When The Trustee Might Assume A Lease
As a general rule, people filing for Chapter 7 bankruptcy aren’t involved in leases or contracts that would likely add value to their bankruptcy estates. This isn’t an absolute rule, however.
If the trustee could sell a lease to someone else for a profit , the trustee might assume the lease and assign it for a lump sum that could be distributed to your creditors. But this would be highly unusual.
What Is An Executory Contract
As many businessmen in Vancouver have learned, dealing with a company on the verge of bankruptcy can be difficult. Payments for goods and services are often late or entirely non-existent, and the threat of a bankruptcy filing and the imposition of the automatic stay are constant threats. These risks are well known, but a lesser-known risk can cause even more financial chaos — the rejection by the trustee of an “executory contract.”
The bankruptcy code gives both a trustee and a debtor-in-possession the power to accept or reject any executory contract or unexpired lease. Unfortunately, the bankruptcy code does not define the term “executory contract.” Many courts have struggled with a definition, but no single definition has been adopted.
In its simplest terms, an executory contract in bankruptcy is a contract under which one or both parties have important duties to perform. Common examples of such agreements are real estate leases whose terms have not expired, equipment leases and supply contracts.
What Is An Executory Contract And Why Must I Assume Or Reject It
Executory contracts are unfulfilled contracts whereby each party to the contract has remaining obligations. A typical example of such contracts is a lease for property, such as a home or a vehicle, or a rent-to-own agreement. In bankruptcy such contracts must be assumed for the debtor to continue to have rights under the agreement. As with reaffirmation agreements and redemption, the debtor must take timely action to assume his or her executory contracts, otherwise the contracts may be deemed rejected and the automatic stay may be lifted.
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Rights Of The Bankruptcy Trustee Or Debtor
Once the petition for bankruptcy is filed, the bankruptcy trustee or debtor-in-possession can take one of these actions:
- Assume the contract by paying any financial defaults and offering satisfactory assurance that the contract terms will be carried out in the future.
- Assume the contract, pay the defaults, and assign or sell the contract to a third party who has to show the ability to comply with the contract terms.
- Reject the contract, which means the trustee or debtor refuses to carry out the obligations under the contract.
The bankruptcy code overrides any clauses in the executory contract that prohibit contract rejection or third-party assignments.
What Happens After A Lease Or Contract Termination
After terminating the lease or contract, you and the other parties to the agreement are cut loose from any obligations, and any money you owe the creditor will be discharged in your bankruptcy, even if the debt arose after your filing date.
Example. Say you are leasing a car when you file for bankruptcy, and you want out of it. The car dealer cannot repossess the car until the trustee terminates the lease, which normally must occur within 60 days of filing. During that 60-day period, you can use the car without paying for it. The court will discharge the payments you don’t make just as if they came due before your bankruptcy.
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Understanding An Executory Contract
As with all contracts, both parties in an executory contract promise to carry out a legal obligation. If either fails to comply, a breach of contract occurs. The contract is considered an executory contract when all parties still have significant duties to fulfill under the terms of the agreement.
A transportation company, for instance, may sign a three-year lease with a bus dealership to use a motorcoach for a designated monthly payment. After one year, the lease agreement is still an executory contract because the dealership must furnish the motorcoach for two more years, and the transportation company has to continue monthly payments for that time.
It is important to note that both sides must have obligations to complete for a contract to be considered executory. A furniture store and a customer might sign a contract where the store promises to deliver a new sofa to the customers home, and the customer agrees to make 12 monthly payments. Once the sofa is dropped off, and the customer accepts delivery, the furniture store has fulfilled its contractual obligation. This document is no longer an executory contract even if the customer still has to make 11 more payments.
Breaching An Executory Contract
Either party to a contract can breach that contract by failing to fulfill their duties as outlined in the agreement. For example, if Jim enters into an executory contract to lease a car, then fails to make the required monthly payments, he has breached the contract. As a result, the dealership may repossess the car, and sue Jim in civil court for uncollected payments.
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Is A Car Loan An Executory Contract
By definition, an executory contract is one where both parties have not yet executed, in substantial terms, their obligations towards one another.
In the context of a car loan, the lender has already fulfilled its obligation in full .
It is only the borrower who has an obligation to pay back the sums borrowed.
This is a debt contract and does not qualify as an executory contract.
However, if you were dealing with a car rental agreement, then the contract could qualify as an executory contract.
In this context, the renter must provide a consumer with a vehicle and the consumer must pay rent for the entire duration of the car rental agreement.
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Comprehending The Importance Of Time Limits
Procedures under federal bankruptcy have strict time limits, and it is vital for the non-debtor counterparty to stay on top of the proceedings and meet all deadlines for legal filings.
- In a Chapter 7 bankruptcy, the trustee must assume the contract within 60 days, or it is automatically rejected.
- In Chapter 11 filings, the debtor has until the reorganization plan approval to assume the contract. However, the counterparty can petition the court to order the debtor to decide whether to assume or reject the contract.
- If the trustee or debtor rejects the contract, the bankruptcy court sets a short timeline for the counterparty to file a rejection damage proof of claim. Once this deadline expires, the opportunity to submit a claim disappears.
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How Executory Contracts Work
When you enter into an agreement like a lease, you’re paying for the right to use an item or property for an agreed-upon amount of time. It’s a cheaper alternative to buying the property. While the lease is in effect, it’s considered an executory contract.
The debtor, otherwise known as a bankruptcy trustee, in the agreement is the person who decides whether they assume or reject to fulfill the obligations set out in an executory contract. The non-debtor party of the contract has to continue on as though bankruptcy has not been filed. If the debtor assumes the contract, then they have to pay their payments and other defaults in full and show that they can pay in the future.
If they choose, the debtor can assume the contract but assign it to someone else. That someone else is typically a buyer of the debtor’s assets. If the debtor chooses to do this, they have to pay any defaults. The buyer then has to prove that they can perform the obligations of the contract in the future.
With the exception of leases for commercial real estate, you have 60 days from the filing of bankruptcy to reject or assume an executory contract. The only way to change the deadline is to go to the bankruptcy court. The rules of bankruptcy that govern executory contracts are pretty complex. If you’re unsure whether your agreement is an executory contract, consult a bankruptcy attorney when the debtor files bankruptcy.
The Bankruptcy Court’s Ruling
The bankruptcy court denied Hain’s motion.
Bankruptcy Judge Karen B. Owens explained that, because Duraneither sought nor obtained court approval to assume and assign thePLP contracts to the Purchaser, the contracts were not assumed andthe Purchaser did not have to pay the cureamount required as a condition to assumption under section 365.Citing University Medical , Judge Owens noted that theThird Circuit has rejected the implied assumption doctrine.Dura, 328 B.R. at 754. Although courts outside of theThird Circuit have permitted implied assumption, she wrote, theyare “a small minority.” Id.
In accordance with University Medical, Judge Owensemphasized, “‘assumption must be approved. It cannot bepresumed.'” Id. . In University Medical,she explained, the Secretary of the U.S. Department of Health andHuman Services asserted that the unique circumstances of theMedicare Act should allow a contract to be assumed if performancecontinues after the petition date even without formal courtapproval. However, the Third Circuit refused to depart from theplain language of the Bankruptcy Code that mandates court approvalfor assumption of an executory contract. In so ruling, Judge Owensnoted, the court of appeals stressed the importance of motionpractice and court approval so that all of the pros and cons to theestate and stakeholders can be considered and an executorycontract’s status with respect to the estate can be finalized.Id. at 755 .
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The Third Circuit Examines The Nature Of Executory Contracts To Find A Work Made For Hire Contract Non
Executory contracts under the Bankruptcy Code are treated uniquely, compared to other contracts. The Code permits debtors to assume or reject executory, but not non-executory contracts. This disparate treatment arises from, among other things, the need to protect a debtor from making an error in judgment according to the Third Circuit in Weinstein Company Holdings.
Such an error could arise if a debtor were to reject a contract which was an asset, or to assume one which was a liability. A contract is an asset when only the non-debtor has material performance obligations. A contract is a liability when only the debtor has such obligations. In such cases, the Bankruptcy Code fosters the debtors rehabilitation by refusing to allow a debtor to mistakenly assume the wrong kind of contract.
Executory contracts, on the other hand, are hybrids that are a combination of asset and liability. It is only in the presence of this inherent uncertainty that the Bankruptcy Code defers to a debtors business judgment in deciding whether the contract provides a net benefit . If the executory contract is beneficial to the debtor, it can be assumed and assigned to a buyer of a debtors assets.
The producer argued that a provision in the contract changed this result:
Takeaway
Assumed contracts remain in full force and effect, whereas rejected contracts effectuated an intentional breach discontinuing the debtors future performance obligations.
Rights Against Persons Or Entities Who Are Not Part Of Bankruptcy Filing
The automatic stay and other bankruptcy protections are generally specific to the entity in bankruptcy. If your agreement has a broad insolvency clause, which includes bankruptcy filings and/or insolvency by affiliates as an event of default or termination of the agreement, and the particular counterparty to the agreement does not immediately file for bankruptcy, it may be possible to terminate the license based on the parent’s or affiliate’s insolvency or bankruptcy filing.
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Third Circuit Clarifies What Makes A Contract Executory Under The Bankruptcy Code
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On May 21, 2021, the Third Circuit issued an opinion in the high-profile bankruptcy of The Weinstein Company, LLC clarifying precisely what ingredients are needed to make a contract executory under § 365 of the Bankruptcy Code.
Section 365 is the provision of the Bankruptcy Code which allows a debtor-in-possession to assume or reject executory contracts and unexpired leases. In order for an executory contract to be assumed , the debtor must cure or provide adequate assurance that it will cure any defaults under that executory contract. See 11 U.S.C. 365. An executory contract that has been assumed may be subsequently assigned by the debtor to another entity, the purchaser of property from Debtors bankruptcy estate pursuant to a § 363 sale. The § 365 cure provision does not, however, apply to non-executory contracts. In this enlightening opinion penned by Judge Ambro, the Third Circuit makes clear precisely which contracts are executory.
At issue before the Third Circuit was whether the Cohen Agreement was executory at the time of the Sale. If so, then Cohen is entitled to the cure amount of approximately $400,000 if not, then Cohen is owed nothing for the unpaid contingent compensation . Ultimately, the Third Circuit found the Cohen Agreement to be non-executory, thereby affirming the District Courts decision, which itself affirmed the Bankruptcy Courts decision.
Executory Vs Executed Contract
An executed contract is a contract that is fully legal immediately after all parties involved have signed, and the terms must be fulfilled immediately. With an executory contract, the terms are set to be fulfilled at a future date. Both contracts however, are considered executed agreements once the parties sign. This means that both parties are legally obliged to follow the terms as and when defined within the agreement.
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Types Of Executory Contracts
- Most licenses dealing with intellectual property, supply agreements that are long-term, and franchise agreements are executory contracts.
- A completed assignment or sale, an agreement that’s completely terminated, an expired agreement, or anything of the like that’s done prior to bankruptcy is usually not considered to be an executory contract.
- Licenses that are perpetual and exclusive are sometimes an executory contract, but you can make a case that they’re a completed assignment for territory or rights. You have to examine other materials to determine whether the ongoing agreement fits the bill.
- Real estate leases are executory contracts, as tenants have to pay rent and, in exchange, the landlord provides them with a place to live.
- Equipment leases are executory contracts. Someone provides equipment and someone pays rent for that equipment.
- Development contracts where development work is requested and payment is given upon the completion of milestones are also executory contracts.
- Leases on vehicles and furniture that is rent-to-own are both kinds of executory contracts.
- Timeshare contracts and utility contracts, including internet and telephone service, are both executory contracts.
- Employment contracts and service and supply contracts are also executory contracts.
Bankruptcy Is A Game Changer With Executory Contracts
Business people take great care with all legal papers and contracts they sign. For example, anyone who leases construction equipment or office space may include a clause in the contract that prohibits the assignment of the lease to a third party. Even if carefully crafted, however, these prudent steps may go out the window if the other party files for bankruptcy. The federal bankruptcy court then takes over, and the well-thought-out contract comes under the restrictions of the bankruptcy code.
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What Is An Executory Contract: Everything You Need To Know
An executory contract holds people to duties they’ve been assigned to a specific date laid out in the contract. 3 min read
An executory contract holds people to duties they’ve been assigned to a specific date laid out in the contract. It goes into effect when someone files for bankruptcy and stipulates that the two people that signed still have an obligation to meet. If the obligations are not met, it’s a breach of contract. These types of contract are usually between a borrower, debtor, and another party.
What Unique Situations Should I Look Out For
The explanation above is simplified to give a general overview of how executory contracts are handled during business bankruptcy proceedings. The reality is far more nuanced and full of conflicting cases and unsettled issues. Intellectual property licenses are the quintessential example of this type of nuance and uncertainty. When IP licenses can be assumed depends heavily on the facts including the type of IP involved as well as the jurisdiction that the bankruptcy case is taking place in.
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Executory Contracts In Bankruptcy
I. INTRODUCTION
The Bankruptcy Code, 11 U.S.C. § 365, provides that, subject to court approval and certain limitations discussed below, debtors can assume or reject any executory contract or unexpired lease. It is an area of the law described as a “thicket . . . where . . . lurks a hopelessly convoluted and contradictory jurisprudence.” In re Drexel Burnham Lambert Group, Inc., 138 B.R. 687, 690 ). “n no area of bankruptcy has the law become more psychedelic than in the one titled ‘executory contracts.'” Drexel Burnham, 138 B.R. at 690 ).
II. THRESHOLD ISSUES
B. Is the contract “executory”?
1. Contracts where performance remains due on both sides are executory. See, e.g., In re Columbia Gas Sys., Inc., 50 F.3d 233 Matter of C & S Grain Co., 47 F.3d 233, 237 In re Spectrum Information Technologies, Inc., 190 B.R. 741, 747 In re Hooker Investments, 145 B.R. 138, 144 Compare Texaco Inc. v. Louisiana Land and Exploration Co., 136 B.R. 658 with In re Philbeck, 145 B.R. 870 .
3. A contract substantially performed is not executory. In re Pacific Exp. Inc., 780 F.2d 1482, 1487 In re Sundial Asphalt Co., 147 B.R. 72, 80 In re Norwood Chevrolet Co., 143 B.R. 804 Compare In re Columbia Gas Sys., 146 B.R. 106 and Heartline Farms v. Daly, 128 B.R. 246, 250 with Cameron v. Pfaff Plumbing and Heating, 966 F.2d 414 and In re Walnut Assocs., 145 B.R. 489, 496 .
E. Postpetition, Pre-Rejection or Assumption Treatment of Executory Contracts.
3. The good to be achieved
