Patrick O'Malley

Rejecting & Renegotiating Leases and Contracts In Bankruptcy

Debt relief is not the only benefit of bankruptcy. In fact, for a business with a large exposure to expensive ongoing contracts, there is a much benefit greater than debt relief. This most powerful bankruptcy tool is the business’ right to either continue with or reject almost any contract that the firm has with third parties. Commercial leases for both real estate and for equipment are typically the largest contracts involved in a bankruptcy. Most importantly, the third party does not need to agree to any of this, such is the power of bankruptcy. Bankruptcy allows you to reject contracts that no longer serve your firm’s interests. Maybe you are leasing an expensive piece of equipment that you no longer need to conduct your business. If so, you can reject the remaining term of the contract and return the equipment to the third party. Penalties, if any, would be given low priority as an unsecured debt.

The counterparty knows all of this, or they will as soon as they consult with their attorney. Given the abysmal economy, they also know the long odds against finding a replacement buyer or lessee. This gives them enormous financial incentive to renegotiate existing agreements. This renegotiation can happen out of court or during the bankruptcy case.

Examples:

Filer Fred leased heavy equipment. Then the construction market dried up. The machines are gathering dust. Fred can reject the contract and return the keys to the equipment lessor. In the unlikely scenario where the lessor actually bothers to sue for contract breach, any damages so awarded are shunted into the class of unsecured creditors, which on average receives two cents on the dollar.

Filer Fred signed a lease that was priced at the top of the commercial real estate market in 2019. Fast forward to 2020 and the lease is priced far above current market rates. The landlord isn’t particularly willing to renegotiate. Fred wants to keep his business running. So he must decide if he still needs this particular commercial space to conduct his business. If he does, then his worst case is that he will be stuck with the original lease even after bankruptcy. If he doesn’t need this particular space, then bankruptcy will allow him to reject the lease and any penalties would be treated as a very low-priority unsecured creditor. The reality is, when the landlord knows he may lose a paying tenant in a high-vacancy market, he will have every incentive to renegotiate terms that are more commercially reasonable.

A filer’s ability to accept, reject and renegotiate contracts is a simple concept to understand. It is complex to strategize and implement.

Contact us for help

Business Bankruptcy Solutions helps Coloradoans lower their debts, renegotiate contracts and save their businesses. Call (720) 674-7311 or email now to schedule a free consultation. We will discuss the problems facing both your business and personal finances and the tools we can use to achieve your goals. We draw upon decades of legal and business experience to provide you with actionable solutions. With BBS on board, we’ll help you weather this storm.

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