The Treatment of Executory Contracts in Bankruptcy

Most businesses in Rockland County attempt to avoid dealing with a business that has filed for bankruptcy under either Chapter 7 or Chapter 11. The chances of being paid for goods and services is obviously reduced if the other party is a bankruptcy petitioner. One of the most serious risks is to have a contract with a debtor rejected, even though the debtor is legally obligated to perform according to the contract. Such contracts are known as “executory contracts,” and they receive special treatment under the Bankruptcy Code.

The Code does not define executory contracts, but the definition that is most commonly used by the courts states that “an executory contract [is] an agreement, including leases, where performance is remaining on all parties to the agreement-and can be enforced by a court.” Real estate leases are among the most common examples of an executory contract.

The Bankruptcy Code authorizes the trustee or a Chapter 11 debtor-in-possession to reject an executory contract, if doing so is in the best interests of the debtor. If a contract is rejected, the non-debtor party can only file a claim as an unsecured creditor.

Executory contracts create many risks for the non-debtor counter party. The debtor has a substantial period of time in which to decide whether to reject executory contracts. The other parties to those contracts can petition the court for an expediting the decision. If the debtor elects to reject an executory contract, it cease immediately. If the debtor elects to affirm an executory contract, all pre-bankruptcy defaults must be cured before the contract is once more effective.

Dealing with executory contracts can be one of the most complex aspects of a business bankruptcy. Anyone who has a continuing contract with a debtor may wish to seek legal advice on the options open to a debtor and strategies for minimizing the damage that may be caused by a rejection of the contract.