How does Chapter 11 handle unprofitable leases?

On Behalf of | Oct 19, 2020 | Chapter 11

If your business seems headed for financial insolvency, the problem might be your leases. Like other businesses, you enter into leases with landlords to set up your business locations across your community. But if one or more of these locations does not draw in a substantial amount of customers on a regular basis, your whole business may suffer.

Businesses cannot break leases on a whim without suffering financial consequences. This is where Chapter 11 bankruptcy can make a difference. A business that is facing financial problems may use Chapter 11 to break unprofitable contracts, and leases are no exception.

The problems with breaking leases

According to the American Bar Association, a business may try to break a lease before the lease period has expired, but it will come at a cost. Say that you have three years left on a lease, but the business location is bleeding money. You might break the lease, but the landlord will likely insist on payment for the rent for the remaining three years.

In addition, if a landlord finds a new tenant after you break a lease and the tenant pays a lower market rent, the landlord might obligate you to pay the difference. Paying years’ worth of rent or other damages may be as bad or worse than letting your unprofitable location remain open.

Capping your damages

If you file for Chapter 11 bankruptcy, you may break your lease while reducing the financial consequences for doing so. Bankruptcy allows you to cap your damages to just one year worth of damages or 15% of the remaining rent up to a three year period, whichever one of these is greater. The damages you will have to pay for breaking a lease will also become part of your bankruptcy reorganization plan.

Assume and assign

Chapter 11 may also give you a way to move your lease from an unprofitable location to somewhere that might generate profits for your business. For instance, you might learn that another landlord wants to work out a lease with your business. Under Chapter 11 bankruptcy, you have the option under assume and assign to transfer your existing lease to this new location.

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