COVID-19 Highlighted Fundamental Failures in § 365 of the Bankruptcy Code

Utilizing Option-Value Theory to Assume or Reject Executory Contracts in Bankruptcy

COVID-19 highlighted inherent problems existing within the Bankruptcy Code (the “Code”), namely, the inflexible timelines in §365(d)(4) given to real property tenant-debtors to assume or reject leases. The Consolidated Appropriations Act of 2021 attempted to solve this problem by modifying the treatment of unexpired leases of real property in bankruptcy. This Note argues that the legislation ultimately failed to address underlying issues present in the Code.

Instead, this Note analogizes the debtor’s assumption or rejection power in bankruptcy as a costless option. Understanding § 365 under this option-value paradigm allows us to realize that prolonged waiting periods in the Code cause landlords to lose-out on value of their unexpired leases. Debtors should be allowed more flexibility to extend the period to assume or reject their leases, but in return they should be required to internalize the added costs of waiting.

If we take the perspective that, at the moment of commencement, an unexpired lease converts to a costless option for the tenant-debtor, we can calculate the value of such an option using the Black-Scholes model and allow for the landlord to recover the lease-value amount as an administrative expense in bankruptcy. As such, we can allow the landlord to recoup some of the lost value of the unexpired lease as compensation for letting the tenant-debtor extend their option over time.

a. J.D. Candidate, 2022, University of Illinois College of Law. B.A. Political Science, 2016, University of Chicago. I would like to thank the editors, members, and staff of the University of Illinois Law Review for their edits, as well as Professor Robert Lawless for his guidance and thoughtful feedback regarding early drafts of this Note.

The full text of this Note is available to download as a PDF.