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59.

Executory Contracts in Bankruptcy -- Introduction, Threshold Issues

I. INTRODUCTION

The Bankruptcy Code, 11 U.S.C. § 365, provides that, subject to court approval and certain limitations discussed below, debtors can assume or reject any executory contract or unexpired lease. It is an area of the law described as a "thicket . . . where . . . lurks a hopelessly convoluted and contradictory jurisprudence." In re Drexel Burnham Lambert Group, Inc., 138 B.R. 687, 690 (Bankr. S.D.N.Y. 1992) (quoting Andrew, Executory Contracts Revisited: A Reply to Professor Westbrook, 62 U. Colo. L. Rev. 1 (1991)). "[I]n no area of bankruptcy has the law become more psychedelic than in the one titled 'executory contracts.'" Drexel Burnham, 138 B.R. at 690 (quoting Westbrook, A Functional Analysis of Executory Contracts, 74 Minn. L. Rev. 227, 228 (1989)).

II. THRESHOLD ISSUES

A. What is an executory contract? The Code does not define "executory contract", but most courts have adopted this definition: "a contract under which the obligation of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other." Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn. L. R. 439, 460 (1973); In re Murexco Petroleum, Inc., 15 F.3d 60 (5th Cir. 1994); In re Texscan Corp., 976 F.2d 1269 (9th Cir. 1992); United States v. Floyd, 882 F.2d 233, 235 (7th Cir. 1989); Sharon Steel Corp. v. National Fuel Gas Distrib. Corp., 872 F.2d 36, 39 (3d Cir. 1989); In re Speck, 798 F.2d 279, 279-80 (8th Cir. 1986); Gloria Mfg. Corp. v. International Ladies Garment Workers' Union, 734 F.2d 1020, 1021 (4th Cir. 1984); In re Chateaugay Corp., 130 B.R. 162, 164 (S.D.N.Y 1991); see generally Andrew, Executory Contracts In Bankruptcy: Understanding Rejection, 59 U. Colo. L. Rev. 845 (1988) (executory contract means "simply a contract under which (a) debtor and non-debtor each have unperformed obligations and (b) the debtor, if it ceases further performance, would have no right to the other party's continued performance"); H.R. Rep. No. 95-595, 95th Cong., 1st Sess. 347 (1977)("[t]hough there is no precise definition of what contracts are executory, it generally includes contracts on which performance remains due to some extent on both sides."). However, some courts have begun to move away from Countryman's approach and have adopted a "functional approach" which works "backward from an examination of the purposes to be accomplished by rejection, and if they have already been accomplished then the contract cannot be executory." See, e.g., In re Magness, 972 F.2d 689, 693 (6th Cir. 1992); In re Cardinal Indus., Inc., 146 B.R. 720 (Bankr. S.D. Ohio 1992) (discusses how 6th Circuit has adopted both Countryman definition and functional approach); In re General Dev. Corp., 177 B.R. 1000, 1013 (S.D. Fla. 1995); In re Drexel Burnham Lambert Group, Inc., 138 B.R. 703, 708 n.24 (Bankr. S.D.N.Y. 1992).

B. Is the contract "executory"?

1. Contracts where performance remains due on both sides are executory. See, e.g., In re Columbia Gas Sys., Inc., 50 F.3d 233 (3d Cir. 1995) (settlement agreement may be an executory contract); Matter of C & S Grain Co., 47 F.3d 233, 237 (7th Cir. 1995) ("For the purposes of the Bankruptcy Code, an executory contract is one in which the obligations of each party remain substantially unperformed. Consequently, when the debtor ... has breached the contract pre-petition with the result that the other party has no further duty to perform, ... the contract is no longer executory for purposes of section 365."); In re Spectrum Information Technologies, Inc., 190 B.R. 741, 747 (Bankr. E.D.N.Y. 1996) ("contracts where one party has completed performance are excluded from the ambit of section 365"); In re Hooker Investments, 145 B.R. 138, 144 (Bankr. S.D.N.Y. 1992) (employment contracts are executory contracts); Compare Texaco Inc. v. Louisiana Land and Exploration Co., 136 B.R. 658 (M.D. La. 1992) (state mineral lease is executory contract) with In re Philbeck, 145 B.R. 870 (Bankr. E.D. Ky. 1992) (coal lease not executory contract).
2. Contracts in which one party has no postpetition obligation or no obligation other than the payment of money are not executory. See In re Munple, Ltd., 868 F.2d 1129 (9th Cir. 1989) (real estate brokerage commission agreement not executory even though payment of fee was conditioned upon closing of sale); In re Newcomb, 744 F.2d 621, 624 (8th Cir. 1984); Chesapeake Fiber Pkg. v. Sebro Packaging Corp., 143 B.R. 360 (D. Md. 1992) (agreements conveying patent rights are not executory contracts); In re Spectrum Information Technologies, Inc., 190 B.R. 741, 748 (Bankr. E.D.N.Y. 1996) ("where the only performance that remains is the payment of money, the contract will not be found to be executory"); In re F.B.F. Indus., Inc., 165 B.R. 544, 549 (Bankr. E.D. Pa. 1994) (promissory notes are not executory contracts); In re U.S. Metalsource Corp., 163 B.R. 260, 269 (Bankr. W.D. Pa. 1993) (terminable-at-will employment contracts are not executory contracts because debtor's only legal obligation is to pay severance pay); In re Chateaugay Corp., 102 B.R. 335, 348 (Bankr. S.D.N.Y. 1989) (safe harbor leasing and tax benefit transfer agreements not executory contracts or unexpired leases); In re Structurlite Plastics Corp., 86 B.R. 922 (Bankr. S.D. Ohio 1988); In re Wisconsin Barge Line, 76 B.R. 695 (Bankr. E.D. Mo. 1987) (contracts under which debtors' only duty was to pay retrospective premiums were not "executory").
3. A contract substantially performed is not executory. In re Pacific Exp. Inc., 780 F.2d 1482, 1487 (9th Cir. 1986); In re Sundial Asphalt Co., 147 B.R. 72, 80 (E.D.N.Y. 1992) (contract for sale of land ceases to be executory when court issues decree of specific performance); In re Norwood Chevrolet Co., 143 B.R. 804 (Bankr. D.R.I. 1992) (substantial performance by both parties precludes rejection of contract); Compare In re Columbia Gas Sys., 146 B.R. 106 (D. Del. 1992) (court approved settlement which required only "perfunctory acts utilizing preapproved terms and conditions" is not executory contract) and Heartline Farms v. Daly, 128 B.R. 246, 250 (D. Neb. 1990) ("mere formality" remaining for performance "does not represent the kind of significant legal obligation that would render a contract executory") with Cameron v. Pfaff Plumbing and Heating, 966 F.2d 414 (8th Cir. 1992) (crediting the debtor's account for amount of money received significant enough obligation to render contract executory) and In re Walnut Assocs., 145 B.R. 489, 496 (settlement agreement which requires only payment by one party and signing of documents by other party is executory contract).
4. A contract or lease no longer in existence is not executory and cannot be assumed. See In re Stewart Foods, Inc., 64 F.3d 141 (4th Cir. 1995) ("a debtor-in-possession does not have the option of rejecting or assuming non-executory contracts and remains bound by the debtor's obligations under those contracts after the bankruptcy filing."); In re Thompson, 186 B.R. 301, 307 (Bankr. N.D. Ga. 1995) (contract terminated prepetition "cannot be revived solely by virtue of a bankruptcy petition. Filing for bankruptcy relief does not confer new rights on a debtor in regard to [] terminated agreements and a debtor is not permitted to cure his defaults and/or assume such agreements."); In re Coast Cities Truck Sales, Inc., 147 B.R. 674, 677 (D.N.J. 1992); In re Interco Inc., 135 B.R. 634 (Bankr. E.D. Mo. 1992) (abandoned contract not executory); In re B & K Hydraulic Co., 106 B.R. 131 (E.D. Mich. 1989) (life insurance policy which lapsed under its own terms postpetition was not assumable by trustee). However, the termination process must be complete and not subject to reversal. See Moody v. Amoco Oil Co., 734 F.2d 1200 (7th Cir.), cert. denied, 469 U.S. 982 (1984); In re Triangle Lab., 663 F.2d 463 (3d Cir. 1981); In re Iriss, 630 F.2d 1370 (10th Cir. 1980) (contract terminated before filing cannot be assumed or rejected); Ross v. Metro. Dade County, 142 B.R. 193 (S.D. Fla. 1992) (discussing test for whether contract is terminated for § 365 purposes); In re Masterworks, Inc., 100 B.R. 149 (Bankr. D. Conn. 1989) (terminated franchise agreement was executory where time for cure had not expired when bankruptcy was filed). Compare In re Huffman, 171 B.R. 649, 653 (Bankr. W.D. Mo. 1994) (lease terminated prepetition cannot be assumed) with In re Morgan, 181 B.R. 579, 584 (Bankr. N.D. Ala. 1994) (a terminated lease is not the same as an expired lease and may be assumed). A contract is not terminated merely because the debtor defaults or breaches the contract prepetition. In re Nemko, Inc., 163 B.R. 927, 939 (Bankr. E.D.N.Y. 1994).
5. What is the correct time to determine whether a contract is executory is subject to controversy. Compare In re Columbia Gas Sys., Inc., 50 F.3d 233, 240 (3rd Cir. 1995) and In re Kong, 162 B.R. 86, 91 (Bankr. E.D.N.Y. 1993) (both look to when petition is filed) with In re Nemko, Inc., 163 B.R. 927, 935 (Bankr. E.D.N.Y. 1994); In re Broaddus Hosp. Ass'n, 159 B.R. 763, 771 (Bankr. N.D.W.V. 1993) and In re Wang Labs., Inc., 154 B.R. 389 (Bankr. D. Mass. 1993) (determination of whether contract is executory is made by looking at the contract at the time the issue is before the court).
6. Contracts as avoidable preferences under §§ 547; 548. Debtors may not avoid a prepetition termination of an executory contract; such terminations are not avoidable transfers of an interest in property. This court disagrees with courts which have permitted such avoidances, stating that it "would be anomalous, to say the least, to expect that the drafters of a generally thrifty codification of bankruptcy law would devote a substantial section of the Code to the subject of the assumption or rejection of executory contracts ... while at the same time allowing a portion of that subject to spill over into the section governing fraudulent transfers and obligations ...." In re Egyptian Brothers Donut, Inc., 190 B.R. 26, 28-30 (Bankr. D.N.J. 1995).
C. A single writing may contain more than one contract for § 365 assumption-rejection purposes. In re Plum Run Serv. Corp., 159 B.R. 496, 498 (Bankr. S.D. Ohio 1993); In re Village Rathskeller, 147 B.R. 665, 671 (Bankr. S.D.N.Y. 1992) (not every provision of an assumed agreement is enforceable against the debtor-in-possession). State law determines if the contract is divisible for assumption-rejection purposes. In re Downtown Props., Inc., 162 B.R. 244, 247 (Bankr. W.D. Mo. 1993); Plum Run Serv. Corp., 159 B.R. at 498-99; In re Independent Am. Real Estate, Inc., 146 B.R. 546, 550-52 (Bankr. N.D. Tex. 1992). Whether there was separate and distinct consideration and performance under each "contract" determines if one part of a single contract is severable and enforceable on its own. In re Leslie Fay Co., Inc., 168 B.R. 294, 301 n.7 (Bankr. S.D.N.Y. 1994).

D. Multiple contract documents may form one uniform agreement for assumption-rejection purposes. Courts have held that two or more contracts which are essentially inseparable can be, and should be, viewed as a single indivisible agreement. In re Atlantic Computer Sys., Inc., 173 B.R. 844, 849-55 (S.D.N.Y. 1994) (six agreements properly constituted one contract for § 365 purposes); In re Karfakis, 162 B.R. 719, 725 (Bankr. E.D. Pa. 1993).

E. Postpetition, Pre-Rejection or Assumption Treatment of Executory Contracts.

1. The status of an executory contract between filing of petition and assumption or rejection is subject to controversy. "Exactly how and when executory contracts come into the estate has been the source of continuing controversy and progressive development. One view, the exclusionary analysis, holds that executory contracts remain outside the estate prior to assumption. The competing view is that they enter the estate initially, but are thereafter subject to abandonment via rejection." In re Drexel Burnham Lambert Group, Inc., 138 B.R. 687, 701 (Bankr. S.D.N.Y. 1992). Compare In re Albion Disposal, Inc., 152 B.R. 794, 806-07 (Bankr. W.D.N.Y. 1993); In re Alert Holdings, Inc., 148 B.R. 194, 203 (Bankr. S.D.N.Y. 1992); In re Seymour, 144 B.R. 524 (Bankr. D. Kan. 1992); Drexel Burnham Lambert Group,, 138 B.R. at 701-02 (all holding that executory contracts are property of estate) with In re Qintex Entertainment, Inc., 950 F.2d 1492, 1495 (9th Cir. 1991) ("An executory contract does not become an asset of the estate until it is assumed pursuant to § 365.").
2. Status of Parties To The Unassumed/Unrejected Contract. During the period a contract is unassumed and unrejected, the rights, duties and obligations of the debtor are unclear. See In re Holly's Inc., 140 B.R. 1213 (Bankr. W.D. Mich. 1992). However, the contract is generally thought of as remaining "in effect" and the nondebtor parties are bound to honor it and perform. See In re Whitcomb & Kelly Mortgage, 715 F.2d 375 (7th Cir. 1983); In re Leslie Fay Companies, Inc., 166 B.R. 802, 808 (Bankr. S.D.N.Y. 1994); cf. In re Continental Airlines, 981 F.2d 1450, 1459-60 (5th Cir. 1993) (court's discussion shows that contract continues to exist postpetition stating that "[a]n agreement cannot 'exist' for one purpose yet take on a 'nonexistent' quality which works to the advantage of one party or the other."); In re Modern Textile, Inc., 900 F.2d 1184, 1191 (8th Cir. 1990) (executory contracts are "an existing and continuing legal obligation of the debtor" subject to rejection); In re Public Serv. Co., 884 F.2d 11 (1st Cir. 1989) (dicta); In re Continental Energy Assoc. Ltd., 178 B.R. 405 (Bankr. M.D. Pa. 1995) (Bankruptcy court may compel the non-debtor party to an executory contract to continue to perform postpetition, "provided that [the court] diligently guard[s] the interests of the non-debtor party to the contract." Although the cost of the services provided "will often times ... be measured by reference to the contract which presumably has been negotiated at arm's length," that is not required; court may order payment of only the "reasonable value of the material or services supplied."); In re Thomas Co., Inc., 166 B.R. 677 (Bankr. C.D. Ill. 1994) (executory contract remains in existence until rejected).
3. Claims based on the unassumed and unrejected contract may be entitled to an administrative expense priority. In re Bridgeport Plumbing Prods., Inc., 178 B.R. 563 (Bankr. M.D. Ga. 1994) (creditor may file an administrative expense claim for the "reasonable value of the use" of the creditor's property during the gap period); In re Sharon Steel Corp., 161 B.R. 934, 937 (Bankr. W. D. Pa. 1994).
F. Effect of Debtor's Failure To Act. An executory contract which is not assumed or rejected during the bankruptcy will be unaffected by the bankruptcy filing, will pass through to, and be binding upon, the reorganized debtor. In re Polysat, Inc., 152 B.R. 886, 890 (Bankr. E.D. Pa. 1993); International Union v. Miles Mach. Co., 34 B.R. 683, 687 (E.D. Mich. 1982) (collective bargaining agreement which is ignored during bankruptcy survives confirmation and is binding upon the debtor); Matter of Central Watch, Inc., 22 B.R. 561, 565 (Bankr. E.D. Wis. 1982).

G. When Must the Decision Be Made. Trustee or DIP is allowed a "reasonable time" to decide whether to assume or reject. See Theater Holding Corp. v. Mauro, 681 F.2d 102, 105 (2d Cir. 1982). What constitutes "reasonable time" is left to bankruptcy court's discretion. Id.; see also In re Beker Indus., 64 B.R. 890, 896-97 (Bankr. S.D.N.Y. 1986). Factors include:

1. The nature of the interests at stake;
2. The balance of harm to the litigants;
3. The good to be achieved;
4. The safeguards afforded the litigants;
5. Whether the action to be taken is so in derogation of Congress' scheme that the court may be said to be arbitrary;
6. With respect to a lease:
(a) whether the debtor is presently paying for the property;
(b) the importance of the leased asset to the debtor's plan of reorganization; and
(c) whether the debtor has taken steps to formulate a plan.
The creditor may move the court to compel the debtor to decide in a shorter time frame. § 365(d)(2).

H. Postpetition contracts are not subject to assumption or rejection. In re Lesle Fay Co., Inc., 168 B.R. 294, 300 (Bankr. S.D.N.Y. 1994) (collecting cases).

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