Executory contract

Abstract: This paper focuses on the treatment in bankruptcy of a debtor's executory contracts - contracts under which the debtor still owes (or is owed) performance at the time it files for bankruptcy. Under the bankruptcy laws of most countries, including the U.S., the bankruptcy trustee usually disposes of an executory contract in one of two ways: either by (1) assuming and seeking performance of the contract; or by (2) rejecting the contract, in which case any resulting damage claim is treated as a prebankruptcy unsecured claim and receives its ratable share of the assets available to pay unsecured claims. Since such unsecured claims are typically paid only a fraction of their face amount, a party injured by rejection usually receives less than full compensation. This approach is widely supported by U.S. bankruptcy commentators. The paper first explains how this ratable damages rule can give the bankruptcy trustee an incentive to reject contracts when performance would be efficient. It then shows that the manner in which the ratable damages rule is actually applied by U.S. courts tends to worsen the problem. The paper concludes by considering various arrangements for eliminating the distortion.

Abstract: This paper focuses on the treatment in bankruptcy of a debtor's executory contracts - contracts under which the debtor still owes (or is owed) performance at the time it files for bankruptcy. Under the bankruptcy laws of most countries, including the U.S., the bankruptcy trustee usually disposes of an executory contract in one of two ways: either by (1) assuming and seeking performance of the contract; or by (2) rejecting the contract, in which case any resulting damage claim is treated as a prebankruptcy unsecured claim and receives its ratable share of the assets available to pay unsecured claims. Since such unsecured claims are typically paid only a fraction of their face amount, a party injured by rejection usually receives less than full compensation. This approach is widely supported by U.S. bankruptcy commentators. The paper first explains how this ratable damages rule can give the bankruptcy trustee an incentive to reject contracts when performance would be efficient. It then shows that the manner in which the ratable damages rule is actually applied by U.S. courts tends to worsen the problem. The paper concludes by considering various arrangements for eliminating the distortion.

Abstract: When beneficiaries of contractual rights suffer financial reversal and seek protection under the Bankruptcy Code, they are given the legal option of assuming the contract, thereby receiving its benefits at the cost of meeting its obligations on a priority basis, or rejecting the contract, thereby foregoing all benefits but absolving themselves of further liability and relegating the other party to the contract to the status of pre-petition creditor for unsatisfied claims. Assumption of executory contracts and leases poses few conceptual problems. However, the impact of rejection on the non-debtor party to an executory contract or lease is less clear. In this article I disagree with recent scholarly work that suggests that rejection of a contract or lease does not affect the enforceability of property rights created thereby in the non-debtor party and suggest instead that rejection must be treated as terminating the contract, much like an avoiding power. I the go on to examine the rights of the third party who may be involved in the contractual relationship between the debtor and the non-debtor ? the secured creditor with an interest in the rights of one of the parties to the rejected contract or lease ? and conclude that, despite the termination of the contract upon rejection, a security interest in the rights of either the debtor or non-debtor party should not be destroyed but should continue to attach to the property underlying the rejected contract or lease or its proceeds.