Executory Contract
An Executory Contract in bankruptcy is a contract subject to treatment under Bankruptcy Code Section 365 that the trustee or debtor in possession may generally assume or reject, subject to statutory conditions, exceptions and court approval.
Section 365 gives the estate a strategic choice
A valuable contract can help preserve an operating business or increase sale value. A burdensome contract can drain cash.
The statute generally allows assumption of contracts the estate wants to keep and rejection of contracts it no longer wants to perform, subject to its requirements.
Assumption carries cure obligations
If a contract is in default, Section 365(b) generally requires cure or adequate assurance of prompt cure, compensation for certain pecuniary losses and adequate assurance of future performance before assumption.
The debtor cannot ordinarily keep the upside while ignoring qualifying defaults.
Some contracts cannot be assumed or assigned freely
Section 365 contains exceptions involving applicable law and specified financial accommodations.
Assignment rights therefore require more than finding a willing buyer.
Rejection is treated as breach
Section 365(g) generally treats rejection of an unassumed executory contract as a breach occurring immediately before the bankruptcy filing.
That treatment helps convert many resulting damages into prepetition claims rather than forcing continued performance.
The assumption decision can be modeled as keep-versus-reject economics
Assume a contract requires future payments of $4 million per year but produces $7 million of annual gross profit for the debtor.
If the contract can be assumed after curing $1 million of defaults, keeping it may preserve substantial going-concern value.
Now assume the same contract costs $4 million annually but produces only $1 million of value and can be replaced easily. Rejection may be economically attractive even if the counterparty receives a damages claim.
The decision is not simply whether the contract is currently in default. It is whether the value of future performance, sale optionality and cure burden exceeds the cost of assumption.
That is why contract schedules can materially affect both reorganization value and Section 363 sale proceeds.
Common mistakes
Assuming every contract in bankruptcy is executory Completed contracts can fall outside Section 365.
Treating rejection as rescission The statute characterizes rejection as breach.
Assuming assumption automatically permits assignment Assignment has separate requirements.
Example
A software company has a five-year licensing agreement under which it must continue providing updates and the customer must continue paying annual fees. Because substantial performance remains due on both sides, the agreement can be analyzed as an executory contract for Section 365 purposes, subject to applicable law.
Example
A software company has a five-year licensing agreement under which it must continue providing updates and the customer must continue paying annual fees. Because substantial performance remains due on both sides, the agreement can be analyzed as an executory contract for Section 365 purposes, subject to applicable law.
Professional note
Do not label a contract executory merely because payments remain due. Classification can be legally significant and jurisdiction-dependent. Identify the remaining obligations on both sides and the governing case law.
Related terms
- Restructuring Support Agreement (RSA)
A Restructuring Support Agreement, or RSA, is a contract among a financially distressed company and supporting creditors or other stakeholders that sets the agreed framework for a restructuring and requires the parties to support specified transactions, subject to the agreement's conditions and termination rights.
- Recovery Rate
Recovery Rate is the value a creditor receives or is expected to receive after a default, restructuring or bankruptcy, expressed as a percentage of the creditor's allowed or affected claim.
- Section 363 Sale
A Section 363 Sale is a bankruptcy-court-approved sale of estate property under Bankruptcy Code Section 363, commonly used to sell substantial assets or an operating business outside the ordinary course of business during Chapter 11.
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