Contracts in Chapter 11: Assumption, Rejection, and Legal Implications
When a business files for Chapter 11 bankruptcy, it has significant implications for contracts it has entered into. Here are the key points regarding what happens to contracts in Chapter 11:
Assumption or Rejection of Contracts
- Debtor's Options: Under Section 365 of the Bankruptcy Code, the debtor (the business in bankruptcy) has the option to either assume or reject unexpired leases and executory contracts. 25
- Definition of Executory Contracts: An executory contract is generally defined as a contract under which both parties have unperformed obligations, and the failure of either party to complete performance would constitute a material breach excusing the performance of the other. 56
Assumption of Contracts
- Curing Defaults: If the debtor chooses to assume a contract, it must cure any defaults (including payment and non-monetary defaults) and provide adequate assurance of future performance. 24
- Assignment: The debtor can also assign an assumed contract to another party, but it must first cure any defaults, and the new party must provide adequate assurance of future performance. 25
Rejection of Contracts
- Rejection Process: If the debtor rejects a contract, it is no longer required to perform under the contract. The other party to the contract can file a claim for damages resulting from the rejection, which is treated as an unsecured claim. 25
- Damages: The damages for rejection of a lease are statutorily limited to the lesser of one year of payments or 15% of the payments over the remaining term of the lease. For other executory contracts, damages are based on state law breach of contract principles. 25
Continued Performance
- Obligations: Until the debtor decides to assume or reject a contract, the other party must continue to perform its obligations under the contract. 12
- Court Permission: Terminating a contract without court permission can result in substantial fines. Even if the contract has a provision allowing termination upon bankruptcy, court permission is still required. 12
Special Considerations
- Leases and Intellectual Property: Tenants under real estate leases and licensees of intellectual property have special protections upon rejection of their leases or licenses by landlords or licensors who file bankruptcy. 12
- Assignment Limitations: If a contract requires the other party's approval for assignment, that term is enforceable, but consent cannot be withheld unreasonably. 25