What are executory contracts, when are they used and how are they viewed by the Bankruptcy Code? Bernstein-Burkley, P.C. Managing Partner, Robert S. Bernstein, answers these questions and more in this 5MLM episode.
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Executory Contracts (5:30)
Welcome to the 5 Minute Legal Master series where expert attorneys help you master important legal topics. Today, board certified creditors’ rights and business bankruptcy attorney Robert S. Bernstein discusses executory contracts.
Executor contracts are a creature of the bankruptcy code, they are not created by the bankruptcy code but under section 365 of the bankruptcy code, the bankruptcy court can change contracts, the expectations of the parties and 1 of the ways it does that is through section 365 and the ability of the debtor or the trustee to assume or reject, live with or terminate executory contracts. So what is an executory contract? It is an contract with duties yet to be performed on both sides, typical executory contract is an open purchase order. You send me a purchase order to send you 1,000 widgets and you will pay me $1,000. At that moment we have an executory contract, assuming we have that purchase order. We have a contract, I have the obligation to ship the widgets and you have the obligation to buy it. On the other hand, if I have already shipped the widgets and invoiced you for $1,000 and you have not paid me, that is not an executory contract, I am already finished there are only obligations on your side, the payment side, that is just the debt. What we are talking about with executory contracts are leases of equipment or real estate or garden variety executory contracts, I have the obligation to pay you rent and you have the obligation to give me possession of the premises for month to month.
One of the important things about the bankruptcy code treatment is that the debtor gets to decide whether to live with it or not. If it is beneficial to the estate, the debtor can decide to keep that contract, even though it is in default, and live with it through the bankruptcy, especially in chapter 11. A debtor in chapter 11 could live with a defaulted real estate lease on through the bankruptcy, but when the debtor assumes the lease, it must cure all of the defaults including prepetition payment defaults. So if the debtor is delinquent on the rent but decides to assume the lease, among the things it has to do to assume that lease is it has to cure the defaults and that of course is beneficial to the landlord, less or the creditor.
The debtor also has to show that it can adequately perform in the future because it is now taking this obligation on a new and the creditor or landlord should not have to take additional risk. The debtor can, in some cases, assume an executory contract and assign it, actually sell it to someone else. So if the debtor happens to have a below market lease rent on that valuable property, the debtor can find someone who wants to be in those premises and can actually get paid cash by the buyer for an assignment of the lease, has to cure the defaults and has to show that the buyer, the assignee would perform in the future. It is possible to have that assignment and recognize the value treating the landlord fairly.
If the lease is rejected, it is treated as though it were breached the day before the bankruptcy. So that in fancy terms means that the claim that results from the breach is a prepetition unsecured claim so we. If you are owed 1 million dollars in rent for the next year and the debtor decides to reject your lease, you damage claim is going to be a prepetitioned claim which can be paid cents on the dollar with everyone else. So it is a way of the debtor freeing itself from this obligation, or if it chooses to assume it and take on this obligation it has to cure the defaults. The deadline for assuming or rejecting is different depending on whether it is a chapter 7 or chapter 11, they are much shorter in chapter 7 and they are automatically rejected if not assumed at certain points. It is important to check those deadlines with the bankruptcy code depending upon the chapter you are in or check with your counsel.
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2 thoughts on “Executory Contracts”
Isn’t payment of a prepetition debt a preference? Is tenancy of a rent-controlled apartment in NYC an executory contract which can be assumed and sold? What is the contract has a provision that it is automatically canceled if one party files for bankruptcy and that the contract cannot be assigned or transferred?
The code permits “cures” of delinquency of executory contract and, when approved and paid, does not constitute and avoidable preference. I don’t know about rent controlled apartments, but executory contract law permits assignment of many contracts even if the contract prohibits the assignment. HOWEVER, the executory contract may not be assumed if “(i) applicable law excuses a party, other than the debtor, to such contract or lease from accepting performance from or rendering performance to the trustee or to an assignee of such contract or lease, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties; and (ii) such party does not consent to such assumption or assignment.” So, the law of rent control in New York may have something to say about whether a lease of a rent controlled apartment, even if assumed, can be assigned. Any provision that nullifies an unexpired lease (or any contract) just because on party files bankruptcy, is generally unenforceable.