- June 9, 2015
- Thomas Adam
Business bankruptcy, typically filed under Chapter 11 of the bankruptcy code, present a host of unique issues. One of those issues is what happens to executory contracts.
What is an executory contract?
Even though it has a large statutory section dedicated to them, the Bankruptcy Code does not explicitly define what an executory contract is. However, courts routinely define such contracts in the same way. Essentially, an executory contract is one where both parties continue to have important, incomplete responsibilities under the contract.
A long term lease paid monthly is a common example of an executory contract, until the term ends, the lessee has ongoing obligations to make monthly payments and the lessor has an ongoing obligation to continue to make the property available to the lessee. Some common executory contracts that are relevant in business bankruptcies are leases, licensing agreements, ongoing development contracts, and services contracts (like cell phone agreements).
What happens to executory contracts during business bankruptcy?
11 USC § 365 governs executory contracts during Chapter 11 bankruptcies. Generally, the business bankruptcy trustee has the option to “assume or reject” any of the bankruptcy debtor’s executory contracts or unexpired leases. An assumption of the contract requires court approval, which is generally granted liberally under the business judgment test. The business judgment test defers to the “judgment,” or wisdom of the trustee. Under the rule, the trustee’s decision to assume is only rejected by the bankruptcy court where there is some type of bad faith or abuse of discretion by the trustee. Except for nonresidential leases, there is generally no hard deadline for assuming or rejecting executory contracts.
One important exception is that assumption cannot take place if the debtor is in default on its obligation under the contract; however, the trustee can overcome this hurdle by “curing” (i.e. fixing) the default or by providing “adequate assurances” to the other party to the contract that the default will be cured. Another restriction is that contracts that are not assignable under non-bankruptcy law generally cannot be assumed. This is in part because once assumed, contracts are typically assignable as well.
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 (IP) 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.
To learn more about business bankruptcy
Business bankruptcy is often a complex area of law with serious practical implications for the business debtor. Contact the Jacksonville business bankruptcy attorneys at Adam Law Group to discuss whether bankruptcy is the best choice for your business and if so, how to most effectively utilize the tools provided by Chapter 11 to revitalize your business.