5.3 Executory Contracts and Unexpired Leases— Section 365

• Library: Bankruptcy Practice in Virginia (Virginia CLE) (2017 Ed.)

5.3 EXECUTORY CONTRACTS AND UNEXPIRED LEASES— SECTION 365

5.301 Introduction. Section 365 of the Bankruptcy Code permits the trustee to reject or assume executory contracts and unexpired leases. If a contract or lease is assumed, it may also be assigned to a third party. While the Code does not provide a standard by which a trustee determines whether to assume or reject a contract or lease, the case law indicates that the decision is subject to a business judgment test. ⁷³ This standard requires the trustee to use the type of judgment that a business person would employ under similar circumstances. In most cases, a court will rely upon the trustee's business judgment. The benefits conferred by this section are especially valuable to the debtor-in-possession.

5.302 Definitions.

A. Executory Contract. Although there are various definitions of "executory contract," the most widely accepted is the Countryman ⁷⁴ definition, which states that it is a contract "under which the obligations of both the [debtor-in-possession] and the other party are so far unperformed that the failure of either to complete the performance would constitute a material breach excusing the performance of the other." ⁷⁵ Simply put, it is a contract under which material obligations remain on both sides. While the Fourth Circuit and others have adopted the Countryman approach, ⁷⁶ other jurisdictions have rejected it and instead focused on whether the debtor has unperformed duties under the contract or unexpired lease, ⁷⁷ or questioned what benefit the assumption or rejection would produce for the estate. ⁷⁸

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B. Unexpired Lease. An unexpired lease is a lease that has not expired by its terms and has not been terminated.

5.303 Assumption or Rejection. Generally speaking, a trustee has two alternatives with regard to executory contracts or unexpired leases: to assume or reject. However, if the trustee assumes a lease or contract, it also will have the option to keep the lease or contract or assign it to a third party.

The trustee may assume an executory contract or unexpired lease when it is in default only upon meeting the requirements set forth in section 365, which state that the trustee must:

1.	Cure, or provide adequate assurance that the trustee will promptly cure, all defaults (if any); 79
2.	Compensate, or provide adequate assurance that the trustee will promptly compensate, a party other than the debtor to such contract or lease for any actual pecuniary loss resulting from the default; 80 and
3.	Provide adequate assurance of future performance under the contract or lease. 81

Section 365(b)(2) makes clear that the provisions of subsection (b)(1) do not apply to a default resulting from lease terms that trigger the default on the basis of the debtor's insolvency, the filing of a bankruptcy petition, or the debtor's financial condition. This provision effectuates the bankruptcy law policy that ipso facto clauses are unenforceable. ⁸²

An executory contract or unexpired lease may only be assumed or rejected in its entirety, taking with it the burdens with the benefits. ⁸³ Once a trustee has assumed a contract or lease, the other party to the contract or

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lease may enforce it against the trustee according to its terms or agree to modify it. ⁸⁴

Not all contracts and leases are assumable. Even if the trustee satisfies all of the requirements discussed above for assuming a contract or lease, section 365(c) prohibits the trustee from assuming or assigning an executory contract or unexpired lease if:

1.	Applicable law excuses a party, other than the debtor, from accepting such performance from or rendering performance to an entity other than the debtor or the debtor-in-possession, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties, and such party does not consent to such assumption or assignment;
2.	The contract is a contract to make a loan, or extend other debt financing or financial accommodations, to or for the benefit of the debtor, or to issue a security of the debtor; or
3.	The lease is of nonresidential real property that has been terminated under applicable nonbankruptcy law prior to the order for relief.

Personal service contracts and patent licenses are the most common examples of contracts that cannot be assumed under section 365(c)(1).

5.304 Time Periods to Assume or Reject.

A. Chapter 7 Cases. In a Chapter 7 case, if the trustee does not assume or reject an executory contract or unexpired lease of residential real property or of personal property of the estate within 60 days after the order for relief, the contract or unexpired lease is deemed rejected. ⁸⁵ The court may, for cause, extend the 60-day period in which the trustee must assume or reject. ⁸⁶

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However, the trustee must file a pleading requesting an extension within the initial 60-day period. ⁸⁷

B. Chapter 9, 11, 12, or 13 Cases. In a Chapter 9, 11, 12, or 13 case, subject to the exceptions listed below, the trustee may assume or reject an executory contract or unexpired lease, either by formal motion or in the plan, at any time before the confirmation of the plan. ⁸⁸ However, upon request of any party to a contract or lease, the court may order the trustee to determine, within a specific period, whether it will assume or reject the contract or lease. ⁸⁹

C. Nonresidential Real Property. In a case under any title of the Bankruptcy Code and notwithstanding the previous two paragraphs, a lease of nonresidential real property is deemed to be rejected if the trustee does not assume or reject it within the earlier of 120 days after the order for relief or the date of the entry of an order confirming a plan. ⁹⁰ The leased property must then be immediately surrendered by the debtor. Once again, the court may, for cause, extend the period to assume or reject for 90 days on motion for cause of the lessor or trustee made before expiration of the 120-day period; subsequent extensions may only be granted if the lessor consents in writing. ⁹¹

D. Residential Real Property. The filing of a petition typically operates to stay an action to obtain possession of property of the estate. ⁹² However, if the lessor of residential real property has already obtained a judgment for possession before the bankruptcy...