Executory Contracts and Unexpired Leases in Bankruptcy

When a business or individual files bankruptcy, their ongoing contracts and active leases don’t automatically disappear or survive. Federal law gives the trustee or debtor-in-possession the power to decide the fate of each one. The framework for executory contracts and unexpired leases in bankruptcy sits at 11 U.S.C. § 365, which lets the debtor assume (keep), reject (walk away from), or assign (transfer) each qualifying agreement, subject to court approval and a set of specific requirements.¹

Which Agreements Section 365 Reaches

A contract is “executory” when both sides still owe meaningful performance. The test, developed by professor Vern Countryman and widely adopted by courts, asks whether each party’s remaining duties are significant enough that walking away would be a material breach. A commercial lease with rent still owed on one side and usable space still owed on the other is the classic example. Equipment leases, software service agreements, and ongoing consulting arrangements also qualify.

An agreement where one side has already finished and the other just owes money is not executory. It’s simply a debt and runs through the ordinary claims process. An “unexpired lease” is any rental agreement that hasn’t reached its natural end date. Section 365 only applies to agreements fitting one of these two categories, so proper classification is the first step in every case.

Assume, Reject, or Assign

Assuming a contract means the debtor keeps it, performs going forward, and fixes any past problems. Rejecting a contract means the debtor walks away and the agreement is treated as breached. Assigning a contract means the debtor transfers both the rights and obligations to a new party.

The calculus is practical: keep what helps the recovery, shed what drags it down. A restaurant chain in Chapter 11 might assume leases at profitable locations, reject leases at money-losing ones, and assign a lease at a closing location that another operator wants to take over. The three-way choice is one of the most powerful tools in the bankruptcy process.

What It Takes to Assume a Contract

Assuming a contract that’s already in default requires three things under §365(b). The debtor must cure the default or show a concrete plan to cure it promptly. If back rent of $10,000 is owed, that balance has to be paid or scheduled for prompt payment. The debtor must also compensate the other party for actual financial losses caused by the default. And the debtor must provide adequate assurance of future performance, usually through financial statements, bank records, or revenue projections demonstrating the ability to meet ongoing obligations.¹

Courts take adequate assurance seriously. A new line of credit, a revised budget, or signed contracts with new customers can serve as evidence. If the debtor can’t make the showing, the court denies the assumption request and the contract dies.

Not every default involves money. Section 365(b)(2) excuses the debtor from curing certain non-monetary defaults when going back and fixing them is genuinely impossible. There’s a catch for commercial tenants: if the default involves failing to operate in accordance with lease terms, the debtor must resume compliant operations going forward and compensate the landlord for resulting financial losses.¹

How Assignment Works

Assignment lets the debtor hand off a valuable contract or lease to someone else, often generating cash for the estate. It’s a two-step process. The debtor must first assume the contract, meeting every requirement above, and then the proposed assignee must independently demonstrate adequate assurance of future performance.¹

One of the more aggressive features of §365(f) is that it overrides anti-assignment clauses. Even if the contract says it cannot be assigned, the trustee can assign it anyway so long as the statutory requirements are met. Clauses that would terminate or modify the contract because of an assignment are equally unenforceable.

Assignment is off the table in certain cases. Under §365(c), a contract cannot be assumed or assigned if applicable law excuses the non-debtor party from accepting performance by someone other than the original debtor and that party doesn’t consent. This commonly arises with personal service contracts, government contracts, and similar arrangements where the identity of the performing party is fundamental. Contracts to make loans or extend financing to the debtor are also non-assignable.

What Rejection Does

Rejection creates a legal fiction: the law treats it as if the debtor breached the contract immediately before filing bankruptcy.¹ The timing matters. The other party’s damages claim is treated as a prepetition general unsecured claim and paid at the same low priority as other basic debts. The non-debtor party gets no special status just because the debtor actively chose to walk away.

For landlords, there’s a further limit. Section 502(b)(6) caps the damages a landlord can claim after a real property lease is rejected. The cap equals rent (without acceleration) for the greater of one year or 15 percent of the remaining lease term, capped at three years, plus any unpaid rent already due before filing or surrender.² Without the cap, a single landlord on a long-term lease could swallow most of the estate.

Deadlines to Decide

Procedural clocks run differently depending on the chapter filed and the type of property. Missing a deadline doesn’t just lose leverage. It can forfeit the contract.

Chapter 7 Liquidation

The trustee has 60 days from the order for relief to assume or reject. If no action is taken, the contract is automatically deemed rejected.³ Courts enforce this strictly.

Chapters 9, 11, 12, and 13

For residential real property leases and personal property leases, the debtor can wait until plan confirmation to decide. Any party to the contract can ask the court to set a shorter deadline, and courts regularly do so when the delay is hurting the non-debtor party.¹

Nonresidential Real Property

Commercial leases face the tightest deadline. The debtor must assume or reject by the earlier of 120 days after the order for relief or the date of plan confirmation. The court can grant one 90-day extension for cause, but only if the motion is filed before the initial 120-day period expires. Any further extension requires the landlord’s written consent for each additional period.¹ If the deadline passes without action, the lease is deemed rejected and the debtor must immediately surrender the property. A missed calendar entry can cost a business its most valuable location.

Obligations While the Decision Is Pending

The period between filing and the assumption-or-rejection decision isn’t a free ride. For commercial real property leases, the debtor must continue performing all lease obligations, most importantly paying rent, from the filing date until the lease is either assumed or rejected.¹ The court can extend the performance window for obligations arising within the first 60 days, but no further. A landlord’s acceptance of these payments doesn’t waive rights under the lease or the code.

These post-petition rent obligations typically receive administrative expense priority, meaning they get paid ahead of general unsecured claims. If the debtor occupies commercial space for three months while deciding, the landlord is entitled to full rent for those three months as an administrative expense, not pennies on the dollar through the claims process.⁴

For personal property leases in Chapter 11 cases, think equipment or vehicle leases, the debtor must timely perform all obligations arising after the first 60 days following the order for relief. This provision does not apply to leases of personal property used primarily for household purposes.

When the Other Side Is the Debtor

Most of §365 addresses the debtor’s position. But a tenant whose landlord files bankruptcy and rejects the lease isn’t left without options. Under §365(h), the tenant can treat the lease as terminated and walk away, or stay in the property for the remaining term and any enforceable renewal periods.¹

A tenant who stays keeps all lease rights, including those related to rent amounts, use of the space, subletting, and quiet enjoyment. If the landlord stops providing services after rejection, such as maintenance or common area upkeep, the tenant can offset the value of those lost services against future rent. The tenant cannot pursue other claims against the estate for post-rejection damages. This matters most for commercial tenants who have invested heavily in a location and cannot relocate quickly.

Intellectual property licensees get a parallel protection. When a licensor rejects a license, §365(n) lets the licensee treat the contract as terminated or elect to keep using the licensed intellectual property for the remaining contract term and any extensions available by right, as long as it continues paying required royalties.¹ A licensee that retains its rights gives up the ability to offset amounts owed and waives administrative expense claims arising from the contract. In exchange, the trustee must provide the intellectual property (including physical or digital embodiments) and cannot interfere with continued use.

The statutory definition of “intellectual property” covers trade secrets, patented inventions, copyrighted works, plant varieties, and mask works.⁵ Trademarks are not on that list. The Supreme Court’s 2019 decision in Mission Product Holdings v. Tempnology narrowed the gap by holding that rejection is a breach rather than a rescission, so a trademark licensee’s rights can survive rejection even without §365(n)’s explicit protection.⁶

Shopping Center Leases

Shopping center leases get a heightened set of rules under §365(b)(3). A shopping center landlord has economic interests beyond rent from a single tenant, including maintaining a particular mix of businesses, honoring exclusivity agreements with other tenants, and preserving the center’s overall appeal. The code imposes additional requirements before a debtor can assume or assign a shopping center lease.

Adequate assurance for a shopping center lease must demonstrate all of the following:

The source of rent is reliable, and any proposed assignee has financial condition and operating performance comparable to the original debtor at the time the lease began.
Any percentage rent owed under the lease will not decline substantially.
The assumption or assignment complies with all lease provisions, including use restrictions, exclusivity clauses, and radius provisions, and won’t breach those same provisions in other leases or master agreements covering the center.
The assumption or assignment won’t disrupt the center’s tenant mix or balance.

If a landlord rejects a shopping center lease and the tenant elects to stay under §365(h), the lease’s restrictive covenants remain enforceable, protecting the tenant’s competitive position within the center.

Ipso Facto Clauses Don’t Work

Many contracts include provisions that automatically trigger a default or termination if a party files bankruptcy or becomes insolvent. These “ipso facto” clauses are generally unenforceable under §365(e). A contract cannot be terminated or modified solely because the debtor filed bankruptcy, became insolvent, or had a trustee appointed.¹ Without this rule, debtors would lose their most valuable contracts the moment they filed, defeating the purpose of reorganization.

Two exceptions apply. If applicable law outside the contract excuses the non-debtor party from performing with anyone other than the original debtor and that party doesn’t consent, the ipso facto protection doesn’t help. And contracts to make loans or extend financing to the debtor are exempt. A bank isn’t forced to keep lending to a borrower in bankruptcy just because the loan agreement is technically executory.

1
Office of the Law Revision Counsel. 11 USC 365 – Executory Contracts and Unexpired Leases
2
Office of the Law Revision Counsel. 11 USC 502 – Allowance of Claims or Interests
3
Legal Information Institute. Federal Rules of Bankruptcy Procedure Rule 6006
4
United States Department of Justice. Civil Resource Manual 60 – Executory Contracts in Bankruptcy
5
Office of the Law Revision Counsel. 11 USC Chapter 1 – General Provisions
6
Supreme Court of the United States. Mission Product Holdings Inc v Tempnology LLC