Navigating Chapter 11 Lease Strategies: Key Takeaways from the SBLI 2026 Panel

At SBLI 2026, bankruptcy experts Jennifer McLemore, Chris Ward, and Scott Williams presented a comprehensive breakdown of section 365 real estate lease dynamics in Chapter 11 cases. Managing unexpired nonresidential real property leases requires balancing estate value optimization, statutory timing constraints, and tactical leverage.

1. Assume, Assign, or Reject: The Debtor’s Decision Framework

A Chapter 11 debtor’s lease election under 11 U.S.C. § 365 is fundamentally an estate-value optimization process bounded by statutory rules and practical constraints.

  • Estate Triage: Debtors evaluate whether a lease creates operational value, holds market value for assignment, or acts as a financial drain. Below-market leases are primed for assumption; transferable leases are targeted for assumption and assignment; and above-market or underperforming locations are queued for rejection.
  • Statutory Timing Constraints: Debtors must elect to assume or reject nonresidential real property leases within 120 days of the petition date, extendable once by 90 days for a maximum 210-day decision window without explicit landlord consent.
  • Assumption Requirements: Assumption requires curing existing monetary and non-monetary defaults (or providing adequate assurance of prompt cure) and establishing adequate assurance of future performance. Leases cannot be assumed à la carte; master leases must be assumed in full.
2. Tactical Leverage & Designation Rights

Because standard lease assumption or rejection is subject to the deferential business judgment standard, debtors utilize the decision framework as bargaining leverage.

  • The Rejection Threat: Debtors credibly leverage the threat of lease rejection—and the resulting capped unsecured claim—to force landlords into negotiating rent concessions, term modifications, or default waivers.
  • Monetizing via Designation Rights: In retail portfolio cases, debtors frequently monetize lease value through § 363 sales of “designation rights”. A third party purchases the right to market the leases and designate assignees during a court-approved period, outsourcing marketing costs and shifting carrying risk away from the estate.
  • Shopping Center Protections: Assigning shopping center leases triggers heightened statutory “adequate assurance” safeguards under § 365(b)(3), designed to protect tenant mix, operating performance, and financial stability.
3. Lease Rejection Damages under Section 502(b)(6)

Rejection converts future lease obligations into a prepetition unsecured claim subject to statutory caps.

  • The Statutory Formula: Under § 502(b)(6), a landlord’s rejection damages are capped at the rent reserved under the lease (without acceleration) for the greater of one year, or 15 percent (not to exceed three years), of the remaining lease term.
  • Cap Starting Point: The cap is calculated following the earlier of the petition date or the date the landlord repossessed/lessee surrendered the premises, plus any unpaid pre-petition rent due.
  • Scope Limits: The statutory cap strictly applies to damages resulting from lease termination and does not cap distinct non-lease damages (In re Kupfer).
4. Defining “Adequate Assurance” Standards

Adequate assurance functions under two distinct standard perspectives in § 365:

  • The Rearview Mirror (Backward-Looking): Governed by § 365(b)(1)(A) & (B), requiring cure or adequate assurance of prompt cure/compensation for pre-existing default. Landlords bear the legal burden of affirmatively raising pre-assumption defaults (In re Diamond Mfg. Co.).
  • The Front Windshield (Forward-Looking): Governed by § 365(b)(1)(C), requiring the debtor or assignee to demonstrate financial and operational capability for future performance. Courts evaluate this using factual conditions and commercial standards rather than strict legal technicalities (In re Sapolin Paints, Inc.).
5. Section 365(h): Protections When the Debtor is the Landlord

Section 365(h) creates a unique power shift when a debtor landlord elects to reject a lease.

  • Tenant Retention Rights: If a debtor landlord rejects an unexpired lease, § 365(h)(1)(A)(ii) permits non-debtor tenants to remain in possession for the balance of the term (and renewals), preserving rights like rent terms, quiet enjoyment, and use.
  • Rent Offsets: Under § 365(h)(1)(B), if the debtor landlord ceases maintenance or required services, the tenant may perform those duties and offset the costs directly against future rent.
  • Section 363 Sales Conflicts: In § 363 sales free and clear of liens and interests, passive tenants risk losing leasehold rights unless they actively object and request adequate protection prior to sale consummation (In re Spanish Peaks Holdings II, LLC).
  • Pre-Bankruptcy Protection: To mitigate bankruptcy risk, commercial tenants should execute Subordination, Non-Disturbance, and Attornment Agreements (SNDAs) and record a Memorandum of Lease in local land records.

The attorneys at Keck Legal LLC represent businesses and creditors across the full business lifecycle, with a focus on complex restructuring, bankruptcy, and commercial transactions.

 

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