Does Bankruptcy Nullify Existing Contracts? What Non-Debtors Need to Know About Executory Contracts and Contract Rejection

Bankruptcy debtors have special rights in contracts or leases where both parties have outstanding obligations, known in legal terms as “executory contracts” or “unexpired leases”. If you are doing business with a company that is in bankruptcy, take action now to protect your interests.

An Executory Contract Has Unfulfilled Obligations On Both Sides

In bankruptcy, the debtor’s assets and debts are catalogued, usually for liquidation or reorganization. But executory contracts don’t fall neatly into the category of “asset” or “debt,” because there are significant unfulfilled obligations for both parties.

Common examples of executory contracts include:

• Real estate and equipment leases. The lessor must make the property or equipment available, and the lessee must make scheduled payments.
• Insurance contracts. The insurer must cover losses, and the insured must pay premiums.
• Licensing agreements. The licensor must pay fees, and the licensee must not pursue legal action.

Note: The bankruptcy code does not define executory contracts explicitly, so the court has developed definitions that vary somewhat across jurisdictions.

Executory Contracts Put Non-Debtors At Risk

As a non-debtor party to an executory contract, you are in a difficult position. The debtor may have missed payments or otherwise defaulted. You may not want to keep doing business with a company in a financial crisis. But once a bankruptcy is filed, you typically can’t immediately act against the debtor or cancel the contract because of the bankruptcy proceeding.

Both the debtor and, if appointed, a trustee (a neutral third party that handles a debtor’s financial obligations) have special rights with executory contracts. The debtor or trustee can assume (keep) or reject (cancel) executory contracts, regardless of your desire in most cases. Prior to a debtor or a trustee deciding whether to assume or reject a contract, in most circumstances, you must continue to perform under the contract.

When the debtor or trustee assumes a contract, the contract remains in force, but:

• If there have been defaults on the contract, the debtor must cure the defaults, compensate you for losses, and provide adequate assurance of future performance. If they do not, the contract cannot be assumed.
• A few types of executory contracts cannot be assumed, like promises to loan money.

The trustee also has the right to assign (sell) the assumed contract to another business.

When a debtor or trustee rejects an executory contract, it is treated as a breach by the debtor. This means that neither party is obligated to perform their remaining contractual duties. However, you may have a claim against the debtor for damages caused by the breach of contract, which can be addressed along with other creditors’ claims.

Contracts can be rejected affirmatively or by default. In a Chapter 7 bankruptcy, the trustee generally has 120 days to assume or reject an executory contract. If the trustee does not act, the contract is rejected automatically. In Chapter 11 bankruptcy, the debtor or trustee can assume or reject the contract any time before confirmation of the bankruptcy plan.

You Can Take Action On Executory Contracts

Bankruptcy protects debtors from some actions, but you can still assert your interests. Potential paths forward include:

• Asking the debtor about its intentions to assume/reject the contract so that you make plans.
• Asking the bankruptcy court to compel the debtor or trustee to assume or reject the contract quickly.
• Pursuing damages for breach of contract and payments owed under the contract.

A Creditor’s Rights Attorney Can Help You Assert Your Rights

Laws about bankruptcy and executory contracts are complex. A creditor’s rights attorney can help you analyze executory contracts, communicate with the debtor or trustee, and represent your interests in bankruptcy court.