Executory Contract

An executory contract is any agreement for which the debtor and its counterparty have material obligations remaining after the petition date. An “unexpired lease” is an executory contract. Real estate leases, equipment leases, licenses of intellectual property, and employment agreements are common types of executory contracts. Non-debtor counterparties to executory contracts are obligated to continue performing under the contracts (even though the bankruptcy debtor may not be current with payment) unless and until the contract is rejected by the debtor through a Bankruptcy Court order (or the contract expires under its ordinary terms). A contract rejection is considered to be a breach of the contract as of the petition date.  A rejection releases both the debtor and the counterparty from further performance under the contract (though real property lessees and intellectual property licensees may elect to retain their rights under some circumstances).  Upon rejection, the counterparty obtains an unsecured claim for rejection damages (amounts owed to it under the contract that are not administrative claims, subject to special limits under some circumstances). On the other hand, if the debtor intends to continue performing under a contract, it must formally assume that contract through an approval order which will compel the debtor to pay all outstanding pre- and post-petition amounts due and past due under the contract (known as the “cure” payment). Upon court approval, the debtor may sell or “assign” its interest under an assumed contract to a third party, provided that the assignee can provide the counterparty with adequate assurance of future performance.

The concept of rejection is not as straightforward as it may seem. For example, On May 20, 2019, the United States Supreme Court held that under Section 365 of the Bankruptcy Code, a debtor’s rejection of a trademark license does not revoke the license and the licensee can continue to exploit the licensed trademark. On first blush, this may appear contrary to the basic principles discussed above.

For more information, see Dealing with Corporate Distress 16: Overview of Bankruptcy Code § 365.