisions.
The new Law provides
that a debtor has a
maximum of 210 days
(i.e., an initial 120-day
period and one additional
90-day extension for
cause) to extend this time
period. A debtor can only
obtain extensions beyond
the 210 days if the
landlord specifically
consents to such
extensions.
Under § 365(d)(4)(B) the Court may extend the period prior to the 120-day
period, for 90 days on the motion of the trustee or the lessor but if the Court grants the
extension, the consent of the lessor must be obtained. However under the Bankruptcy
Abuse and Consumer Protection Act (BACPA), the Courts are in no instance allowed to
extend the deadline to a date that is more than 210 days after the order for relief (usually
the petition date). If the debtor assumes and later rejects a commercial lease, the landlord
will be paid in full as an administrative creditor in real dollars for the rent due for two
years following the rejection. Bankruptcy and Consumer Protection Act of 2005, Section
404.
Some courts, including the Ninth Circuit Court of Appeals, have held that simply
filing a motion for an extension of the 60-day period is sufficient to prevent automatic
rejection at the end of that period. In re Southwest Aircraft Services, Inc., 831 F.2d 848
(9th Cir. 1987); In re By-Rite Distributing, Inc., 55 B.R. 740, 742 (D. Utah 1985); In re
Unit Portions, 53 B.R. 83 (Bankr. E.D.N.Y. 1985). See also In re Flugel, 197 B.R. 92,
TREATMENT OF EXECUTORY CONTRACTS AND
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95 (Bankr. S.D. Cal. 1996); In re Deane Communications, Inc., 1994 WL 840976, 1-4
(D. Colo.). Other courts have held that the extension must actually be granted within the
60-day period. In re House of Deals of Broward, Inc., 67 B.R. 23 (Bankr. E.D.N.Y.
1986); In re Coastal Industries, Inc., 58 B.R. 48 (Bankr. D.N.J. 1986). See also
Debartolo Properties Management, Inc. v. Devan, 194 B.R. 46, 52 (D. Md. 1996); In re
Simpson, 1994 WL 114693, 2-3 (Bankr. W.D. Okla.). Likewise, based on recent BACPA
changes, courts have held that the extension must be granted within the 120 day period.
In re Tubular Technologies, LLC., 2006 WL 2405711, 2 (Bankr. D.S.C. June 21, 2006).
Multiple extensions of the period may be granted. In re Victoria Station, Inc., 875 F.2d
1380, 1385 (9th Cir. 1989). The lessor need not be given notice of a motion for such an
extension. Id. at 1386. See also In re Albert, 113 B.R. 617, 618-619 (9th Cir. BAP 1990);
In re Health Science Products, Inc., 191 B.R. 895, 903 (Bankr. N.D. Ala. 1995).
It is possible for a landlord to waive the deemed rejection by its conduct, such as
by accepting rent after the end of the 60-day period. See In re THW Enterprises, Inc., 89
B.R. 351 (Bankr. S.D.N.Y. 1988) and cases cited therein. But see In re Seniors
Enterprises, Inc., 70 B.R. 79 (Bankr. ND. Tex. 1987); In re BDMCorp., 71 B.R. 142, 145
(Bankr. N.D. Ill. 1987). See also In re George, III, 177 F.3d 885, 889 (9th Cir. 1999); In
re Food Barn Stores, Inc., 174 B.R. 1010, 1015 (Bankr. W.D. Mo. 1994). But see In re
Tri-Glied, 179 B.R. 1014, 1021 (Bankr. E.D.N.Y. 1995). It has been held that the 60-day
period for assumption may be tolled until appointment of a trustee for a non-operating
entity in appropriate circumstances. In re Southern Energy, Ltd., 98 B.R. 42 (Bankr.
N.D. Fla. 1989).
3.
Standard for Allowing Extension of Sixty-Day Period to Assume or
Reject Lease
The “cause” which warrants an extension of time to assume or reject a lease is not
specified in the Code. Determination of what constitutes sufficient “cause” is within the
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discretion of the court. This issue primarily arises in the Chapter 11 cases or in the rare
Chapter 7 case where the trustee has an operating order. To determine whether cause
exists for granting an extension, case law indicates that courts balance a number of
nonexclusive factors, such as the following:
(1)
Whether the lease is a primary asset of the bankruptcy estate;
(2)
Whether the landlord has a reversionary interest in any buildings built by
the debtor on the landlord’s property;
(3)
Whether the debtor has had sufficient time to appraise its financial
situation and the potential value of its assets in terms of the formulation of
a Chapter 11 plan;
(4)
Whether the lessor continues to receive rental payments and whether the
debtor fails to pay the rent reserved in the lease;
(5)
Whether the lessor will be damaged beyond compensation available under
the Bankruptcy Code due to the debtor’s continued occupation;
(6)
Whether the case is exceptionally complex and involves a large number of
leases;
(7)
Whether need exists for judicial determination of whether the lease is a
disguised security agreement;
(8)
Whether the debtor has failed or is unable to formulate a plan when it has
had more than enough time to do so;
(9)
Any other factors bearing on whether the debtor had a reasonable amount
of time to assume or reject the lease.
See In re Wedtech Corp., 72 B.R. 464 (Bankr. S.D.N.Y. 1987); In re Muir Training
Technologies, Inc., 120 B.R. 154 (Bankr. S.D. Cal. 1990). See also, In re 611 Sixth
Avenue Corp., 191 B.R. 295, 298 (Bankr. S.D.N.Y. 1996); In re Ernst Home Center, Inc.,
209 B.R. 974, 980 (Bankr. W.D. Wash. 1997).
The Ninth Circuit has held that the debtor’s failure to pay lease obligations timely
under § 365(d)(3) is one of the elements to be considered in determining whether cause
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exits for granting an extension. In re Southwest Aircraft Services, Inc., 831 F.2d 848 (9th
Cir. 1987), cert. denied, 487 U.S. 1206 (1988). In Muir Training, the court held that the
debtor’s failure to stay current on post-petition rental obligations weighs heavily in favor
of limiting extensions of time to assume or reject a lease.
G.
CLAIMS FOR REJECTION
1.
In General
Post-petition rejection of an executory contract or unexpired lease which has not
been previously assumed constitutes a breach as of the petition date, giving rise to a prepetition claim for damages. 11 U.S.C. §§ 365(g), 502(g). If the lease or contract has
been assumed and is later breached, the claim resulting from the breach has
administrative expense priority. In re Coast Trading Co., Inc., 744 F.2d 686, 692 (9th
Cir. 1984). See also In re Klein Sleep Products, Inc., 78 F.3d 18, 26 (2nd Cir. 1996).
2.
Real Property Leases
(a)
Claims for Post-Petition Rent
Prior to the 1984 amendments to the Bankruptcy Code, it was clear that, where a
real property lease was rejected, the debtor/lessee was liable only for the reasonable value
of the use and occupancy of the premises even if that was less than the rent provided for
in the lease. In re Orvco, Inc., 95 B.R. 724, 727 (9th Cir. B.A.P. 1989). In the Ninth
Circuit, that remains the rule. Id. However, courts in other jurisdictions have held that
Section 365(d)(3), which requires the debtor as lessee of nonresidential real estate to
timely perform its obligations under the lease until the lease is assumed or rejected,
commands payment of the full rent provided for in the lease during the pre-rejection
period. In re National Oil Co., 80 B.R. 525, 527 (Bankr. D. Colo. 1987); In re Coastal
Dry Dock & Repair Corp., 62 B.R. 879 (Bankr. E.D.N.Y. 1986). See also, In re Florida
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Lifestyle Apparel, Inc., 221 B.R. 897, 899-900 (Bankr. M.D. Fla. 1997).
Section 365(d)(3) does not give the landlord the right to be paid ahead of other
holders of administrative expense priority claims if the estate does not have enough assets
to pay all administrative expense claims in full. In re Orvco, Inc., supra at 728. In the
Orvco case, the bankruptcy appellate panel held that the bankruptcy court did not err in
deferring payment of the landlord’s claim for post-petition rent until it determined the
ability of the estate to pay all administrative expense claims.
However under the BACPA, there has been change in the amounts that are
determined an administrative expense and those that are now entitled to a priority under
Section 502 (b)(6).
BACPA
Change
Old Law
New Law
Damages for
rejection of
lease that was
previously
assumed
Some cases had held
that all payments due
under the assumed
lease would become
administrative
expenses.
All rent due for 2 years following
the actual rejection or turnover
shall be an administrative expense
claim without reduction except for
amounts paid by a non-debtor. All
remaining amounts due under the
assumed (and then rejected) lease
are entitled to priority under
§ 502(b)(6).
The BACPA has put a cap on expenses to the landlord for leases rejected by the debtor.
The first two years following the rejection will be administrative expenses but any amounts
beyond the two years will not be entitled to priority. Bankruptcy and Consumer Protection Act of
2005, Section 445.
(b)
Claims for Damages for Termination of Lease of Real Property
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The total amount of a landlord’s claim for damages arising from the termination of a
lease of real property, whether the termination occurs before or after the bankruptcy petition is
filed, is limited by § 502(b)(6). That provision essentially limits such a claim to:
(A)
the greater of (i) one year’s rent, or (ii) fifteen percent of the rent for the
remaining term of the lease not to exceed three years rent; plus
(B)
any unpaid rent due on the earlier of the date of the bankruptcy
petition or the date the debtor vacated the property.
3.
Security for Rejection of Claim
A party to a lease or executory contract may protect itself against the effects of the
party’s rejection by taking a security interest in the other party’s property to secure its
obligations. Such a security interest survives rejection of the lease or contract. Leasing Service
Corporation v. First Tennessee Bank National Association, 826 F.2d 434, 437 (6th Cir. 1987).
See also, Employees’ Retirement System of Alabama v. Resolution Trust Corp., 840 F. Supp.
972, 985 (S.D.N.Y. 1993).
H.
SPECIAL PROVISIONS RELATING TO SHOPPING CENTER LEASES
1.
Introduction
Because of the unique interrelationship of the tenants in a shopping center and because of
the existence of provisions such as percentage rent and use restrictions in most shopping center
leases, §365(b)(3) imposes special requirements regarding adequate assurance or future
performance which must be met by a trustee seeking to assume or assume and assign a lease in a
shopping center.
2.
Determining if it is a Shopping Center Lease
The term “shopping center” is not defined in the Code. Important characteristics in
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determining whether the debtor is in a shopping center include (1) multiple leases held by a
single landlord, (2) leases to commercial retailers, and (3) common parking areas. 2 Collier
¶ 365.04 at 365-43.
Courts have grappled with the problem of determining whether or not a particular lease is
a shopping center lease, with sometimes surprising results. For example, a district court in
Missouri found that property was not part of a shopping center for purposes of § 365(b)(3),
although the following evidence indicated that it was a shopping center: (a) stores advertised
jointly; (b) the leasing brochure geared toward potential tenants depicted the area as a shopping
center; and (c) restrictive covenants were entitled “Restrictive Covenants of Cloverleaf Plaza
Shopping Center” and contained language expressing the lessor’s desire to preserve the tract as a
first-class shopping center. See In re 905 International Stores, Inc., 57 B.R. 786, 788 (E. D. Mo.
1985).
The court refused to enter a finding that the property constituted a shopping center,
because leases failed to contain provisions that would be “hallmarks of the joint working
arrangements [among tenants] Congress sought to protect.” Id. Specifically, the leases
contained (a) no provision for percentage rents and (b) no right to relinquish leasehold if the
anchor tenant ceased operation. Id.
Similarly, the court in Matter of Goldblatt Bros., Inc., 766 F.2d 1136, 1140-41 (7th Cir.
1985), held that a shopping center did not exist, although there was common ownership of
contiguous parcels, an anchor tenant, and joint parking adjacent to stores. The court noted that
there was no evidence that the property was purposefully developed as shopping center.
On the other hand, the court in In re Joshua Slocum Ltd., 922 F.2d 1081, 1087-89 (3d
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Cir. 1990), held that three separate buildings containing seven stores in a downtown area
constituted a shopping center, because other factors indicating the intent to create a shopping
center outweighed the lack of contiguousness among the buildings. The other factors listed by
the Slocum court were:
(a)
A combination of leases;
(b)
All leases held by a single landlord;
(c)
All tenants engaged in the commercial retail distribution of goods;
(d)
The presence of a common parking area;
(e)
The purposeful development of the premises as a shopping center;
(f)
The existence of a master lease;
(g)
The existence of fixed hours during which all stores are open;
(h)
The existence of joint advertising;
(j)
[sic] Contractual interdependence of the tenants as evidenced by
restrictive use provisions in their leases;
(k)
The existence of percentage rent provisions in the leases;
(l)
The right of the tenants to terminate their leases if the anchor tenant
terminates its lease;
(m)
Joint participation by tenants in trash removal and other maintenance;
(n)
The existence of a tenant mix.
Id. at 1087-88.
3.
Providing Adequate Assurance
As with all unexpired leases, adequate assurance of future performance in conjunction
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with the assumption of a shopping center lease is required only if there has been a default.
2 Collier ¶ 365.04 at 365-42, 43. If the lease is assigned after assumption, the assignee must
provide adequate assurance of future performance. 11 U.S.C. § 365(f)(2)(B). For shopping
center leases, the Code specifies that adequate assurance of future performance must include
adequate assurance: (a) of the source of rent and any other considerations due under the lease,
and that the financial condition and operating performance of any assignee and its guarantors
will be similar to that of the debtor and its guarantors at the time the debtor became the lessee,
(b) that percentage rent due will not decline substantially, (c) that the assumption or assignment
is subject to all provisions of the lease and will not breach provisions of other leases, financing
agreements, or the master agreement relating to the shopping center, and (d) that the assumption
or assignment will not disrupt the tenant mix or balance in the shopping center. 11 U.S.C.
§ 365(b)(3).
The tenant mix and balance requirement is often a point of contest when a debtor
attempts to assume and assign a shopping center lease. See In re TWS Stores of Nanuet, Inc., 34
B.R. 299 (Bankr. S.D.N.Y. 1983) (assignment of shopping center lease denied where proposed
assignee’s use would violate a restrictive use provision and disrupt tenant mix); In re Ames
Department Stores, Inc., 127 B.R. 744 (Bankr. S.D.N.Y. 1991) (absent a specific use clause in
leases, change in use by assignee allowed because § 365(b)(3)(D) does not preserve tenant mix if
it is not a bargained for element of the lease). See also In re Jamesway Corp., 201 B.R. 73, 77
(Bankr. S.D.N.Y. 1996) (subject to irrelevant restrictions lease construed to permit debtor to use
premises for any legal purpose). The proposed assignee must demonstrate its ability to satisfy
the financial obligations of the lease, but an absolute guarantee such as a letter of credit is not
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necessary. In re Tech Hifi, Inc., 49 B.R. 876, 879 (Bankr. D. Mass. 1985). See also In re Casual
Male Corp., 120 B.R. 256, 264 (Bankr. D. Mass. 1990) (financial condition and operating
performance of proposed assignee must be at least as strong as was the debtor’s at the time the
lease was executed).
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