Turning Lemons into Lemonade

The news about the economy seems to be getting grimmer by the minute. And nobody is immune from the adverse effects of the recession. I have heard many of my clients—from real estate developers, to dentists, to product manufacturers—express their frustration and fear about the state of the economy and their businesses today. They are preparing for the worst. But those of my clients, who are a bit more savvy and gutsier, are looking to bankruptcy to help them trim the proverbial fat from their companies and turn lemons into lemonade. When a company falls on hard times and its ability to pay its creditors is hampered, bankruptcy may provide the lifeline. With bankruptcy, companies can restructure and emerge as profitable entities. Indeed, the Bankruptcy Code provides many benefits to a debtor, such as the ability to halt collection efforts, object to creditors’ claims, avoid liens, extend the time for paying creditors and reduce payments to creditors. However, one of the most valuable tools a debtor can utilize to restructure—and trim fat—is the ability to reject or get out of unprofitable contracts or leases. Here’s how this works:

Let’s say your company, LottaLemonade, Inc., has a 10-year contract with LemonGrowers, Inc., for the purchase and delivery of 100 tons of lemons every month. After two years into the contract, the country goes into a deep recession and demand for LottaLemonade’s product is cut in half. LottaLemonade is losing substantial amounts of money as a result of this contract with LemonGrowers. Thus, LottaLemonade no longer needs or wants 100 tons of lemons a month from LemonGrowers. In fact, LottaLemonade learned that it can get a much better deal on lemons from another source.

If LottaLemonade files a bankruptcy proceeding, it can seek to reject (or get out of) the contract with LemonGrowers. This means that LottaLemonade may have no further obligation to accept or pay for any future deliveries of the lemons for the remainder (eight years) of the contract. Without the protection of the Bankruptcy Code, LottaLemonade would remain obligated to LemonGrowers for the entire length of the contract and LemonGrowers could sue LottaLemonade for breaching the contract.

As another example, during LottaLemonade’s peak times, it entered into a five-year lease for additional warehouse space with Tart Properties. One year into the lease, LottaLemonade’s business declined and it no longer needed the additional space, nor does it anticipate needing the space in the future. In bankruptcy, LottaLemonade can seek to have the remaining term of that lease rejected.

The examples here provide a mere bird’s eye view of rejecting a contract in bankruptcy. The Bankruptcy Code is complex; there are many requirements that must be met to reject a contract. Moreover, there are instances when a contract may not be rejected. Thus, it is important to consult with an experienced attorney to see if your contract may be rejected and whether bankruptcy is an appropriate option for you.

By Lisa A. Lori, Esq.
Lisa A. Lori, Esq., is a partner in the litigation department at Klehr, Harrison, Harvey, Branzburg & Ellers, LLP. Lori represents clients in a full range of complex commercial litigation matters, including employment, intellectual property and general business torts. She also counsels clients on a variety of issues, including advertising, marketing, branding and regulatory compliance.