Bankruptcy is a challenging process for any business, especially when it involves assets like leasehold interests. A business leasehold — the right to occupy or use leased premises — can be a valuable asset or a burdensome liability, depending on the terms and market conditions. When a company files for bankruptcy, the treatment and potential sale of these leaseholds become important parts of the proceedings, impacting landlords, creditors, and the debtor itself.
Understanding Business Leaseholds in Bankruptcy
A leasehold is a contractual agreement giving the business the right to use real property for a specified period. This could include office space, warehouses, or retail stores. In bankruptcy, these leaseholds are considered executory contracts — ongoing agreements where both parties still have performance obligations.
Under U.S. bankruptcy law (particularly Chapter 11 and Chapter 7 cases), leaseholds are treated with specific considerations governed by the Bankruptcy Code, particularly Section 365.
Key Legal Concepts
1. Assumption or Rejection
The debtor (or trustee) must decide whether to assume (keep) or reject (terminate) the lease:
-
Assumption: The lease continues, and the debtor must cure any defaults and continue performance.
-
Rejection: The lease is terminated, and any resulting damages become unsecured claims.
The decision typically must be made within 120 days (with possible extensions), especially in Chapter 11 cases.
2. Assignment and Sale
If a lease is assumed, it can be assigned or sold to another party, even if the lease contains anti-assignment clauses — as long as the new party provides adequate assurance of future performance. This can unlock value for the estate and help satisfy creditor claims.
Sale of Leaseholds in Bankruptcy
In certain markets, a business lease — especially one with favorable terms or a prime location — can be a highly desirable asset. Here's how the sale process generally works:
Step 1: Assumption of the Lease
The debtor must first assume the lease, which includes curing any unpaid rent and addressing defaults. The court must approve this step.
Step 2: Finding a Buyer or Assignee
The debtor or trustee then markets the lease to potential buyers. Common buyers include:
-
Competitors or industry players
-
Investors or real estate firms
-
Landlords looking to regain control or re-lease the space at a higher rate
Step 3: Approval and Transfer
The court must approve the sale or assignment, ensuring that the proposed assignee is capable of fulfilling the lease obligations. The landlord's concerns are considered, but the Code allows assignment over objections if legal criteria are met.
Impact on Landlords and Creditors
-
Landlords: Must be notified of the debtor’s intentions and have the right to object to assumption or assignment, especially if it threatens the property's value or tenant mix.
-
Creditors: The proceeds from the sale of a leasehold become part of the estate and can help pay secured or unsecured claims.
Practical Considerations
-
Lease Terms Matter: Leases with below-market rent, long duration, and minimal defaults are more likely to be assumed and sold.
-
Market Conditions: In a strong real estate market, leases can be sold for a premium. In weaker markets, they may be rejected and returned to landlords.
-
Negotiations: Landlords may negotiate lease modifications or buybacks during bankruptcy to regain control over the space.
Conclusion
Business leaseholds are a complex but often overlooked component of bankruptcy cases. Whether the goal is to retain, terminate, or sell a leasehold interest, these decisions must balance the needs of the business, its creditors, and landlords. With strategic planning and legal guidance, the treatment and sale of leaseholds can unlock significant value — or help streamline a company's exit from burdensome obligations.
