A debtor’s decision regarding the assumption or rejection of executory contracts and unexpired leases is entitled to deference under the business judgment rule. When a debtor sells substantially all of its assets, the analysis does not change even though the debtor and its estate no longer stand to benefit or bear obligations under a continuing lease. In Matter of J.C. Penney Direct Marketing Services, L.L.C., the U.S. Court of Appeals for the Fifth Circuit confirmed that regardless of how the business judgment rule applicable to a debtor’s assumption or rejection of a contract is articulated across courts, the debtor’s decision is entitled to deference. Even where an objection concerns a lease to which the debtor has designated the right to assume or reject to the purchaser of its assets, the focus is on whether the debtor acted reasonably in honoring the designee’s determination regarding a contract or lease. The business judgment standard applies to the debtor and the analysis is not displaced by third-party misconduct or other factors affecting the process by which the purchaser made its decision.

Background

In 1971, J.C. Penney Properties, Inc. entered a long-term commercial real estate lease covering property eventually owned by Vinci. The lease had a primary term of 30 years and provided Penney with the unilateral option of extending the lease in 10 year intervals for up to an additional 70 years. After the first 10 years of the lease, however, Penney subleased its interest in the leasehold to Klairmont Korners, LLC’s predecessor in interest First National Bank. Penney served as a pass through between the landowner and subtenant as the subtenant paid all amounts owed under the lease and would call upon Penney to exercise its option to extend the lease term. Under the terms of the sublease, Penney did not receive revenue but remained liable in the event Klairmont defaulted on continuing lease obligations. In turn, Klairmont received the benefit, while Vinci bore the burden, of a long-term commercial lease for below market rent.

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