Executory Contracts in Bankruptcy under Bankruptcy Law
Executory Contracts in Bankruptcy: Detailed Explanation
What Is an Executory Contract?
An executory contract is a contract under which both parties have ongoing performance obligations at the time the bankruptcy case is filed. Neither party has fully performed their obligations; each has significant duties remaining.
Examples:
Lease agreements where the debtor is the tenant and still owes future rent.
Service contracts where future services are yet to be rendered.
Supply contracts with ongoing deliveries.
Why Are Executory Contracts Important in Bankruptcy?
Executory contracts present special challenges in bankruptcy because the debtor may want to either:
Assume (continue) the contract, or
Reject (disclaim) the contract.
This decision affects creditors’ rights and the estate’s value.
Governing Law: Section 365 of the Bankruptcy Code
11 U.S.C. § 365 governs executory contracts and unexpired leases in bankruptcy.
Assumption (Section 365(a)): The debtor may choose to assume an executory contract, subject to court approval, thus continuing the contract.
Rejection (Section 365(a)): The debtor may reject an executory contract, which is treated as a breach as of the petition date, allowing the counterparty to file a claim for damages.
Key Concepts
Assumption
The debtor must cure all defaults and compensate for any actual losses.
The debtor must provide adequate assurance of future performance.
Assumption requires court approval and benefits the estate by preserving valuable contracts.
Rejection
Rejection is a breach of contract by the debtor.
The non-debtor party may file a claim for damages (usually treated as a general unsecured claim).
Often used to eliminate burdensome contracts.
Assignment
Assumed contracts can sometimes be assigned to third parties if the court approves.
Adequate assurance of future performance must be provided by the assignee.
Non-Assumable Contracts
Certain contracts may be excluded from assumption or assignment, such as personal service contracts or contracts that are non-transferable by their nature.
Test for Whether a Contract Is Executory
The classic test comes from Professor Countryman:
An executory contract is one under which the obligation of both parties to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other.
Key Case Law on Executory Contracts
1. NLRB v. Bildisco & Bildisco, 465 U.S. 513 (1984)
Facts: The debtor sought to reject a collective bargaining agreement.
Holding: The Supreme Court held that the debtor may reject executory contracts but must cure defaults and provide fair treatment.
Significance: The ruling established that rejection is a breach, not termination, and sets standards for assumption and rejection.
2. In re Orion Pictures Corp., 4 F.3d 1095 (2d Cir. 1993)
Facts: The debtor sought to assign an executory contract to a third party.
Holding: The court ruled that assumption and assignment require adequate assurance of future performance.
Significance: Established criteria for “adequate assurance” including financial ability and willingness to perform.
3. In re Klein Sleep Products, Inc., 78 B.R. 407 (Bankr. S.D.N.Y. 1987)
Facts: Court analyzed the assumption of a lease agreement.
Holding: Debtor must cure defaults and provide adequate assurance of future performance before assumption.
Significance: Clarified debtor’s obligations under § 365(b)(1).
4. In re HQ Global Holdings, Inc., 290 B.R. 507 (Bankr. D. Del. 2003)
Facts: Court considered whether a non-compete agreement was executory.
Holding: Contracts with ongoing obligations on both sides can be executory; personal service contracts may not be assignable.
Significance: Helped define the limits on assumption and assignment.
5. In re Footstar, Inc., 323 B.R. 566 (Bankr. S.D.N.Y. 2005)
Facts: The debtor rejected multiple leases.
Holding: Rejection treated as breach; damages capped under lease rules.
Significance: Reaffirmed that rejection is a breach and impacts creditors’ claims.
Summary
| Aspect | Explanation |
|---|---|
| Executory Contract | Contract with significant unperformed obligations by both parties. |
| Assumption | Debtor continues contract after curing defaults and providing assurance. |
| Rejection | Debtor refuses to perform, treated as breach, creditor gets damages claim. |
| Assignment | Assumed contracts may be assigned if adequate assurance is given. |
| Legal Authority | 11 U.S.C. § 365 governs treatment in bankruptcy. |
| Key Cases | NLRB v. Bildisco, In re Orion, In re Klein Sleep, etc. |
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