What Is Section 365?
Section 365 of Title 11 of the United States Code authorizes the trustee (or the debtor in possession in Chapter 11 and Subchapter V) to assume, reject, or assign the debtor's executory contracts and unexpired leases. The provision is one of the most consequential tools in bankruptcy reorganization: it lets the debtor keep contracts that are favorable, discard contracts that are burdensome, and transfer contracts to a third party where transfer creates value.
The statute is long and structurally dense. Subsections (a) through (f) set the basic assume/reject/assign framework and the cure and adequate-assurance requirements. Subsections (d) through (i) impose time limits and special rules for particular contract categories: residential leases, nonresidential real-property leases, personal-property leases, intellectual-property licenses, and timeshare interests. Subsections (j) through (p) address specific edge cases.
Plain-text rule: Except as provided in sections 765 and 766 of this title and in subsections (b), (c), and (d) of this section, the trustee, subject to the court's approval, may assume or reject any executory contract or unexpired lease of the debtor.
What Is an Executory Contract?
The Bankruptcy Code does not define "executory contract." The definition most courts use comes from Professor Vern Countryman's 1973 law-review article: a contract under which the obligations of both the debtor and the other party are so far unperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other.
The Countryman test asks two questions:
- Do both sides have ongoing material obligations?
- Would the failure of either side to perform those obligations excuse the other side's continued performance?
If both answers are yes, the contract is executory and within Section 365's reach. If either answer is no - if one side has fully performed, or if the remaining obligations are not material - the contract is not executory and falls outside Section 365. A fully performed contract on the debtor's side leaves only a claim or a receivable, administered like any other estate asset.
Classic executory contracts:
- Leases of real or personal property
- Long-term supply or output contracts
- License agreements (software, intellectual property)
- Franchise agreements
- Employment contracts
- Insurance contracts
- Construction contracts
Assumption - Section 365(a) and (b)
Assumption is the election to keep the contract or lease in force. The debtor brings the contract through the bankruptcy intact; the contract counterparty continues to perform; the debtor takes on the contract as an estate obligation going forward.
Assumption is subject to the Section 365(b) cure requirements when there has been a default under the contract:
- Cure of default. The trustee must cure, or provide adequate assurance of prompt cure, of the default. Cure means paying past-due amounts in full.
- Compensation for pecuniary loss. The trustee must compensate, or provide adequate assurance of prompt compensation, for any actual pecuniary loss the counterparty suffered as a result of the default.
- Adequate assurance of future performance. The trustee must provide adequate assurance of future performance under the contract.
Adequate assurance is fact-specific. For a lease, it might mean a security deposit, a guarantee from a parent or affiliate, or evidence of the reorganized debtor's projected operating income. For a supply contract, it might mean evidence the debtor will have the cash to pay invoices on terms. The standard is "reasonably likely," not absolute certainty.
Effect of assumption. Once assumed, the contract becomes a post-petition obligation of the estate. Liabilities incurred under the assumed contract are administrative expenses under Section 503(b)(1) with second priority under Section 507(a)(2). The counterparty steps into a much stronger position than an unsecured pre-petition creditor.
Rejection - Section 365(a) and (g)
Rejection is the election to breach the contract or lease as a matter of bankruptcy law. The debtor stops performing; the contract counterparty loses the benefit of future performance; the counterparty acquires a breach-damages claim treated as a pre-petition unsecured claim under Section 365(g).
Critically, rejection is not rescission. The Supreme Court in Mission Product Holdings v. Tempnology (2019) confirmed that rejection operates the same way a pre-bankruptcy breach would have operated - it stops the debtor's performance but does not undo rights the counterparty already has. For executed obligations (like prior delivery, prior license grants, or paid-up rights), the counterparty retains the benefit of what was already performed.
The rejection-damages claim is calculated as if the breach had occurred immediately before the bankruptcy filing. It is reduced to present value for damages that would have accrued over time. For certain contract categories - notably long-term real-property leases - Section 502(b)(6) caps the rejection-damages claim to limit the disproportionate impact of long-tail contract obligations.
Assignment - Section 365(f)
Assignment allows the trustee to transfer the debtor's interest in an executory contract or unexpired lease to a third party even where the contract or applicable law restricts assignment. Section 365(f) overrides anti-assignment provisions to enable estate-value maximization through transfer.
Assignment requires:
- Assumption. The trustee must first assume the contract under Section 365(a)/(b), including cure of all defaults.
- Adequate assurance of future performance by the assignee. The same standard as in assumption, applied to the proposed assignee's ability to perform.
Section 365(c) carves out a narrow but important exception. Where applicable law (typically federal patent or trademark law, or specific state-law restrictions on personal-service contracts) excuses the counterparty from accepting performance from anyone other than the original debtor, the contract cannot be assumed or assigned. This is the "actual test" vs. "hypothetical test" split that has produced significant circuit-court conflict.
The 120-Day Commercial-Lease Rule - Section 365(d)(4)
BAPCPA dramatically shortened the time a Chapter 11 debtor has to decide whether to assume an unexpired lease of nonresidential real property. Section 365(d)(4) imposes a 120-day deemed-rejection rule:
- The debtor has 120 days from the order for relief to assume the lease.
- The court may extend that period by up to 90 days for cause. (Maximum total: 210 days.)
- Any further extension requires the prior written consent of the lessor.
- If the deadline is missed without assumption, the lease is deemed rejected, and the debtor must surrender the premises immediately.
The deemed-rejection rule places extraordinary time pressure on retail-tenant and other commercial-tenant debtors. In multi-location chains, the debtor must work through every lease portfolio decision - keep, assign, surrender - within the statutory window. The result is often early-case decisions about which locations to keep that have lasting strategic consequences.
The 120-day clock starts at the order for relief, not at the moment counsel realizes it. Retail Chapter 11 cases routinely involve lease-decision strategies developed pre-petition and executed in the first 100 days post-petition. Missing the deadline produces immediate eviction exposure that can collapse the case.
Section 365 in Subchapter V
Section 365 applies in Subchapter V cases with one notable modification. Section 365(d)(4) - the 120-day nonresidential-lease deadline - applies the same way, but the smaller scale and faster timetable of Sub V cases means that lease decisions are typically made even earlier in the case.
The Sub V plan-filing deadline under Section 1189 is 90 days from the order for relief (extendable for cause). Because the plan must address contract assumption and rejection, debtors are effectively making contract decisions in the first 60 to 90 days post-petition. The compressed Sub V timetable produces concentrated contract-decision pressure earlier than in traditional Chapter 11.
Contract assumption in a Sub V case still requires the cure of defaults and adequate-assurance showing under Section 365(b). The Sub V trustee under Section 1183 is often actively involved in contract-decision analysis, particularly where contract economics drive the broader plan feasibility analysis under Section 1191.
Section 365(n) - Intellectual Property License Protection
Section 365(n), enacted in 1988 in response to the Lubrizol decision, gives licensees of intellectual property protection if the debtor-licensor rejects the license. The licensee may elect to:
- Treat the contract as terminated and assert a Section 365(g) rejection-damages claim; or
- Retain its rights under the license (including any exclusivity provisions) for the duration of the license term, subject to continued payment of royalties.
Section 365(n) covers "intellectual property" as defined in Section 101(35A) - patents, copyrights, trade secrets, and a few related categories. Trademarks were notably not included in the original 1988 list. The Supreme Court in Mission Product Holdings v. Tempnology (2019) closed that gap by holding that trademark-license rejection operates as a breach under general contract principles, preserving the licensee's continuing rights under the license despite the rejection.
Section 365 in the Bankruptcy Architecture
Section 365 is one of the operational tools of bankruptcy reorganization. It sits alongside the other estate-administration provisions:
- Section 541 - Property of the estate; executory contracts and leases are part of the estate
- Section 362 - Automatic stay; contract counterparties cannot take self-help action without relief from the stay
- Section 363 - Sale of property of the estate; often coupled with Section 365 contract assignment in 363 sales
- Section 502 - Allowance of claims, including the 502(b)(6) cap on landlord lease-rejection damages
- Section 503 - Administrative expenses, including post-petition rent during the assumption-decision period
- Section 1129 - Chapter 11 plan confirmation; the plan reflects assumption and rejection decisions