How to Avoid Losing Key Contracts in a Chapter 11 Reorganization
- Melissa A. Youngman
- Mar 6
- 15 min read
By Melissa A. Youngman Florida Chapter 11 & Subchapter V Business Reorganization Attorney | Winter Park, FL
For many businesses, the value of the enterprise is not primarily in its physical assets. It is in its contracts.
A long-term supply agreement that locks in below-market pricing. A commercial lease in a location the business spent years building its customer base around. A software license that runs the business's core operations. A government service contract that represents 40 percent of annual revenue. A franchise agreement. A distribution deal. A key customer relationship governed by a master service agreement.
When a business files for Chapter 11, these contracts, and whether the business emerges from bankruptcy still holding them, can determine whether the reorganization succeeds or fails. Contracts that survive the process intact can form the foundation of a viable reorganized business. Contracts that are lost, whether through inadvertent rejection, a counterparty's termination attempt, or a missed deadline, can make reorganization economically impossible.
This is one of the most consequential and least-discussed dimensions of Chapter 11 practice. The Bankruptcy Code gives debtors significant tools to protect and preserve their most important contractual relationships. But those tools require deliberate, early, and informed use. Businesses that understand how the framework operates before they file are in a substantially better position than those who discover it in the middle of the case.
The Legal Framework: Section 365 and Executory Contracts
The rules governing contracts in Chapter 11 are primarily found in Section 365 of the Bankruptcy Code. Under that section, a business that files for Chapter 11, operating as the "debtor in possession," has the authority to assume, reject, or assume and assign what are known as executory contracts and unexpired leases.
An executory contract is generally defined as an agreement under which material performance obligations remain on both sides. The classic formulation, which courts have widely adopted, is that an executory contract is one where the failure of either party to complete performance would constitute a material breach. Supply agreements, service contracts, software licenses, distribution agreements, franchise agreements, and most long-term commercial relationships typically qualify. A promissory note, by contrast, is usually not executory once the money has been lent because the only remaining obligation is repayment.
Unexpired leases are leases for real or personal property that remain in effect as of the bankruptcy filing date, such as office leases, warehouse leases, equipment leases, vehicle fleets. The choice between assumption and rejection is, in most cases, one of the most strategically important decisions in a Chapter 11 case.
Assumption means the debtor commits to continuing to perform under the contract going forward. The contract survives into the reorganized business. The counterparty has the right to receive cure payments for any pre-bankruptcy defaults, and the debtor must demonstrate adequate assurance of future performance.
Rejection is treated under the Bankruptcy Code as a breach of the contract as of the day before the bankruptcy filing. The counterparty no longer receives ongoing performance and holds an unsecured claim for rejection damages which in a reorganization may recover only a fraction of the claimed amount, and in many cases significantly less.
The debtor in possession generally has until the confirmation of the reorganization plan to decide which contracts to assume and which to reject, with one critical exception for commercial real property leases discussed below.
The First Thing Business Owners Get Wrong: Assuming Contracts Will Automatically Terminate
Before addressing how to protect key contracts in a Chapter 11, it is worth correcting the most common misunderstanding about how filing for bankruptcy affects existing agreements.
Nearly every commercial contract includes a clause that purports to terminate the agreement automatically upon the filing of a bankruptcy petition by either party. These clauses — known as ipso facto provisions — appear standard. Many business owners (and even some attorneys who don't regularly practice in bankruptcy) assume they are enforceable.
They are not. Under Sections 365(e)(1) and 541(c)(1)(B) of the Bankruptcy Code, ipso facto clauses are unenforceable in bankruptcy. A contract cannot be legally terminated, by the counterparty or automatically, solely because one party filed for bankruptcy, became insolvent, or experienced a deterioration in financial condition. The Bankruptcy Code renders these provisions void as a matter of federal law.
This is a foundational protection, and it matters enormously in practice. Without it, the moment a business filed for Chapter 11, every vendor, landlord, licensor, and customer with a "termination on bankruptcy" clause could exit the relationship, stripping the debtor of every material contract simultaneously. The business would have nothing left to reorganize around.
Florida bankruptcy courts have consistently applied this protection, reinforcing that ipso facto clauses cannot serve as the basis for terminating executory contracts after a bankruptcy filing. See 11 U.S.C. § 365(e)(1); In re Ernie Haire Ford, Inc., 403 B.R. 750, 758 (Bankr. M.D. Fla. 2009).
There are narrow exceptions, particularly for contracts governed by financial market safe harbor rules (securities contracts, swap agreements, and certain financial accommodations) and for certain personal services contracts where applicable law otherwise bars assignment. But, for the vast majority of ordinary commercial agreements, the ipso facto prohibition holds.
The practical implication: a counterparty who receives notice of a Chapter 11 filing and sends the debtor a termination notice citing the bankruptcy clause is violating the automatic stay. The stay itself reinforces the ipso facto prohibition. Any act to terminate or modify a contract solely because of the filing is stayed under 11 U.S.C. § 362(a). Courts can impose sanctions, including actual damages and attorneys' fees, on parties who willfully violate the automatic stay.
What the Debtor Must Do to Keep a Contract: Cure and Adequate Assurance
Assuming a contract in Chapter 11 is not cost-free. The Bankruptcy Code requires the debtor to satisfy two conditions to assume an executory contract or lease where a pre-petition default exists:
First, cure the default. The debtor must pay or cure all monetary defaults under the agreement, including past-due amounts, unpaid invoices, rent arrears, and address any non-monetary defaults as well. Alternatively, the debtor can provide "adequate assurance" that the default will be promptly cured. The cure requirement ensures that counterparties are not simply saddled with the full pre-petition debt being dragged into a continuing relationship.
Second, provide adequate assurance of future performance. The debtor must demonstrate that the reorganized entity can and will perform its ongoing obligations under the contract going forward. What qualifies as adequate assurance depends on the circumstances. Courts have looked at post-reorganization cash flow projections, DIP financing availability, management stability, and the overall feasibility of the reorganization plan. The standard is not perfection; it is a reasonable basis to believe performance will continue.
These requirements create a negotiating dynamic that is important to understand. The counterparty to a contract the debtor wants to assume holds significant leverage: the debtor must resolve the arrearage and satisfy the court that it can perform. If the arrearage is large or the debtor's financial condition uncertain, this negotiation can be contentious.
Conversely, the counterparty to a contract the debtor does not need (or is prepared to reject) has little leverage at all. Rejection converts the counterparty's claim to an unsecured breach-of-contract claim, which in a reorganization often receives cents on the dollar. That asymmetry gives the debtor real negotiating power to renegotiate burdensome agreements: counterparties who prefer a modified ongoing relationship to an unsecured claim often agree to modified terms as a condition of assumption.
The Critical Deadline for Commercial Real Property Leases
For most executory contracts, the debtor has until plan confirmation to decide whether to assume or reject. For leases of nonresidential real property such as commercial office space, retail locations, warehouses, and manufacturing facilities, the rules are stricter and the deadline is unforgiving.
Under 11 U.S.C. § 365(d)(4), a Chapter 11 debtor has an initial 120-day period from the petition date to assume or reject a nonresidential real property lease. The court can grant one extension of up to 90 additional days for cause, bringing the maximum non-consensual extension to 210 days. After that, any further extension requires the written consent of the landlord, who has every incentive to withhold it.
If the lease is not assumed within this period, it is automatically deemed rejected. The lease is terminated. The landlord can demand surrender of the premises and file a damages claim. For a business whose location is essential, like a restaurant, a retail operation, a medical practice, or a professional services firm, an inadvertent lease rejection can end the reorganization before it begins.
The 210-day deadline sounds generous, but consider what is happening in a Chapter 11 case during those same months: the debtor is managing operations, negotiating with secured creditors, preparing schedules and statements, attending initial debtor interviews, responding to creditor motions, potentially negotiating DIP financing, and beginning to develop a plan of reorganization. The deadline for commercial leases runs concurrently with all of that.
For Subchapter V filers, small businesses with debt under $3,424,000 using the streamlined Chapter 11 process, the plan must be filed within 90 days of the petition. In practice, Subchapter V debtors with important commercial leases need to address those leases very early in the case, often as part of the initial planning before or immediately after filing.
The practical takeaway: any business considering Chapter 11 that holds commercial real property leases it must keep should treat the lease assumption decision as a Day 1 priority, not a mid-case task.
The Practical Strategy: Categorizing Contracts Before You File
The single most effective thing a business can do to protect its key contracts in a Chapter 11 is to analyze and categorize them before the petition is filed.
This analysis serves several functions. It identifies which contracts are executory and thus governed by Section 365. It maps out which agreements are essential to the reorganized business (candidates for assumption), which are unprofitable and should be exited (candidates for rejection, which converts counterparty claims to unsecured status), and which fall somewhere in between. It surfaces potential cure amounts and allows the debtor's counsel to estimate the cost of assuming the priority contracts. And it identifies counterparties who may attempt to exploit the bankruptcy to extract concessions or exit relationships, allowing the debtor's counsel to be prepared with the ipso facto argument and stay enforcement from the first day of the case.
For each material contract, the pre-filing analysis should address:
Is this agreement essential to the reorganized business? Would losing it make a workable reorganization plan impossible or substantially impair business value? If yes, this is a priority assumption candidate.
What are the current defaults? How large is the arrearage? Can the debtor fund a cure from operations or DIP financing? The cure cost affects the financial feasibility of the reorganization plan.
What does "adequate assurance" look like for this contract? For a major customer relationship, what does the debtor need to demonstrate to show adequate assurance? Financial projections, management continuity, DIP financing availability, operational track record?
Does the counterparty pose a termination risk? Some vendors and landlords will immediately attempt to terminate on bankruptcy grounds. Others will not. Identifying those likely to act aggressively allows the debtor to move first, filing a motion to assume the contract early in the case and establishing the automatic stay as a shield against termination attempts.
Is the contract a candidate for renegotiation rather than straight assumption? If the contract has above-market pricing, unfavorable terms, or an onerous structure, the threat of rejection may be the lever that brings the counterparty to the table to negotiate improved terms before assumption.
Specific Contract Types and Their Particular Risks
Not all contracts carry the same risk profile in Chapter 11. The following categories warrant particular attention:
Commercial real property leases. As discussed, the 120-day/210-day deadline creates urgency that is disproportionate to how quickly the rest of a Chapter 11 case develops. Location-dependent businesses, such as hospitality, retail, food and beverage, or healthcare businesses, should treat their leases as the first filing-day priority.
Software and technology licenses. Software licenses present complex issues because they may implicate intellectual property rules that create exceptions to the general rule allowing assumption and assignment. Non-exclusive patent licenses, in particular, are subject to arguments that they cannot be assumed without the licensor's consent. Technology-dependent businesses need their bankruptcy counsel to analyze these carefully before filing.
Customer contracts and master service agreements. For businesses that derive revenue from long-term customer relationships governed by written contracts, the assumption decision has both financial and relationship dimensions. A customer who receives a formal notice that their vendor has filed for bankruptcy may begin evaluating alternatives regardless of the legal prohibition on termination. Early, transparent communication with key customers, assuring them that the business is continuing and that their contracts will be assumed, can prevent relationship erosion that the Bankruptcy Code's protections alone cannot address.
Franchise agreements. Franchise agreements typically involve significant personal services and intellectual property components, and franchisors regularly argue that they are non-assumable without consent under the "applicable law" exceptions to the ipso facto prohibition. This is a live and fact-specific issue. Franchisees in Chapter 11 need counsel with experience in this specific intersection of franchise and bankruptcy law.
Government contracts. Federal government contracts are subject to the Anti-Assignment Act, which limits the assignment of government contracts without government consent. Assumption is generally permitted, but assignment requires government approval. Businesses that derive significant revenue from federal contracts need to understand this before filing.
Supply agreements with key vendors. If a supply agreement provides below-market pricing, or locks in access to critical raw materials or components, it may be one of the most valuable assets the business owns. These agreements are prime candidates for early assumption motions, particularly if the vendor is likely to object or attempt to terminate.
Employment agreements and non-compete covenants. Retention of key management and employees can be critical to the credibility of adequate assurance demonstrations. Employment agreements should be reviewed for ipso facto provisions and for whether they qualify as personal services contracts (a category where assumption without the individual's consent may not be possible).
What Counterparties Can and Cannot Do
If your business files Chapter 11, your counterparties will receive notice and will be making their own strategic calculations. Understanding what they are legally permitted to do, and what they are not, helps you anticipate and respond.
What counterparties cannot do:
Terminate the contract solely because of the bankruptcy filing (ipso facto clause — void under § 365(e))
Refuse to continue performing under an executory contract pending the debtor's assumption/rejection decision
Use the bankruptcy as grounds to accelerate payment obligations not otherwise due
Demand modified terms or prepayment as a condition of continuing to perform, where no default existed pre-petition
File a new lawsuit to collect pre-petition amounts owed (which would violate the automatic stay)
What counterparties can do:
File a motion with the bankruptcy court to compel the debtor to assume or reject the contract within a specified period of time, particularly useful for counterparties in long-running cases where uncertainty is damaging their own business planning
Seek relief from the automatic stay if they have a legal basis independent of the bankruptcy filing itself to exercise termination rights (for example, a pre-petition, non-bankruptcy-related default that existed before the filing)
Negotiate the terms of assumption, including cure amounts, modifications to ongoing terms, and adequate assurance requirements
Participate in the plan confirmation process and object to a reorganization plan that proposes to assume contracts on terms they believe are inadequate
Understanding this framework allows a debtor's management team to respond appropriately to counterparty pressure. A vendor's attorney sending a termination letter citing the bankruptcy clause is taking a legally indefensible position. A vendor who files a motion to compel assumption or rejection within 90 days is exercising a legitimate right that requires a strategic response.
Early Assumption Motions: Using Offense as a Defensive Strategy
In cases where a key contract has a counterparty likely to challenge the debtor's right to maintain it, the most effective strategy is often to move first: file a motion to assume the contract early in the case, before the counterparty has organized its opposition.
Early assumption motions serve several purposes. They signal to the counterparty, the court, and other stakeholders that the debtor views the contract as central to the reorganization. They resolve the uncertainty that counterparties find most damaging, the limbo period between filing and assumption. They lock in the contract as a post-petition obligation, which carries administrative priority status and must be paid as a condition of plan confirmation. And they accelerate the cure negotiation on the debtor's timeline rather than the counterparty's.
Courts review assumption motions under a business judgment standard - essentially, whether the debtor has a rational basis for assuming the contract and whether the assumption serves the interests of the estate and its creditors. This is a deferential standard that the debtor's management typically satisfies without difficulty for contracts essential to the reorganization.
The adequate assurance demonstration in connection with an assumption motion should be prepared carefully. It is effectively the debtor's argument for why the contract will work in the reorganized business. Cash flow projections, DIP financing terms, management continuity, post-petition operating performance, and the overall feasibility of the proposed plan are all relevant inputs.
Subchapter V Considerations
For small businesses filing under Subchapter V (the streamlined Chapter 11 framework available to businesses with debt below $3,424,000), the contract management challenge is compressed into a tighter timeline.
The plan must be filed within 90 days of the petition. That means the debtor's reorganization strategy, including which contracts to assume, must be largely developed within that initial period. For businesses with multiple material executory contracts, who have several commercial leases, key vendor agreements, and/or important customer contracts, this requires a level of pre-filing preparation that cannot be accomplished in the first weeks of a new case.
Subchapter V also typically operates without the creditor committee that exists in larger traditional Chapter 11 cases, which means the counterparties to material contracts don't have an institutional voice in the case through that channel. That said, individual counterparties can still file motions to compel assumption or rejection, object to proposed cure amounts, and participate in plan confirmation. The absence of a committee does not make their rights disappear.
The combination of faster timelines and smaller case infrastructure in Subchapter V makes pre-filing contract analysis especially valuable for small business debtors.
The Communication Dimension: What the Law Can't Do For You
The Bankruptcy Code can prevent counterparties from terminating your contracts. It cannot repair relationships damaged by surprise, uncertainty, or a sense that the debtor was not dealing straight with them.
Many businesses that file Chapter 11, particularly smaller companies, have counterparties who are also small businesses, and for whom the filing of a bankruptcy case by a key customer or vendor is genuinely disruptive. A landlord who discovers the tenant has filed for bankruptcy from a court notice, rather than from a direct conversation, starts the relationship in a defensive posture. A key supplier who is owed six months of arrears and whose first contact from the debtor is a formal cure notice drafted by bankruptcy counsel is not positioned for cooperative renegotiation.
The debtors who preserve their most important relationships through Chapter 11 typically do several things beyond the legal mechanics:
They contact key counterparties directly, before or immediately upon filing, to explain the process and what it means for the existing relationship. They make clear that the business is continuing to operate, that post-petition obligations will be paid, and that the contract will be assumed (if that is the intent). They treat the legal process as a framework for resolving pre-existing financial difficulties, not as a tactic for escaping valid obligations.
This is not naive. It is strategic. Counterparties who feel respected and informed are substantially more likely to cooperate on cure amount negotiations, adequate assurance discussions, and lease modification talks than those who feel blindsided and are left to piece together what is happening from court filings.
The legal protections of Section 365 are the floor. They prevent the worst outcomes. The relationship management around them is what determines whether the reorganization produces a business that its key partners want to continue doing business with after the plan is confirmed.
Frequently Asked Questions
Can my counterparty terminate our contract because I filed Chapter 11? No, not based on the bankruptcy filing alone. Ipso facto clauses, which are contract provisions that purport to allow termination because of insolvency or bankruptcy, are unenforceable under Sections 365(e)(1) and 541(c)(1)(B) of the Bankruptcy Code. A counterparty who attempts termination on that basis is also violating the automatic stay and can be subject to sanctions.
What if the counterparty had grounds to terminate before I filed? Pre-petition termination rights that were validly exercised before the bankruptcy filing are generally not undone by the filing, though the facts matter significantly. If a contract was properly terminated before the petition date, there may be no executory contract to assume. If the termination notice was sent but the cure period had not yet expired, or the notice was defective, the analysis is different. This is a fact-intensive question that requires careful review of the contract's termination provisions and the timeline of events.
Do I have to cure defaults to keep a contract? Yes. If there are pre-petition monetary or non-monetary defaults, assumption requires cure (or adequate assurance that cure will be prompt) as a condition of court approval. The cure amount is often contested and may be the subject of negotiation or litigation during the case.
What happens if I miss the 120-day deadline for a commercial lease? The lease is automatically deemed rejected. It is treated as if it were breached as of the day before the bankruptcy filing. The landlord can demand surrender of the premises and file an unsecured claim for rejection damages. Once automatically rejected, the lease generally cannot be reinstated. The 90-day extension requires a court motion filed before the 120-day period expires.
Can my reorganization plan force a counterparty to accept contract modifications? Generally, no. Assumption under Section 365 requires assuming the contract as it stands. The debtor cannot pick and choose which provisions to honor. The exception is through negotiation: the threat of rejection (which converts the counterparty to an unsecured creditor) often creates willingness to discuss modified terms as a condition of assumption. Modified assumptions require the counterparty's agreement.
What if a counterparty refuses to perform despite the automatic stay? The debtor can file a motion for contempt and seek an order enforcing the stay, along with damages, attorneys' fees, and potentially punitive damages for willful violations. Courts take stay violations seriously, particularly when the violating party is represented by counsel.
Does Chapter 11 affect contracts I have as a customer or purchaser, not just contracts where I am the seller? Yes. All executory contracts, whether you are the buyer or seller, the tenant or landlord, the licensee or licensor, are subject to Section 365. A purchase agreement where you are the buyer and still owe payment is an executory contract from which you may seek relief through rejection (converting the obligation to an unsecured claim) or which you may assume (preserving the favorable pricing or terms).
Summary: The Contract Decisions That Define Whether Reorganization Succeeds
Chapter 11 gives a business extraordinary tools to preserve and rationalize its contractual relationships. The automatic stay and the ipso facto prohibition prevent the most damaging immediate consequences of filing. The assumption framework gives the debtor the power to keep the contracts it needs. The rejection tool converts burdensome agreements into manageable unsecured claims. The cure-and-assurance process creates a structured path to resolving pre-filing defaults with counterparties.
But these tools are most powerful when deployed deliberately and early. A business that has mapped its material contracts before filing, categorized them, estimated cure costs, identified counterparty risk, and developed an adequate assurance narrative, arrives at the bankruptcy court with a plan. A business that treats the contract question as something to figure out after the filing date is managing a crisis rather than executing a strategy.
For Central Florida businesses considering Chapter 11 or Subchapter V, the contract analysis is not a secondary planning task. For many businesses, it is the reorganization.
This article is intended for informational purposes only and does not constitute legal advice. Every business situation is different. For guidance specific to your circumstances, consult a qualified business bankruptcy attorney licensed in Florida.
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