When a company files for bankruptcy, what happens to the contracts and leases it has with other parties? A business bankruptcy attorney can walk corporate leaders through the effects of bankruptcy on business contracts and commercial leases.
Types of Business Bankruptcy
Businesses may file for two types of bankruptcy: Chapter 7 and Chapter 11. In Chapter 7 bankruptcy, also called liquidation bankruptcy, a business ceases operations and sells its assets to generate funds to repay creditors. Businesses in Chapter 7 bankruptcy can terminate their contracts and leases as they shut down operations, although the company may still have financial liabilities to contractual counterparties who may become creditors.
Conversely, in Chapter 11 bankruptcy, a business can reorganize its debts and operations to catch up on outstanding liabilities and become a more profitable enterprise. In some cases, a business can use a Chapter 11 bankruptcy to wind down operations under more financially favorable conditions than in a Chapter 7 bankruptcy. A business that continues operations in Chapter 11 can assume, reject, or renegotiate contracts or leases.
Executory Contracts in Bankruptcy
An executory contract refers to a contract in which both parties have ongoing obligations, such as a supply contract. In Chapter 11 bankruptcy, the bankruptcy trustee or the company as a debtor-in-possession may choose to assume the contract or reject it. Assuming a contract means the business wishes to continue performing the agreement. However, to require the counterparty also to continue performing under the agreement, the company must cure any default, such as unpaid amounts due under the contract.
Rejecting a contract may lead the counterparty to file a creditor claim for losses they incurred due to the business’s cancellation of the contract. Furthermore, a company must obtain the bankruptcy court’s approval to assume or reject an executory contract.
Leases in Bankruptcy
The law treats commercial leases as executory contracts. As for commercial real estate leases, a business in Chapter 11 bankruptcy must decide whether to assume or reject the contract within a specific timeframe – usually 120 days, although companies can ask the bankruptcy court to extend this deadline.
For a real estate or equipment lease, a business in bankruptcy that wishes to assume the lease must cure any default, such as missed lease payments, and provide adequate assurance of on-time future performance, such as creating an escrow or providing financial projections sufficient to demonstrate the company’s ability to make future payments.
However, when a business wishes to reject a lease, the lessor can treat the rejection as a breach of contract and file a creditor claim against the bankruptcy estate. Additionally, or alternatively, the lessor can pursue claims against parties who have signed personal guarantees for the business’s obligations under the lease.
Practical Consideration for Business Owners
Business owners who file for bankruptcy should keep specific considerations in mind when deciding how to deal with their company’s contracts and leases:
- The need to carefully review contracts to understand the company’s obligations, including financial claims that a counterparty may have if the company rejects the contract
- The balance between the burden and benefit of a contract or lease
- The importance of communicating with contractual counterparties before filing for bankruptcy or as soon as possible after filing
- The ability to leverage bankruptcy protections to renegotiate terms in assumed contracts or leases
Contact a Business Bankruptcy Attorney Today
When your business must file for bankruptcy, an experienced commercial bankruptcy lawyer can help you understand what may happen to your company’s contracts and leases during bankruptcy. Contact The Cooney Law Offices today for an initial consultation with our legal team to learn more about business bankruptcy in Pennsylvania.
