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Executory Contracts in Bankruptcy -- Assumption and Rejection
A. Mechanics. Assumption of an executory contract is accomplished by motion of the debtor-in-possession or trustee, subject to objection by other creditors and court approval. A motion to assume an executory contract is a summary proceeding; it is not the place for prolonged discovery or a lengthy trial with disputed issues. In re Orion Pictures Corp., 4 F.3d 1095, 1098-99 (2d Cir. 1993), cert. denied, 114 S. Ct. 1418 (1994); In re F.W. Restaurant Assocs., Inc., 190 B.R. 143, 148 (Bankr. D. Conn. 1995) ("[C]ourt reads Orion to establish a preliminary 'likelihood of success' standard" in deciding issues related to debtor's motion to assume a contract. Thus, the court makes preliminary determinations concerning defaults and claims arising therefrom, but these determinations are not final, rather they are "collapsed into the 'business judgment' analysis."). The debtor has the burden of persuasion that the contract is (1) subject to assumption and (2) all the requirements of § 365 have been met. Generally, courts then require the nondebtor party to prove any defaults, which then shifts the burden back to the debtor to prove adequate "cure" of those defaults. In re Diamond Mfg. Co., Inc., 164 B.R. 189, 199 (Bankr. S.D. Ga. 1994). Although a debtor may provide for assumption of a contract in its plan of reorganization, § 1123(b)(2), at least one court has refused to allow that to satisfy § 365(a)'s requirements for motion and notice. In re Golden Triangle Film Labs, Inc., 176 B.R. 608, 610 (Bankr. M.D. Fla. 1994) (court was "unwilling to accept the proposition that the entry of an Order" confirming the plan satisfied § 365's requirements). Finally, some courts have held that filing of a motion to sell a contract under § 363 satisfies the requirements of § 365. In re Specialty Foods, Inc., 91 B.R. 364 (Bankr. W.D.Pa. 1988) ("[T]he Trustee filed a motion to sell which of necessity incorporates an assumption of the asset to be sold to the extent that the Trustee cannot sell an asset which he has rejected or abandoned."); In re Zacherl Coal Co., Inc., 15 B.R. 1001 (Bankr. W.D.Pa. 1981) (same). Denial of a motion to assume does not result in rejection of the contract. In re F.W. Restaurant Assocs., Inc., 190 B.R. 143, 149 n.8 (Bankr. D. Conn. 1995).
B. Standard of Review By Bankruptcy Court. A debtor's decision to assume an executory contract is subject to review under the "business judgment standard." See, e.g., In re Orion Pictures Corp., 4 F.3d 1095, 1099 (2d Cir. 1993); In re Gardiner, Inc., 831 F.2d 974, 975 n.2 (11th Cir. 1987); In re Health Science Products, Inc., 191 B.R. 895, 909 n.15 (Bankr. N.D. Ala. 1995) (Bankruptcy courts must approve a debtor's decision to assume or reject an executory contract "unless there is bad faith or a gross abuse of discretion." In other words, the court must decide "whether the decision of the debtor is so manifestly unreasonable that it could not be based on sound business judgment, but only on bad faith, whim, or caprice.").
C. Assumption Through Conduct. Whether a debtor-in-possession can assume a contract by conduct, without court approval, is subject to controversy. Compare In re University Medical Ctr., 973 F.2d 1065, 1075-79 (3d Cir. 1992); In re Whitcomb & Keller Mortg. Co., 715 F.2d 375, 380 (7th Cir. 1983); NCL Corp. v. Lone Star Bldg. Ctrs., 144 B.R. 170, 179 (S.D. Fla. 1992); In re Houbigant, 188 B.R. 347, 355 (Bankr. S.D.N.Y. 1995); In re Broaddus Hosp. Ass'n, 159 B.R. 763, 771 (Bankr. N.D.W.V. 1993); and In re Drexel Burnham Lambert Group, Inc., 138 B.R. 687, 712 (Bankr. S.D.N.Y. 1992) (all holding that assumption of an executory contract is not effective unless and until the court approves) with In re Frontier Properties, 979 F.2d 1358, 1365 (9th Cir. 1992) (court approval of stipulation that specifically provided for assumption of contract satisfies requirement for court approval under § 365(a)); In re Schleifer, 170 B.R. 283, 285 (Bankr. D.V.I. 1994) (where debtor remains employee during bankruptcy he assumes contract of employment and is bound by the statutorily defined conditions of that employment); In re Audra-John Corp., 140 B.R. 752, 755 n.7 (Bankr. D. Minn. 1992); In re Carlisle Homes, 103 B.R. 524 Bankr. D.N.J. 1988) (both holding that the debtor can assume a contract by communication of unequivocal intent to assume); In re Hodgdon, 54 B.R. 688 (Bankr. W.D. Wis. 1985) (contract may be assumed through conduct; conduct must be either express declaration of assumption or specific, unequivocal action leading to no possible conclusion other than assumption).
D. Timing of Assumption [§ 365(d)].
1. Chapter 7. Contracts must be assumed within 60 days or deemed rejected; unless extension of time granted within the 60 day period. See § 365(d)(1); Cameron v. Pfaff Plumbing and Heating, 966 F.2d 414 (8th Cir. 1992); In re Independent American Real Estate, Inc., 146 B.R. 546, 552 (Bankr. N.D. Tex. 1992); In re 6177 Realty Assocs., 142 B.R. 1017 (Bankr. S.D. Fla. 1992). The contract will be rejected by operation of law on the 61st day even if a motion to assume or reject is filed in the court but the court has not yet acted. The order must be entered on or before the 60th day. In re Horowitz, 167 B.R. 237 (Bankr. W.D. Okla. 1994); In re Compuadd Corp., 166 B.R. 862, 866 (Bankr. W.D. Tex. 1994).
2. Chapters 9, 11, 12 and 13. Debtor may assume or reject at any time before confirmation but court may order trustee/debtor to act within shorter time period. 11 U.S.C. § 365(d)(2); see Theater Holding Co. v. Mauro, 681 F.2d 102 (2d Cir. 1982); In re Holly's Inc., 140 B.R. 643 (Bankr. W.D. Mich. 1992).
3. If a nonresidential lease is not assumed within 60 days when the debtor is the lessee, then it is deemed rejected. 11 U.S.C. § 365(d)(4); In re Lonepine Corp., 184 B.R. 370, 375 (Bankr. D. Colo. 1995) (filing a motion to assume within 60 days is sufficient, court may approve after 60 days has expired); In re Golden Triangle Film Labs, Inc., 176 B.R. 608, 610 (Bankr. M.D. Fla. 1994); In re Food Barns Stores, Inc., 174 B.R. 1010, 1013-16 (Bankr. W.D. Mo. 1994) (failure to act within 60 days results in rejection of contract, but creditor may be held to have waived the right to have the lease deemed rejected; comprehensive discussion of waiver in this context); In re Hunan Rose, Inc., 146 B.R. 313 (Bankr. D.D.C. 1992) (discusses impact of failure to act); In re 6177 Realty Assocs., 142 B.R. 1017 (Bankr. S.D. Fla. 1992) (same). The court may grant an extension if the debtor moves within the 60 day period and the court acts within the 60 day period. § 365(d)(4). Whether the court may grant an extension after the 60 day period if the debtor filed for an extension within the 60 day period is subject to controversy, as is whether the court may grant a subsequent extension after the original 60 days expires. In re Channel Home Ctrs., Inc., 989 F.2d 682 (3d Cir. 1993); Compare Southwest Aircraft Servs., Inc. v. City of Long Beach, 831 F.2d 848 (9th Cir. 1987) (if debtor moves for extension within 60 days court may grant the motion even after 60 days has expired) with In re Horwitz, 167 B.R. 237 (W.D. Okla. 1994) (court bound by plain language of statute -- may not grant extension if 60 days has expired). During the period that the debtor is making the decision to assume or reject a lease, it must "timely perform all obligations of the lease." § 365(d)(3); compare In re All For A Dollar, Inc., 174 B.R. 358, 361 (Bankr. D. Mass. 1994) (debtor must pay only current, postpetition obligations) with In re R.H. Macy & Co., 152 B.R. 869, 872-73 (Bankr. S.D.N.Y. 1993), aff'd, 1994 WL 482948 (S.D.N.Y. Feb. 23, 1994) (debtor must pay all postpetition obligations, even if bills cover prepetition period) with In re Slim Life Weight Loss Ctrs., Corp., 182 B.R. 701, 705-06 (Bankr. D.N.J. 1995) (debtor-in-possession must pay all rents due on an unexpired lease of non-residential real estate as an administrative expense; creditor need not prove its right to an administrative expense under § 503).E. Impact of Assumption.
1. The decision to assume a contract merely allows the contract to continue to operate and does not change the obligations of the parties, except as provided explicitly in the Code, i.e., permit the debtor to cure defaults, ignore ipso facto clauses, and resume its contractual obligations if the statutory tests are met. See In re Washington Capital Aviation & Leasing, 156 B.R. 167, 173 (Bankr. E.D. Va. 1993); In re Drexel Burnham Lambert Group, Inc., 138 B.R. 687, 706 (Bankr. S.D.N.Y. 1992); In re Allen, 135 B.R. 856, 864 (Bankr. N.D. Iowa 1992) (assuming a contract under § 365 only allows the debtor to carry on with the contract according to its terms); In re LeRoux, 167 B.R. 318 (Bankr. D. Mass. 1994), aff'd, 1995 WL 447800 (D. Mass. Oct. 20, 1995), aff'd sub nom. Summit Inv. and Dev. Corp. v. LeRoux, 69 F.3d 608 (1st Cir. 1995) (statute and contract clause which otherwise would convert a general partner's interest into a limited partnership interest upon the filing of a bankruptcy petition unenforceable); Jay Westbrook, A Functional Analysis of Executory Contracts, 74 Minn. L. Rev. 227, 231 (1989) ("'Assume' and 'reject' are merely bankruptcy terms for the decision to perform or to breach, an election open to any party to a contract outside of bankruptcy."); Michael T. Andrew, Executory Contracts in Bankruptcy: Understanding "Rejection", 59 Colo. L. Rev. 845, 847 (1988) ("Assumption permits the estate to obtain the benefits of continued performance by the nondebtor party to the contract, as would assumption by an ordinary contract assignee.").
2. A party who assumes an executory contract must assume it in its entirety; it may not be assumed in part and rejected in part. NLRB v. Bildisco & Bildisco, 465 U.S. 513, 531 (1984); Department of the Air Force v. Carolina Parachute Corp., 907 F.2d 1469, 1472 (4th Cir. 1990); In re Chicago, R.I. & Pac. R.R., 860 F.2d 267, 272 (7th Cir. 1988); Richmond Leasing Co. v. Capital Bank, 762 F.2d 1303, 1311 (5th Cir. 1985); In re B & L Oil Co., 782 F.2d 155, 157 (10th Cir. 1987); Lee v. Schweiker, 739 F.2d 870, 876 (3d Cir. 1984); In re Leslie Fay Companies, Inc., 166 B.R. 802, 808 (Bankr. S.D.N.Y. 1994); In re Village Rathskeller, 147 B.R. 665, 671 (Bankr. S.D.N.Y. 1992). In other words, a debtor cannot assume the benefits of an executory contract without assuming its burdens as well. See, e.g., Covington v. Covington Land L.P., 71 F.3d 1221, 1226 (6th Cir. 1995) ("When a debtor assumes the lease or contract under § 365, it must assume both the benefits and the burdens of the contract. Neither the debtor nor the bankruptcy court may excise material obligations owing to the non-debtor contracting party."); In re Pacific Exp. Inc., 780 F.2d 1482 (9th Cir. 1986); In re Godwin Bevers Co., Inc., 575 F.2d 805, 807 (10th Cir. 1978) (trustee who accepts executory contract takes burdens with benefits); In re Fitch, 174 B.R. 96, 101 (Bankr. S.D. Ill. 1994) ("debtor cannot change the nature of a contract merely by ... assum[ing] it ... debtor may not 'conditionally' assume such a contract, and ... must assume its burdens as well as its benefits"); In re Monroeville Dodge, Ltd., 166 B.R. 264, 267 (E.D. Pa. 1994) (debtor-in-possession takes contract cum onere); In re MacDaniel, 89 B.R. 861, 863 (Bankr. E.D. Wash. 1988); In re Maine, 32 B.R. 452, 455 (Bankr. W.D.N.Y. 1983); In re Yonkers Hamilton Sanitarium, Inc., 22 B.R. 427 (Bankr. S.D.N.Y. 1982). The debtor must perform "in full, just as if the bankruptcy had not intervened." In re Frontier Properties, 979 F.2d 1358, 1367 (9th Cir. 1992); In re Airlift Int'l, 761 F.2d 1503 (11th Cir. 1985); In re Steelship Corp., 576 F.2d 128, 132 (8th Cir. 1978).
3. The assumption of an executory contract results in an administrative expense status for all obligations under the contract, regardless of whether the expenses arose pre- or postpetition. In re U.S. Metalsource Corp., 163 B.R. 260, 269 (Bankr. W.D. Pa. 1993). This includes liabilities flowing from the rejection of a previously assumed executory contract. In re Frontier Properties, Inc., 979 F.2d 1358, 1367 (9th Cir. 1992).F. Limits On The Debtor's Ability To Assume
1. Contracts In Default. § 365(b). A contract in default may only be assumed if the debtor meets certain Code requirements:
(a) Cure pre- and postpetition defaults or provide adequate assurance of prompt cure. Courts define "cure" as "taking care of the triggering event and returning to pre-default conditions." In re Johnson, 184 B.R. 570, 574 (Bankr. D. Minn. 1995). In other words, "a cure returns the parties to the status quo ante by paying all arrearages on the debt and reinstating the debt's original payment terms." Id.; see In re Embers 86th Street, Inc., 184 B.R. 892 (Bankr. S.D.N.Y. 1995) ("[a]dequate assurance of a prompt cure requires that there be a firm commitment to make all payments and at least a reasonably demonstrable capability to do so"); In re Diamond Mfg. Co., Inc., 164 B.R. 189, 197-99 (Bankr. S.D. Ga. 1994) (when bankruptcy court approves assumption of contract it necessarily finds that no uncured default exists); In re Washington Capital Aviation & Leasing, 156 B.R. 167, 173 (Bankr. E.D. Va. 1993) (discussing general requirements for cure); NCL Corp. v. Lone Star Bldg. Ctrs., 144 B.R. 170 (S.D. Fla. 1992) (when bankruptcy court approves assumption of contract it necessarily finds that no uncured default exists). Compare In re Coors, Inc., 27 B.R. 918 (Bankr. N.D. Miss. 1983) (cure need not be made by immediate cash payment; can be "adequately assured" by future business prospects) with In re Liggins, 145 B.R. 227, 231 (Bankr. E.D. Va. 1992) (deferred plan payments over a period of years do not constitute prompt cure);
(b) Compensate for pecuniary loss caused by defaults (or provide adequate assurance of compensation), which may include interest on the amount of the default and attorney's fees and expenses if provided for in the contract or by law. See 11 U.S.C. § 365(b)(1)(B); In re Ryan's Subs, Inc., 165 B.R. 465, 467-69 (Bankr. W.D. Mo. 1994); In re Eagle Bus Mfg., Inc., 148 B.R. 481 (Bankr. S.D. Tex. 1992);
(c) Provide adequate assurance of future performance, i.e., provide adequate assurance of ability to satisfy outstanding and upcoming financial obligations. See § 365(b)(1)(c); In re Washington Capital Aviation & Leasing, 156 B.R. 167, 173 (Bankr. E.D. Va. 1993) (while an absolute guarantee is not required, more than speculative plans are needed); See generally Epling, Contractual Cure In Bankruptcy, 61 Am. Bank. L.J. 71 (1987).
(d) Defaults constituting breach of contract provisions which do not require cure include: (1) insolvency or financial condition; (2) commencement of a case; or (3) appointment of a trustee. § 365(e)(1).
2. Contracts which, under non-bankruptcy law, are not assumable or assignable. § 365(c)(1).
(a) General rule: contract may not be assumed if:
(1) Applicable non-bankruptcy law excuses the nondebtor party from accepting performance from a third party; and
(2) That nondebtor party does not consent.
(b) The scope of this exception is subject to controversy. Compare In re Catron, 158 B.R. 629 (E.D. Va. 1993) (adopts hypothetical test; state statute which excuses partners from rendering or accepting performance from assignee of partnership interest satisfies as "applicable nonbankruptcy law" making contract unassumable without consent of nondebtor party), aff'd, 25 F.3d 1038 (4th Cir. 1994); In re Midway Airlines, Inc., 6 F.3d 492, 495 (7th Cir. 1993) (§ 365 not limited to personal services contracts); In re West Elecs., 852 F.2d 79, 83 (3d Cir. 1988) (§ 365 applies to all contracts and even if debtor-in-possession is party assuming the contract); In re Pioneer Ford Sales, 729 F.2d 27, 29 (1st Cir. 1984); In re Braniff Airlines, 700 F.2d 935, 943 (5th Cir. 1983) (§ 365 applies to all executory contracts); In re Claremont Acquisition Corp., Inc., 186 B.R. 977, 981-84 (C.D. Cal. 1995) (reconciling confusion over § 365(c)(1) and § 365(f)(1) by holding that the latter applies only "to state laws that validate contractual anti-assignment provisions, regardless of state law. However, where federal or state statutory or common law prohibits assignment of certain types of agreements ... it is appropriate to apply those laws in a bankruptcy proceeding.") and 2 Collier on Bankruptcy, § 365.05 (15th ed. 1991) ("the wording of [§ 365(c)] is such that considerably more contracts than those which one would normally consider personal service contracts are affected.... The reference to applicable law in section 365(c) includes situations in which state or federal law can be said to bar assignment.") with Summit Inv. and Dev. Corp. V. Leroux, 69 F.3d 608, 610 (1st Cir. 1995) (The court rejects the hypothetical test and holds instead that courts must "undertake a fact 'sensitive' inquiry to determine whether or not, in the circumstances of the particular case," the debtors can provide the nondebtor party to the contract with the "full benefit of their bargain." Only if they cannot is the contract not assumable as of right in bankruptcy proceedings.); In re James Cable Partners, L.P., 154 B.R. 813 (M.D. Ga. 1993), aff'd, 27 F.3d 534 (11th Cir. 1994) (district court rejects West Elecs. and holds that § 365 only applies when third party rather than debtor-in-possession assumes the contract; the circuit court applies the hypothetical test but holds that "applicable law" in § 365 means laws other than general prohibitions against assignment); In re Optimum Merchants Servs., 163 B.R. 546, 554-55 (Bankr. D. Neb. 1994) (rejects West Elecs.'s hypothetical test; holds that § 365 (c) only applies to personal services contracts); In re Terrace Apartments, 107 B.R. 382 (Bankr. N.D. Ga. 1989) (§ 365(c)(1) applies only to nondelegable personal service contracts). See In re Magness, 972 F.2d 689 (6th Cir. 1992) (country club membership which was subject to detailed rules and procedures for selection was not assignable); In re Antonelli, 148 B.R. 443 (D. Md. 1992) (analysis of conflict as to assumption of partnership executory contract).
(c) We argue that government contracts, because of the Anti-Assignment Act, 41 U.S.C. § 15, are not assumable as of right in bankruptcy proceedings. Compare In re West Elecs., 852 F.2d 79 (3d Cir. 1988) (Anti-Assignment Act proscribes assignment of contract to a third-party absent Government consent therefore contract may not be assumed absent government consent); In re Plum Run Serv. Corp., 159 B.R. 496, 501 (Bankr. S.D. Ohio 1993) (same) with Texaco v. Louisiana Land and Exploration, 136 B.R. 658 (M.D. La. 1992) (rejects West Elecs. and collects cases); In re American Ship Bldg. Co., 164 B.R. 358 (Bankr. M.D. Fla. 1994) (Anti-Assignment Act does not preclude contractor from assuming contract without Government consent) and In re Cardinal Indus., 116 B.R. 964 (Bankr. S.D. Ohio 1990) (rejects West Elecs. and discusses legislative history of § 365(c)(1)); see also Dept. of the Air Force v. Carolina Parachute Corp., 907 F.2d 1469 (4th Cir. 1990)(executory government contract may be assumed by debtor-in-possession in plan of reorganization absent government objection). See generally In re Robert E. Derecktor, Inc., 142 B.R. 29 (Bankr. D.R.I. 1992) (A creditor is not required to comply with Assignment of Claims Act to perfect security interest in proceeds of chapter 11 debtor's government contract; the Act was intended to establish procedures for assignees asserting claims against government, not perfection of liens.); Defense Acquisition Regulations, 32 C.F.R. § 26-402(a).
(d) Other provisions in particular programs: See, e.g., In re Braniff Airways, 700 F.2d 935 (5th Cir. 1983) (ticket counter lease not assumable without airport manager's approval under Washington Nat'l Airport Act); In re Whitcomb & Keller Mortgage Co., 8 B.R. 83 (Bankr. N.D. Ind. 1980) (GNMA mortgage backed securities contract could not be assumed/assigned).
3. Contracts to make a loan or extend other debt financing or financial accommodations. § 365(c)(2); see In re Hamilton Co., 969 F.2d 1013 (11th Cir. 1992) (court reviews meaning of term "financial accommodation;" collects cases discussing definition thereof); Watts v. Pennsylvania Hous. Fin. Co., 876 F.2d 1090 (3d Cir. 1989) (suspension of mortgage assistance payments upon filing did not violate automatic stay because housing authority's commitments were executory contracts to "make a loan or extend other debt financing" which are terminable by housing authority under § 365(e)(2)(B)); In re Boutiette, 168 B.R. 474, 481 (Bankr. D. Mass. 1994) ("Congress undoubtedly envisioned a more expansive meaning of 'financial accommodations' than the extension of credit or the making of loans."); In re Cardinal Indus., Inc., 146 B.R. 720, 730-31 (Bankr. S.D. Ohio 1992) (revolving line of credit is contract for financial accommodation); In re United Press Int'l, 55 B.R. 63, 66 (Bankr. D.D.C. 1985) ("[T]he intent of Congress was to prohibit the assumption of any contract wherein the Debtor is extended, directly or indirectly, cash or a line of credit."); In re Adana Mortgage Bankers, 12 B.R. 977, 987 (Bankr. N.D. Ga. 1980) (Guaranty Agreements issued by Gov't Nat'l Mortgage Assoc. deemed executory contracts to make financial accommodations for the benefit of the debtor and therefore not assumable.) But cf. In re TS Indus., 117 B.R. 682 (Bankr. D. Utah 1990) (a creditor plan could provide for the recalcitrant debtor's assumption of a pre-petition "workout" executed in anticipation of debtor's bankruptcy even though it is a contract to extend financial accommodations). Whether this prohibition applies to contracts with "incidental financial accommodations" is subject to controversy. In re Cole Bros., Inc., 154 B.R. 689 (W.D. Mich. 1992).IV. REJECTION.
1. The debtor may reject an executory contract through a motion to reject under § 365(a) or through a provision in the plan of reorganization pursuant to § 1123(b)(2). In re Parkwood Realty Corp., 157 B.R. 687, 690 (Bankr. W.D. Wash. 1993). However, boilerplate terms in a plan which reject all contracts not assumed, without further specificity, may not always be effective. Parkwood, 157 B.R. at 690-91.
2. As with assumption, there is controversy over whether court approval is required for an effective rejection of a contract. Compare In re Thinking Machines Corp., 67 F.3d 1021 (1st Cir. 1995); Paul Harris Stores v. Mabel L. Salter Realty Trust, 148 B.R. 307 (S.D. Ind. 1992) (both holding that court approval necessary for effective rejection of contract); In re 1 Potato 2, Inc., 182 B.R. 540, 542 (Bankr. D. Minn. 1995) ("rejection ... is only effective upon court approval"); In re Compuadd Corp., 166 B.R. 862, 866 (Bankr. W.D. Tex. 1994) (same); In re Four Star Pizza, 135 B.R. 498, 501 (Bankr. W.D. Pa. 1992) (same) and In re Worths Stores Corp., 130 B.R. 531 (Bankr. E.D. Mo. 1991) (finds court approval required for rejection of contract, distinguishing between assumption and rejection) with In re Joseph C. Spiess Co., 145 B.R. 597, 600-06 (Bankr. N.D. Ill. 1992) (court approval of assumption or rejection is not a condition precedent to its effectiveness, rather it makes it subject to review and possible reversal) and In re 1 Potato 2, Inc., 58 B.R. 752 (Bankr. D. Minn 1986) (rejection effective with unequivocal conduct).B. Standards for Rejection of a Contract. An executory contract may only be rejected if the proponent satisfies the business judgment test. In re Chi-Feng Huang, 23 B.R. 798, 800 (Bankr. 9th Cir. 1982). The primary issue is whether the rejection of the contract would benefit general unsecured creditors. E.g., In re Orion Pictures Corp., 4 F.3d 1095, 1098 (2d Cir. 1993), cert. dismissed, 114 S. Ct. 1418 (1994); In re Kong, 162 B.R. 86, 94 (Bankr. E.D.N.Y. 1993); In re Lawson, 146 B.R. 663, 664-65 (Bankr. E.D. Va. 1992); In re Audra-John Corp., 140 B.R. 752, 755 (Bankr. D. Minn. 1992). However, other factors courts may consider include whether (a) the contract burdens the estate financially; (b) rejection would result in a large claim against the estate; (c) the debtor showed real economic benefit resulting from the rejection; and (d) upon balancing the equities, rejection will do more harm to the other party to the contract than to the debtor if not rejected. "Generally, absent a showing of bad faith, or an abuse of business discretion, the debtor's business judgment will not be altered." In re G Survivor Corp., 171 B.R. 755, 757-58 (Bankr. S.D.N.Y. 1994).
C. Effect of Rejection. See § 365(g) and (h); see generally Michael T. Andrew, Executory Contracts in Bankruptcy: Understanding "Rejection", 59 U. Colo. L. Rev. 845 (1988).
1. Rejection of a contract not assumed constitutes a breach immediately before the date of filing of the petition. Aslan v. Sycamore Inv. Co., 909 F.2d 367 (9th Cir. 1990); In re Continental Airlines, Inc., 146 B.R. 520, 531 (Bankr. D. Del. 1992) (rejection of lease).
2. Rejection makes other party to the contract simply an unsecured creditor. NLRB v. Bildisco and Bildisco, 465 U.S. 513 (1984). The nondebtor party has (1) a claim against the debtor for damages for breach of contract, which claim is deemed to have arisen immediately before the filing of the petition and is a prepetition claim, and (2) an expense of administration claim for any benefits received by the debtor in possession prior to rejection. In re Bridgeport Plumbing Prods., Inc., 178 B.R. 563 (Bankr. M.D. Ga. 1994) (creditor may file administrative expense claim for the "reasonable value of the use" of the creditor's property prior to rejection); In re Hooker Investments, 145 B.R. 138, 144 (Bankr. S.D.N.Y. 1992); see also Texaco Inc. v. Louisiana Land and Exploration Co., 136 B.R. 658, 663 (M.D. La. 1992) (rejection of the prepetition contract does not cancel the contract; it constitutes a breach of the contract and grants the other party a claim against the estate as an unsecured creditor). The amount of the damages may be controlled by state law or the remedies specified in the contract. In re Yasin, 179 B.R. 43, 49-50 (Bankr. S.D.N.Y. 1995) (After rejection parties must resort to state law to determine their rights as a result of the breach.); In re Independent American Real Estate, Inc., 146 B.R. 546, 553 (Bankr. N.D. Tex. 1992) (state law specifies the remedies of a non-breaching party to a contract, to the extent state law does not contravene the Code); In re Audra-John Corp., 140 B.R. 752, 757 (Bankr. D. Minn. 1992) (state law, not federal bankruptcy law, controls remedies available to non-rejecting party upon a breach). Compare In re Hamilton Roe Int'l, Inc., 162 B.R. 590, 596 (Bankr. M.D. Fla. 1993) (contract damages provisions do not control after rejection) with In re Hughes, 166 B.R. 103, 105 (Bankr. S.D. Ohio 1994) (Debtor remains subject to covenant not to compete despite rejection of contract.). Rejection does not extinguish the contract. It merely constitutes a breach of the contract, and the terms of the contract still control the relationship of the parties. In re Flagstaff Realty Assocs., 60 F.3d 1031 (3d Cir. 1995) (Rejection of a lease does not alter the substantive rights of the parties to the lease. Hence, creditor-lessee could rely on lease provision permitting it to make repairs to leased property and deduct the cost of those repairs from its rent payments to the debtor-landlord.); In re Austin Development Co., 19 F.3d 1077, 1082 (5th Cir. 1994) (rejection breaches rather than terminates the contract), cert. denied, 115 S. Ct. 201 (1994); In re Continental Airlines, 981 F.2d 1450, 1459-61 (5th Cir. 1993) (rejection does not invalidate or extinguish contract); In re Printronics, Inc., 189 B.R. 995, 1000 (Bankr. N.D. Fla. 1995) (Rejection of an executory contract does not terminate the contract, it merely breaches the contract.); In re Yasin, 179 B.R. 43, 49-50 (Bankr. S.D.N.Y. 1995) (Rejection constitutes a breach of the contract or lease, it does not terminate it.); In re Fitch, 174 B.R. 96, 100 (Bankr. S.D. Ill. 1994) ("rejection ... neither adds to nor detracts from a claim for payment under the contract or the estate's liability for such payment"); In re Old Electralloy Corp., 167 B.R. 786, 791 (Bankr. W.D. Pa. 1994) ("The Trustee's rejection of the contract ... does not render the contract non-existent. ... [nor does] the Trustee's rejection extinguish the Debtor's obligations under the ... provisions of the contract or render the [contract's] provisions inapplicable as of the date of rejection. ... [Finally], the rejection does not relieve the Trustee of his obligations which arise from the period of time during which the Trustee operated the business [postpetition but prior to rejection]."); In re South Motor Co. of Dade County, 161 B.R. 532, 545-46 (Bankr. S.D. Fla. 1993) ("rejection has no effect on a contract's continued existence ... Accordingly, rejection of an executory contract does not ipso facto terminate rights and obligations that arise from rejected contracts."); In re Walnut Assocs., 145 B.R. 489, 494 (Bankr. E.D. Pa. 1992) (rejection of contract does not "invalidate, rejudicate, repeal, or avoid" an executory contract; it merely means that contract is not assumed and nondebtor party cannot make an administrative claim against debtor's estate if debtor fails to perform).
3. Despite the apparently limited impact of rejection, one court has held that claims arising from rejection of an executory contract are not available for recoupment. United States v. Dewey Freight Sys., Inc., 31 F.3d 620 (8th Cir. 1994) (claims arising from rejection may only be recovered through proof of claim). But see In re Hirschorn, 156 B.R. 379, 388 (Bankr. E.D.N.Y. 1993); In re Don & Lin Trucking Co., 110 B.R. 562, 568 (Bankr. N.D. Ala. 1990)) (both holding that rejection does not limit the non-debtor party to filing a proof of claim for damages) and Howard Johnson, Inc. v. Tucker, 157 F.2d 959, 961 (5th Cir. 1946) (claims for damages arising on rejection of an executory lease in bankruptcy are properly subject to recoupment where the obligations both arise out of the same transaction); In re Chestnut Ridge Plaza Assocs., 156 B.R. 477, 485 (Bankr. W.D. Pa. 1993) (creditor can offset losses incurred from rejection of lease against rents due the debtor under the rejected lease); In re Express Freight Lines, Inc., 130 B.R. 288, 291-92 (Bankr. E.D. Wis. 1991) (court allows setoff of claims resulting from rejection of an unexpired lease); cf. In re Columbia Gas Sys., Inc., 50 F.3d 233, 239 n.8 (3rd Cir. 1995) ("Rejection ... is equivalent to a nonbankruptcy breach. Rejection leaves the nonbankrupt with a claim against the estate ... and unless the nonbankrupt's claim is somehow secured, he will be a general unsecured creditor of the estate.")(emphasis added); In re Klein Sleep Prods., Inc., 173 B.R. 296, 299 (S.D.N.Y. 1994) ("Section 365 merely establishes the method for determining the date upon which a breach of an [executory contract] is deemed to occur. It does not purport to assign the priority awarded to damages flowing from the rejection of a[n executory contract].").
4. Leases of Personalty. To compensate and protect the non-debtor lessor while a debtor is deciding whether to reject an unexpired lease of personalty, the Code allows the lessor to : (1) claim an administrative expense of the actual, necessary costs and expenses of preserving the estate; (2) seek relief from the automatic stay; (3) request adequate protection payments; or (4) move for the court to set a date by which the lease must be assumed or rejected. In re Continental Airlines, Inc., 146 B.R. 520 (Bankr. D. Del. 1992).
5. Rejection of a contract previously assumed constitutes a breach as of date of rejection unless conversion from 11 or 13 to 7, in which case breach deemed to occur immediately before conversion. Whether damages resulting from rejection of a previously assumed contract are entitled to administrative expense status is subject to controversy. Compare In re Frontier Properties, 979 F.2d 1358, 1367 (9th Cir. 1992) (damages from rejection of previously assumed contract are administrative expenses) with In re Klein Sleep Products, Inc., 173 B.R. 296, 298-99 (S.D.N.Y. 1994) (damages arising from rejection of previously assumed contract are only entitled to administrative expense status if they meet the requirements of § 503) and In re Chugiak Boat Works, Inc., 18 B.R. 292 (Bankr. D. Alaska 1982) (damages from rejection of previously assumed contract are administrative expenses but not entitled to superpriority under § 726(b)).
6. Rejection Of Leases. § 365(h).
(a) Whether the rejection by the debtor-lessor always terminates the lease is subject to controversy. Compare In re Carlton Restaurant, Inc., 151 B.R. 353 (Bankr. E.D. Pa. 1993) (rejection always terminates lease and lessor's obligations thereunder; lessee is entitled to only those rights provided under § 365(h)) with In re Chestnut Ridge Plaza Assocs., L.P., 156 B.R. 477 (Bankr. W.D. Pa. 1993) (§§ 365(g),(h), read together, do not mandate automatic termination where debtor-lessor rejects lease); In re Kong, 162 B.R. 86, 95-96 (Bankr. E.D.N.Y. 1993) (rejection of lease by debtor-lessor only results in termination of covenants that require future performance by debtor); and In re Mr. Gatti's, Inc., 162 B.R. 1004, 1011-12 (Bankr. W.D. Tex. 1994) (collecting cases). Whether rejection by the debtor-lessee always terminates the lease is also subject to controversy. In re Austin Development Co., 19 F.3d 1077 (5th Cir. 1994) (rejection by debtor-lessee does not terminate lease). Whether the lessor-nondebtor's claim for the postpetition, pre-rejection rents is limited by § 502 and/or are entitled to an administrative priority is subject to controversy. Compare In re Templeton, 154 B.R. 930, 932 (W.D. Tex. 1993) (collecting cases and holding that such claims are not entitled to administrative expense status); In re Mr. Gatti's, Inc., 164 B.R. 929, 1007-1011 (Bankr. W.D. Tex. 1994) (exhaustive discussion of history and present treatment of postpetition, prerejection claims for lease-related obligations as administrative expenses; court holds that such claims are not automatically entitled to administrative expense status) with In re Compuadd Corp., 166 B.R. 862, 864-66 (Bankr. W.D. Tex. 1994) (rejecting conclusion of court in Mr. Gatti's).
(b) Tenant's options:
(1) Treat lease as terminated;
- or -
(2) Remain in possession. § 365(h)(1); In re Kong, 162 B.R. 86, 95-96 (Bankr. E.D.N.Y. 1993).
(c) If remain in possession:
(1) May offset against rent any damages caused by debtor-lessor's non-performance
- BUT -
(2) No further, independent claim against estate for further damages. § 365(h)(2).
(d) The status of claims based on future rents when the lease is assumed and then subsequently rejected is subject to controversy. See In re Johnston, Inc., 164 B.R. 551, 553-56 (Bankr. E.D. Tenn. 1994) (loss of future rents from lease which is assumed and then rejected is not an administrative expense).