When a business files for bankruptcy, one of the most critical components of the reorganization or liquidation process involves its executory contracts — legally binding agreements that have yet to be fully performed by both parties. The U.S. Bankruptcy Code provides clear guidance on how these contracts may be handled: they may be assumed, assigned, or rejected. Understanding these concepts is essential for both debtors seeking relief and counterparties looking to protect their rights.
What Are Executory Contracts?
In the context of bankruptcy, an executory contract is a contract under which both parties still have material performance obligations. Common examples include:
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Leases
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Service agreements
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Franchise and license agreements
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Purchase orders
These contracts represent potential liabilities or assets depending on the terms and the business's ability to fulfill them.
1. Assumption of Contracts
Assumption occurs when the bankrupt entity (the debtor) decides to keep a contract in place and continue fulfilling its obligations. To do this, the debtor must:
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Cure any defaults (i.e., pay past-due amounts)
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Provide adequate assurance of future performance
This is common when a contract is beneficial to the reorganization process — for example, a favorable lease in a prime location or a key supplier agreement that supports continued operations.
✦ Practical Implication:
Assumption binds the debtor to the contract going forward, and the counterparty regains rights to enforce performance.
2. Assignment of Contracts
Once a contract is assumed, it can be assigned to a third party — even if the contract contains language prohibiting assignment. Under §365(f) of the Bankruptcy Code:
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The debtor may transfer the assumed contract to another party
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The new party must provide adequate assurance of performance
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The counterparty cannot object solely on anti-assignment grounds
This provision enables debtors to monetize valuable contracts by selling them during bankruptcy.
✦ Limitations:
Contracts that are “personal in nature” (e.g., involving a specific person’s unique skills or trust) are typically not assignable without the non-debtor party’s consent.
3. Rejection of Contracts
Rejection is the process by which a debtor declines to continue performing under an executory contract. It is treated as a breach of contract, effective as of the date of rejection.
Rejection allows the debtor to:
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Eliminate burdensome obligations
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Shed unprofitable or unfavorable agreements
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Streamline operations during reorganization or liquidation
The non-debtor party may file a rejection damage claim, which is usually treated as a general unsecured claim — and often only partially recovered.
Procedural Aspects
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Court Approval: The assumption, rejection, or assignment of an executory contract typically requires bankruptcy court approval.
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Time Limits: In Chapter 11, debtors generally have until plan confirmation to decide on executory contracts; in Chapter 7, decisions are made more quickly.
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Automatic Stay: While decisions are pending, counterparties are barred from terminating contracts or taking collection actions.
Special Cases
✦ Intellectual Property Licenses:
Debtors can reject IP licenses, but under §365(n), licensees may retain rights to use the IP under certain conditions.
✦ Real Property Leases:
Debtors must decide on nonresidential real property leases within 210 days (120 days plus a possible 90-day extension), or the lease is deemed rejected.
Considerations for Contract Counterparties
If your business is a party to a contract with a bankrupt company:
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Monitor court filings for motions to assume, assign, or reject your contract
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Be prepared to file a proof of claim for rejection damages
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Evaluate the financial strength of any proposed assignee
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Understand your rights under §365 and applicable case law
Conclusion
The treatment of executory contracts in bankruptcy — assumption, assignment, and rejection — plays a pivotal role in the outcome of a case. For debtors, it is a tool for maximizing value and cutting losses. For counterparties, it's essential to stay informed and proactive to protect contractual and financial interests. Consulting bankruptcy counsel is often crucial to navigate this complex process effectively.
