Disclaimer: This article is a brief overview of executory contracts in Chapter 7 and 11 bankruptcies. The information is not, nor is it intended to be legal advice. It is imperative that any action you take to be done on the advice of competent legal counsel, and not based solely upon this article.
In most business bankruptcies there are secured and unsecured creditors, with specific rules applying to each category. However, there is another, third category of creditors, which are usually unsecured, but must be listed separately in Schedule G. This third category is made up of executory contracts and unexpired leases — the rules for which are found in 11 U.S. Code § 365 ” Executory Contracts and Unexpired Leases.
What is an Executory Contract in Bankruptcy Law?
The Bankruptcy Code does not specifically define the executory contract. However, most bankruptcy courts have adopted the following definition:
“A contract under which the obligation of both the bankrupt and the other party to a contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other.”
Some types of business executory contracts include:
- Equipment leases (lessee pays rent/lessor provides the machinery)
- Real Estate leases or rental agreements (tenant pays rent/landlord provides space)
- Service contracts (user makes regular payments for the service/provider provides the service)
- Copyright and patent license agreements (licensee pays for use within the scope of the license/licensor cannot sue if use is within the scope of the license)
- Insurance contracts (insured makes regular payments/insurer provides protection according to the stipulations in the contract)
How are Executory Contracts Handled in Bankruptcy Cases?
Executory Contracts are treated differently from general unsecured claims in that:
- The customer, or the bankruptcy trustee, has the right to decide whether to agree to perform or refuse to perform the obligations under the executory contract. The consent of the non-debtor is not necessary. Agreeing to perform is called the “assumption” of the contract. Refusing to perform is “rejection”.
- Until the customer, or bankruptcy trustee, determines whether to assume or reject the executory contract, the non-debtor must continue the performance of the contract. There are some options for the non-debtor if its continued performance of the contract creates an undue burden. If the non-debtor wants to claim such an option, however, he should employ the services of a knowledgeable bankruptcy attorney as claiming undue burden requires very specific proofs.
- Except in the case of commercial real property leases, there are deadlines by which the assumption or rejection of the executory contract must be made. In Chapter 7 liquidations, the decision must be made within 60 days of filing the bankruptcy petition. In Chapter 11, the decision must be made prior to the confirmation of the Plan of Reorganization. The bankruptcy court does have the right to change the deadlines, but in most cases these dates apply.
- If the customer decides to assume the executory contract, he must assume it in its entirety. He also has to pay any missed payments or other defaults and show that he can perform under the contract in the future. All amounts owed by the customer under the contract become administrative expense claims under the bankruptcy, and are generally entitled to payment in full.
- The customer has the right to assume the contract and then assign it to someone else. In such a case, the customer has to pay any defaults and the buyer has to show that it has the ability to perform under the contract in the future.
- Should the customer decide to reject the executory contract, he can no longer be compelled to perform any unperformed obligations under the contract. The non-debtor’s sole recourse becomes the filing of a breach of contract claim, which is usually considered a general unsecured claim as of the petition date.
The specific bankruptcy rules governing executory contracts are complex. If you believe your agreement with the bankruptcy filer may be an executory contract, be sure to obtain advice from a bankruptcy attorney as soon as possible.
To learn more about bankruptcy, check out these other articles on our website:
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