Executory contracts are often referred to as unexpired leases. If an individual or corporation should file for bankruptcy protection under Chapter 11, then the issue of an executory contract is whether it should be assumed or rejected for the benefit of the estate.
An executory contract is one where the obligations of both parties are “so far unperformed that the failure of either to complete performance would constitute a material breach” that would excuse the other party from performing its obligations.
Examples of Executory Contracts
Executory contracts include the following:
- Employment contracts
- Long-term purchase agreements
- Construction contracts
- Equipment leases
- Settlement agreements
- Real estate contracts
- Other unexpired leases
Any of these and others can present a burden to the debtor that can affect its business operations and present an impediment to effectively restructuring its business and getting a viable plan confirmed by the creditors and court in a Chapter 11 bankruptcy.
When is the Determination Made Regarding Assumption or Rejection?
In Chapter 7 matters, the court will determine if an executory contract will be assumed or rejected within 60 days after filing. In a Chapter 11 restructuring, there are no time constraints for making the decision, which typically occurs when the Chapter 11 plan is confirmed or when the assets underlying the contract, or the entity itself, are divided or sold.
An executory contract may provide burdensome provisions or terms such as inflated rent or costs for construction materials, labor or property. If the debtor elects to reject the contract, it is informing the other party that it will no longer perform its obligations under the contract though the other party may still be willing and able to perform its duties. At this point, the rejection is considered a pre-petition breach of the contract and the only remedy available to the non-debtor party is to file an unsecured claim. Such claims are given the lowest priority and result in either no funds given to the claimant or only pennies on the dollar.
The bankruptcy court will examine the debtor’s or trustee’s decision to assume or reject the executory contract using the business judgment standard and will not typically consider the harm or damages to the other party to the contract. This standard defers to the debtor and will affirm any valid business reason for rejecting the contract, which may offer little or no benefit to the debtor in its reorganization efforts.