When you file for Chapter 7 bankruptcy, any leases or unfinished contracts get special handling. The trustee assigned by the court to administer your case will decide whether the lease or contract benefits the bankruptcy estate—that is, will staying in the lease or continuing the contract help pay creditor claims? If the answer is yes, the trustee will "assume" the obligation. But if fulfilling the lease or contract will be a burden (deplete the estate's assets to the detriment of creditors), the trustee will "reject" it.
In this article, you'll learn what it means to assume a lease or contract and how likely it is that the trustee will assume your lease or contract.
Executory means the contract is still in force—that is, both parties are still obligated to perform important acts. Similarly, unexpired means that the contract or lease period hasn't run out, therefore, it is still in effect. Common examples of executory contracts and unexpired leases include:
When you file for Chapter 7 bankruptcy, the court appoints a trustee to oversee the case. In a way, the trustee steps into your shoes and is charged with the responsibility for carrying out some of the duties that would ordinarily belong to you. When the trustee encounters a lease, the trustee will, just as a tenant would, evaluate whether it makes economic sense to stay in the lease or
The Chapter 7 bankruptcy trustee has 60 days (120 days for a nonresidential lease) after you file for bankruptcy to decide whether to assume an executory contract or unexpired lease. If the lease or contract would generate funds for your unsecured creditors (creditors whose debt isn't secured by collateral), and the court agrees that it should be assumed, then the trustee will assume it; otherwise, after 60 days (or 120 days) elapses, it will be deemed rejected.
A trustee who assumes a lease or contract is generally substituting the bankruptcy estate for the debtor as the responsible party. But, most of the time, the trustee goes one step further and sells or assigns the contract or lease to a third party. That brings in money that the trustee can use to pay the creditors.
As a general matter, the trustee rejects most leases and contracts because they don't have any value to the creditors (more below) or because the contract contains language prohibiting a transfer of interests (these restrictions are typically in clauses titled "No Assignment and Subletting").
The trustee accomplishes the assumption of the lease or contract by filing a motion with the court and obtaining approval from the judge. To reject the contract or lease, the trustee is not required to take any action.
As a general rule, people filing for Chapter 7 bankruptcy aren't involved in leases or contracts that would likely add value to their bankruptcy estates. This isn't an absolute rule, however.
If the trustee could sell a lease or contract to someone else for a profit (because you're paying less than market rent, for example), the trustee might assume the lease and assign it for a lump sum that could be distributed to your creditors. But this doesn't often happen with leases in consumer bankruptcy cases.
When a trustee assumes a lease or a contract, it is almost always for the purpose of selling it or assigning it to a third party for money that the trustee will use to pay creditor claims. But that isn't always the case. If the debtor is a business or the debtor operates a sole proprietorship, the trustee could determine that there would be value in the contract if it could continue for some time. (Note that this is rare and only occurs with commercial contracts.) Here's an example:
Example: Sunshine Bird Baths, Inc. filed bankruptcy just as it started work on a contract to supply the City of Frisco with 150 park fountains at $2,500 each. It would take Sunshine just two weeks to produce those 150 fountains. Usually, work stops immediately when a company files a Chapter 7 case, but here the trustee decided to run the company for the two weeks it would take to complete the contract and earn $375,000.
Assuming and assigning certain contracts can be problematic. Contracts that involve the provision of personal services, like painting a mural for an office building, are not assignable by law, because presumably, the client chose the painter because of the artist's skill and reputation. It would be unfair to the parties to substitute a painter whom the parties had not chosen.
If the trustee rejects a lease, you'll have the right to assume it on your own, as long as you give the creditor written notice and the creditor agrees. You provide this written notice on the Statement of Intention for Individuals Filing Under Chapter 7 form, which you file with your bankruptcy papers.
It's also possible that you'll want to get out of a lease, such as an auto lease you can't afford. On the same paperwork, you'll indicate that you will not assume the lease by checking the appropriate box. Any money that you owe under that lease or contract will be discharged (eliminated) along with your other unsecured debts (credit cards, medical bills, personal loans.)
After terminating the lease or contract, you and the other parties to the agreement are cut loose from any obligations, and any money you owe the creditor will be discharged in your bankruptcy, even if the debt arose after your filing date.
Say you are leasing a car when you file for bankruptcy, and you want out of it. The car dealer cannot repossess the car until the trustee terminates the lease, which normally must occur within 60 days of filing. During that 60-day period, you can use the car without paying for it. The court will discharge the payments you don't make just as if they came due before your bankruptcy. Of course, you will have to surrender the property if you don't assume the contract.
Rent-to-own contracts have some of the characteristics of a lease or rental agreement. You make regular payments and can turn the furniture, appliance, or electronic equipment back into the store whenever you want to stop paying for it. But, they also share some characteristics with loans that have security agreements covering collateral. After making payments for some agreed-upon period of time, according to the paperwork, you own it. But if you fail to make a regular payment in the meantime, the store will come knocking at your door, expecting you to turn over its collateral.
Rent-to-own contracts and loans with security agreements are treated differently in bankruptcy cases, depending on the type of bankruptcy you file.
Chapter 7. If the contract is a lease agreement like the ones we've considered in this article, the appropriate procedure is for the trustee to assume or reject the contract. If it's rejected, the debtor can choose to assume and continue paying it according to its terms, or reject it and discharge any remaining debt.
If the contract is a security agreement, the Chapter 7 debtor could keep the collateral by entering into a reaffirmation agreement (agree to pay the contract out according to its terms), or by redeeming the collateral
Chapter 13. In a Chapter 13 case, the debtor will pay a rent-to-own agreement according to its terms. The rent-to-own contract will normally be treated like a rental agreement and be paid outside the Chapter 13 plan. If the rent-to-own contract is a security agreement, the Chapter 13 debtor might be able to change the terms of repayment significantly by reducing the interest rate and paying only the value of the collateral, in a process known as a "cramdown."
How do you tell if a rent-to-own contract is a rental agreement or a secured loan? Bankruptcy lawyers and finance specialists have grappled with this question for years. The law provides no clear definitions, very few states have attempted to define the difference, and the bankruptcy laws provide little help. In most cases, it comes down to local practice and the preferences of the creditor.
If you have a rent-to-own agreement and you're considering filing bankruptcy, an experienced bankruptcy attorney can help you sort it out.
You'll list all executory contracts and leases on the official bankruptcy form Schedule G: Executory Contracts and Unexpired Leases. You'll also list any associated property on Schedule A/B: Property and any related debt on Schedule E/F: Creditors Who Have Unsecured Claims. (Learn more in How to Fill Out Bankruptcy Forms.)
Like many things in bankruptcy, understanding what will happen to your property—including leases and contracts—can be confusing. Consider speaking to a local bankruptcy attorney before deciding whether bankruptcy is right for you.