When a business files for Chapter 11, every commercial lease on its books immediately becomes a strategic decision — not just a contractual obligation. Whether a lease is an asset worth preserving, a liability worth shedding, or a bargaining chip worth monetizing depends on market conditions, the terms of the lease, and how quickly counsel moves.

The Southeastern Bankruptcy Law Institute’s 52nd Annual Seminar featured a detailed panel discussion on how Chapter 11 debtors, landlords, and commercial tenants navigate unexpired nonresidential real property leases under 11 U.S.C. § 365. What follows is a practical breakdown of the key issues every business attorney should understand.

 

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

A Chapter 11 debtor’s lease election under § 365 is fundamentally an estate-value optimization process. The decision framework is bounded by statutory deadlines and practical constraints — and it is one of the most consequential early decisions in any Chapter 11 case.

 

Estate Triage

The starting point is evaluating each lease on its own terms. Below-market leases are typically assumed — they represent a financial benefit worth preserving. Leases with strong assignment value are targeted for assumption and assignment to generate cash for the estate. Above-market leases or locations that no longer serve the business are queued for rejection. The debtor’s goal is to shed financial drag, retain value, and create optionality.

 

Statutory Timing Constraints

Timing is critical. Under § 365, a Chapter 11 debtor must elect to assume or reject nonresidential real property leases within 120 days of the petition date. That window can be extended once by 90 days — for a maximum of 210 days — without explicit landlord consent. Missing this deadline is not a recoverable error; the lease is deemed rejected by operation of law.

 

Assumption Requirements

Assuming a lease is not a simple election. The debtor must cure all existing defaults — both monetary and non-monetary — or provide adequate assurance of prompt cure. The debtor must also demonstrate adequate assurance of future performance. One important constraint: leases cannot be assumed selectively. A master lease must be assumed in full or not at all. Debtors cannot cherry-pick favorable terms while leaving others behind.

 

2.  Tactical Leverage and Designation Rights

Because the business judgment standard governs lease assumption and rejection decisions, debtors have broad discretion — and they use it as leverage.

 

The Rejection Threat

A credible threat of rejection is a negotiating tool. Landlords facing the prospect of a capped unsecured claim — rather than continued rent payments — often have strong incentive to negotiate. Debtors leverage this dynamic to obtain rent concessions, term modifications, or waivers of existing defaults that would otherwise be difficult to unwind outside of bankruptcy.

 

Monetizing Leases Through 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. This approach outsources marketing costs, shifts carrying risk away from the estate, and can generate significant recoveries on leases that the debtor cannot or does not intend to operate.

 

Shopping Center Protections

Assigning shopping center leases triggers heightened statutory protections under § 365(b)(3), designed to protect the landlord’s tenant mix, operating performance, and financial stability. Proposed assignees must meet elevated “adequate assurance” standards, including financial capacity and operational compatibility with the center’s existing tenant profile.

 

3.  Lease Rejection Damages Under Section 502(b)(6)

When a debtor rejects a lease, that rejection converts future rent obligations into a prepetition unsecured claim — subject to a statutory cap that significantly limits landlord recoveries.

 

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. The cap is calculated from the earlier of the petition date or the date the landlord repossessed the property or the debtor surrendered it, plus any unpaid pre-petition rent.

 

Scope of the Cap

The statutory cap applies strictly to damages resulting from lease termination. It does not cap distinct non-lease damages — such as claims arising from property damage, environmental liability, or other non-rent obligations. Courts have confirmed this limitation (In re Kupfer), and landlords should be careful not to conflate capped rejection damages with the full range of claims available to them.

 

4.  Defining “Adequate Assurance” Standards

“Adequate assurance” is one of the most litigated concepts in § 365 practice. It operates differently depending on whether the analysis looks backward at existing defaults or forward at future performance.

 

Backward-Looking: Curing Existing Defaults

Under § 365(b)(1)(A) and (B), a debtor must cure or provide adequate assurance of prompt cure for pre-existing defaults before a lease can be assumed. Importantly, landlords bear the burden of affirmatively raising pre-assumption defaults — they are not automatically preserved (In re Diamond Mfg. Co.). Counsel representing landlords should ensure all defaults are clearly identified on the record before assumption is approved.

 

Forward-Looking: Future Performance

Under § 365(b)(1)(C), the debtor or proposed assignee must demonstrate financial and operational capability to perform future lease obligations. Courts evaluate this using factual conditions and commercial standards — not strict legal technicalities (In re Sapolin Paints, Inc.). The analysis is practical: can this party actually perform? Evidence of financial strength, operating history, and business plan are all relevant.

 

5.  Section 365(h): When the Debtor Is the Landlord

The analysis changes significantly when the debtor is not the tenant but the landlord. Section 365(h) creates a unique framework that shifts leverage toward the non-debtor tenant.

 

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 lease term — including any renewal periods — preserving their rights to rent terms, quiet enjoyment, and permitted use. The tenant’s decision to remain in possession is an election that must be made carefully and on the record.

 

Rent Offsets for Failed Services

Under § 365(h)(1)(B), if the debtor landlord stops providing maintenance or required services after rejection, the tenant may step in, perform those obligations, and offset the costs directly against future rent. This self-help remedy can be significant in commercial settings where the debtor landlord controls essential building systems.

 

Section 363 Sales and Tenant Risk

Tenants face particular risk when a debtor landlord pursues a § 363 sale free and clear of liens and interests. Passive tenants risk losing leasehold rights entirely unless they actively object and request adequate protection before the sale is consummated (In re Spanish Peaks Holdings II, LLC). Waiting is not a viable strategy.

 

Pre-Bankruptcy Protection for Commercial Tenants

The most effective protection against landlord bankruptcy risk is established before any filing occurs. Commercial tenants should execute Subordination, Non-Disturbance, and Attornment Agreements (SNDAs) with their landlord’s lender, and record a Memorandum of Lease in local land records. These steps preserve leasehold rights even through a sale or foreclosure and are significantly easier to obtain before a bankruptcy filing than after.