CHAPTER 4 EXECUTORY CONTRACTS AND THE PLAN OF REORGANIZATION
| Jurisdiction | United States |
(May 1986)
EXECUTORY CONTRACTS AND THE PLAN OF REORGANIZATION
Reynolds, Ridings & Hargis
Oklahoma City, Oklahoma
I. ASSUMPTION AND REJECTION OF EXECUTORY CONTRACTS.
A. Introduction.
With the passage of the Bankruptcy Reform Act of 1978, §365 of the Bankruptcy Code became effective. Subject to certain restrictions and conditions, the trustee (or debtor in possession pursuant to §1107(a)), with court approval, may assume or reject executory contracts to which the debtor was a party prior to the commencement of the case. Assumption of an executory contract carries with it all benefits and burdens attendant to the contract and the trustee must cure all defaults existing at the time of the assumption. Upon assumption, the trustee can assign a contract notwithstanding any provision in the contract which restricts such assignment.
On July 10, 1986, Congress enacted the Bankruptcy Amendments and Federal Judgeship Act of 1984. The 1984 Amendments significantly changed the treatment of shopping center leases and non-residential real property leases under §365. The effect of the Amendments, and, to a lesser extent, the unamended provisions of §365 upon contracts involving the oil and gas industry, to a significant degree, have not determined by the courts. However, decisions interpreting pre-1979 bankruptcy provisions are applicable for many purposes. See, Theatre Holding Corp. v. Mauro, 681 F.2d 102 (2nd Cir. 1982).
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B. Definition of Executory Contract.
The Bankruptcy Code provides no precise definition of "executory contract" or, for that matter, "unexpired lease". The drafters of the Bankruptcy Code remarked that "contracts on which performance remains due to some extent on both sides" are generally executory. The most widely accepted definition of "executory contract" is that of Harvard Professor Vern Countryman who defined an executory contract as one which the "obligations of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete the performance would constitute a material breach excusing the performance of the other" Countryman, Executory Contracts and Bankruptcy, 57 Minn. L.Rev. 439, 460 (1973). Since the enactment of the Bankruptcy Code, however, the Countryman definition has been subject to some criticism. For instance, one court, while noting the Countryman definition provided a workable test, ruled that the determination of when a contract was executory depended upon a balancing of the following considerations:
1. Enlarging the value of the estate.
2. Furthering the rehabilitation of the debtor.
3. Adequate protection of creditors.
In Re Booth, 19 B.R. 53 (Bankr. D. Utah 1982).
Likewise, the Bankruptcy Court in Skeen v. Harms (In Re Harms), 10 B.R. 817 (Bankr. D. Colo. 1981), noted that decisions in the Tenth Circuit required consideration of the complexity of the remaining obligations of both parties to a contract.
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The Countryman definition is also questioned by the author of Julis, Classifying Rights and Interests Under The Bankruptcy Code, 55 Am. Bank. L.J. 223, (1981).
The impact of the foregoing definitional disputes is perhaps best illustrated by cases involving installment land sale agreements where title to the land is retained by the vendor. Noting the inequities of requiring the debtor to either reject and forfeit amounts paid to the vendor or assume and commit the estate to payment of the debt in full, at least three courts have classified such contracts as liens rather than executory contracts. In Re Booth, supra; In Re Kampman Farms, Inc., 6 B.R. 653 (Bankr. W.D. Okl. 1980); Matter of Cox, 28 B.R. 588 (Bankr. D. Idaho 1983). See also, B. Weintraub & A. Resnick, What Is An Executory Contract? A Challenge To The Countryman Test, 15 U.C.C.L.J. 273 (1983). In contrast, other courts have applied the Countryman test and determined that the vendor's obligation to convey title to the property and the vendee's obligation to complete payments pursuant to the contract were sufficiently substantial to render the contract executory. In Re Alexander, 6 C.B.C. 2d 771 (9th Cir. 1982).
It is clear that certain contracts are, by nature, not executory. Thus, the committee on the judiciary noted that a "note is not usually an executory contract if the only performance that remains is repayment." Senate Report No. 95-99.
A lease or contract which has effectively terminated under state law prior to the commencement of the case are not executory contracts which can be assumed by the debtor. Moody
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v. Amoco Oil Co., 734 F.2d 1200 (7th Cir. 1984); In Re Trigg, 630 F.2d 1370 (10th Cir. 1980); In Re Jolly, 574 F.2d 369 (6th Cir. 1978), cert. denied, 439 U.S. 29 (1978). The 1984 amendments added §365(c)(3) which effectively codifies the foregoing authorities with respect to expired leases. Likewise, a contract entered into by the estate subsequent to the commencement of the bankruptcy case is not governed by §365. In Re IML Freight, Inc., 37 B.R. 556 (Bankr. D. Utah 1984).
C. Standard For Assumption Or Rejection.
The trustee may only assume an executory contract with authority of the Bankruptcy Court. However, while court approval must be granted before assumption becomes effective, the trustee assumes the lease when he makes his decision to do so. As the court noted in By-Rite Distributing, Inc. v. Brierley (In Re By-Rite Distributing, Inc.), 55 B.R. 740, 742-3 (D. Utah 1985):
"The court concludes that the trustee assumes or rejects the lease within the meaning of section 365(d)(4) when he makes up his mind to do so and communicates his decision in an appropriate manner, such as by filing a motion to assume. The assumption may become effective only after the court approves it. It is, in effect, subject to defeasance by the court. By the trustee's act of assuming the lease is complete for purposes of section 365(d)(4) before the trustee ever obtains court approval." (footnote omitted)
In determining whether to permit an assumption or rejection of an executory contract, the court must first determine whether the trustee's proposed action is in the best interest of the estate. In making such determination, "great deference to the business judgment of the debtor in possession
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or trustee" is allowed. In Re By-Rite, 47 B.R. 66, 668 (Bankr. D. Utah), reversed on other grounds, 55 B.R. 740 (D. Utah 1985).
§365(b)(1) provides that the trustee may not assume a contract or lease if the contract or lease is currently in default unless the trustee cures the default and compensates any party to the contract other than the debtor for any damages caused by the default, or provides adequate assurance of such cure and compensation, and provides adequate assurance of future performance pursuant to the contract or lease. In approving the trustee's proposed assumption, the court must, of course, determine whether the trustee is capable of curing defaults, compensating for damages, and providing adequate assurance of future performance. §365(b)(2) specifically provides that the breach of a contractual provision relating to the financial condition of the debtor, the commencement of the bankruptcy case, or the appointment of a receiver or trustee are not defaults which must be cured as a condition to assumption.
Special provisions pertain to the assumption of shopping center leases. As to such leases, adequate assurance of future performance must include assurance that rent, including percentage rent, will be paid, lease provisions, including radius, location, use or exclusivity provisions will be observed and that assumption or assignment will not disrupt the shopping center's tenant mix or balance.
While the trustee is not precluded from assuming an executory contract or unexpired lease by provisions thereof terminating the contract upon insolvency or similar conditions,
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the trustee may not assume if applicable law does not require the other party to accept performance from one other than the debtor or if the contract requires the other party to loan money or otherwise extend financing to the debtor or issue a security of the debtor.
Rejection of an executory contract or unexpired lease generally constitutes a breach of the contract or lease. Damages sustained as a result of such breach are treated as a pre-petition claim unless a previously assumed contract is subsequently rejected after conversion of the case to a different chapter. If the trustee is the lessor or vendor under a contract or lease relating to real property, the lessee or purchaser has an option upon the trustee's rejection of such lease or contract. Such lessee or purchaser may treat the rejection as a breach or, notwithstanding such rejection, may remain in possession. If the latter option is chosen, the lessee or purchaser may remain in possession of the property in accordance with the lease or contract and may offset any obligations it may have to the trustee pursuant to the contract against any damages sustained by the rejection, but the lessee or purchaser may assert no further claims against the estate in connection with such rejection. §365(h) and (i). If a purchaser of real property from the debtor treats an executory contract for the purchase of real property as terminated as a result of the trustee's rejection, such purchaser has a lien on the interest of the debtor in the real property to secure all amounts paid to the debtor.
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D. Time For Assumption Or Rejection.
The time within which executory contracts or unexpired leases must be assumed by the trustee differs according to the type of proceeding and the nature of the contract or lease. Failure to assume or reject within the proper time period results in a deemed rejection of the contract or lease.
In a Chapter 7 proceeding, the...
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