Page 52 - Bankruptcy Volume 1

 the holder may be compelled to accept monetary satisfaction.

Executory Contracts and Leases

One of the most powerful tools a debtor has in bankruptcy is the ability to reject (breach and cease to
perform) or assume (undertake and continue to perform) its executory contracts. An executory contract
is a contract under which performance is due by both parties. Executory contracts must be assumed or
rejected in total and may not be bifurcated into parts that will be rejected and those that will not. The
remaining duties that either party must perform under the contract must be material and substantial so
that if either party failed to perform as called for, the contract would be materially breached.

Section 365 of the Bankruptcy Code requires the debtor-in-possession to cure certain defaults before as-
sumption and to provide adequate assurance of future performance of contracts or leases that are in de-
fault. It also permits the assignment of most contracts and leases — notwithstanding contractual provi-
sions that might otherwise limit assumption or assignment. Moreover, Section 365 also provides addi-
tional protections for parties to certain types of contracts and leases, such as licensees of intellectual
property and lessees of real property.

There is no time limitation for assuming an executory contract or unexpired lease, except for an unex-
pired lease for nonresidential real property in Chapter 11 cases, provided that the contract is accepted or
rejected before a plan of reorganization is confirmed. Under BAPCPA, the debtor must decide to assume
or reject an unexpired lease for nonresidential real property by the earlier of 120 days from the date of
the order of relief or the date of entry of an order confirming a plan. However, this 120-day time period
may be extended by 90 days, either by agreement of the lessor or by requesting the bankruptcy judge to
approve an extension. The debtor must begin making current payments on any executory contracts or
unexpired leases not yet rejected 60 days after the filing of an order for relief.

Rejection

If an executory contract or unexpired lease is rejected, the contract or lease is deemed breached as of the
date immediately preceding the filing of the petition, and the lease or contract assets will be excluded
from the debtor’s estate. Therefore, all claims for damages associated with lease and contract rejections
are treated as prepetition claims. Additionally, the Bankruptcy Code has specified the maximum amount
that a lessor of nonresidential real property can claim as damages for the rejected lease, as will be dis-
cussed. Payments made for the use of the facilities during bankruptcy and prior to rejection are an ad-
ministrative expense. Courts have held that the contract rate applies to amounts that are due for rent after
the petition is filed and prior to rejection. See Burival, 613 F.3d 810 (8th Cir. 2010) and Pacific-Atlantic
Trading Co., 27 F.3d 401 (9th Cir. 1994).

Accountants frequently provide advice to debtors-in-possession regarding the allowed amount of reject-
ed lease claims. Bankruptcy Code Section 502(g) provides that the claim arising out of the rejection of
an executory contract or lease is a prepetition claim. Section 502(b) limits the claims from rejected real
property lease commitments to the prepetition lease payments plus damages resulting from the lease re-
jection. The Bankruptcy Code caps the damages at the greater of one year’s lease payment or 15% of the
rent reserved, not exceeding three years of the rent reserved. For example, assume a retailer-debtor with
one leased location enters bankruptcy proceedings on December 31, 20XX. At the time of filing, the re-
tailer has 15 years remaining on its lease obligation. If the amount of its annual rent is $100,000, the les-
sor’s capped lease rejection claim will be the greater of one year’s lease payment ($100,000) or 15% of
the total amount owed under the terms of the remaining lease (.15 x $100,000 x 15 years or $225,000),

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