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Understanding executory contracts in a bankruptcy proceeding

When a New York business faces bankruptcy, one of the first choices that must be made is whether to seek reorganization under Chapter 11 or dissolution under Chapter 7. Choosing Chapter 7 is essentially a choice to end the business's existence, whereas Chapter 11 reflects management's desire to continue the business with reorganized debts and perhaps additional capital. If a corporation chooses Chapter 11, management must decide which business relationships should be preserved and which should be ended.

The Bankruptcy Code gives the trustee or a debtor in possession the right to accept or reject all "executory contracts," including unexpired leases. Understanding the concept of an executory contract can be difficult, even for judges. Many federal courts define an executory contract as an agreement that is either unperformed or partially performed and where the failure of either party to perform would be deemed material breach of the agreement. Other federal courts look at the manner in which the contract is intended to function. Long term agreements such as a franchising agreement or patent licensing agreement would be deemed to be executory. Agreements in which both parties have performed, such as the repayment of a promissory note or completion of a contract for the sale of goods, are not considered to be executory contracts. Unexpired real estate leases are perhaps the most common example of an executory contract.

The trustee or the debtor in possession in a Chapter 11 bankruptcy can either accept or reject an executory contract. If the contract is rejected, performance by both parties is no longer required. If a contract is accepted, both the debtor and the non-debtor counter party must perform the contract according to its terms. Both creditors and the counterparty to an executory contract can seek relief from the court reversing the decision to accept or reject an executory contract.

Deciding which contracts may be executory and which should be accepted or rejected can be a complex decision. The assistance of a knowledgeable bankruptcy attorney can materially simplify the task.

Source: Association of Corporate Counsel, "Executory Contracts in Bankruptcy," Bob Richards and Chris Soper, accessed on July 16, 2017

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