assumption and assignment of executory contracts

An official website of the United States government

Here's how you know

Official websites use .gov A .gov website belongs to an official government organization in the United States.

Secure .gov websites use HTTPS A lock ( Lock A locked padlock ) or https:// means you’ve safely connected to the .gov website. Share sensitive information only on official, secure websites.

MENU Justice Manual

Title 1: Organization and Functions
Title 2: Appeals
Title 3: EOUSA
Title 4: Civil
Title 5: ENRD
Title 6: Tax
Title 7: Antitrust
Title 8: Civil Rights
Title 9: Criminal
Organization And Functions Manual
Appeals Resource Manual
1. United States Attorney General Opinion, January 14, 1879
2. United States Attorney General Opinion, February 19, 1902
3. United States Attorney General Opinion, October 2, 1934
4. United States Attorney General Opinion, January 30, 1879
5. United States Attorney General Opinion, December 14, 1868
6. United States Attorney General Opinion, May 8, 1929
7. United States Attorney General Opinion, July 11, 1894
8. United States Attorney General Opinion, January 17, 1900
9. United States Attorney General Opinion, October 24, 1933
10. United States Attorney General Opinion, August 26, 1881
11. United States Attorney General Opinion, August 7, 1911
12. United States Attorney General Opinion, June 3, 1919
13. United States Attorney General Opinion, November 27, 1895
14. Attorney General Opinion, March 7, 1935
30. Immunity of the United States from Suit, Absent Express Consent
31. Consent to be Sued is Strictly Construed
32. Government Agencies are not Subject to Suit, Absent Statutory Waiver of Immunity
33. Immunity of Government Officers Sued as Individuals for Official Acts
34. Exhaustion of Administrative Remedies
35. Standing to Sue
36. Effect of Declaratory Judgment Act and Administrative Procedure Act
37. Indispensable Party
39. Venue -- Government As Plaintiff
40. Venue -- United States As Defendant
41. Venue -- Government Officers And Agencies As Defendants
42. Change Of Venue
43. Service Of Process
44. Service on Government Officers in Official Capacity, Agencies
45. Removal
46. Redelegation Of Authority To Compromise Civil Claims
47. Court Of Federal Claims Litigation
48. The Bankruptcy "Players" -- Outline
54. Bankruptcy And The Government As Regulator -- Part I
55. Bankruptcy And The Government As Regulator -- Part II
56. Bankruptcy And The Government As Regulator -- Part III
57. Avoidance Powers -- Strong-Arm Clause, Fraudulent Conveyances
58. Avoidance Powers -- Preferences, Statutory Liens, Postposition Transactions, Preferential Offsets, Limitations
59. Executory Contracts in Bankruptcy -- Introduction, Threshold Issues

60. Executory Contracts in Bankruptcy -- Assumption and Rejection

61. Executory Contracts in Bankruptcy -- Government and Special Contracts
62. Claims In Bankruptcy
63. Creditor's Claims In Bankruptcy Proceedings
64. Creditor's Claims in Bankruptcy Proceedings -- The Debtor-Creditor Relationship In Bankruptcy -- Allowance and Payment of Claims
65. Setoff and Recoupment in Bankruptcy -- Setoffs (cont'd), Recoupment
66. Setoff and Recoupment in Bankruptcy -- Setoff (cont'd)
67. Setoff and Recoupment in Bankruptcy -- Recoupment
68. The Government As Secured Creditor
69. Appellate Procedures In Bankruptcy
70. The Contract Disputes Act
71. Protest Of Contract Awards
72. Principles Of Contract Interpretation
73. Ambiguities
74. Liquidated Damages Provisions
75. Claims Of Mistakes In Bids
76. Nonappropriated Fund Instrumentality Claims
77. Quasi-Contractual Claims
78. Conversion Of Property Mortgaged To The Government
79. Decedent's Estate
80. Devises And Bequests To The Government
81. VA Escheat Claims
82. VA Vesting Claims
83. Grants -- Breach Of Conditions
84. Guaranty Agreements
85. Medicare Overpayment Cases
86. Sureties
87. VA Loan Claims
88. Warranties
89. Warranty Of Prior Endorsements On Checks
90. Transfer Restrictions And Remedies Under The Financial Privacy Act
93. Social Security Act Review Procedures
94. Types Of Judgments Authorized Under The Social Security Act
95. Priority Of Liens
96. The "Who, What, When, Where, Why, And How" Of Appeals In Bankruptcy Proceedings -- Generally
97. The "Who, What, When, Where, Why, and How" of Appeals in Bankruptcy Proceedings -- Standard of Review, Mootness, etc.
99. SG's Guidelines For Direct Certified Appeals In Bankruptcy Cases
102. Office Of Consumer Litigation
149. Odometer Fraud Prosecutions -- Agencies, Contacts and Resources
150. Recodification Of The Odometer Fraud Statutes
151. Repealed Odometer Fraud Statutes
152. Commonly Charged Odometer Tampering Offenses
153. Subpoenas To Targets For Forensic Evidence
154. Appeal Brief -- Required Records
155. Sample Letter -- Required Records
156. Sample Odometer Fraud Indictment
157. Sample Odometer Fraud Indictment
158. Sample Odometer Fraud Indictment
159. Sample Trial Memorandum -- Odometer Fraud
160. Sample Trial Memorandum -- Odometer Fraud
161. Sample Trial Memorandum -- Odometer Fraud
162. Sample Odometer Fraud Jury Instructions
163. Sample Response To Defense Motion Re Mailing
164. Multi-defendant Odometer Fraud Prosecution
165. Proposed findings that can be used to support a complex case finding and exclusion of time under the Speedy Trial Act
166. Sample Response To Motions To Dismiss Due To Alleged Multiplicity
167. Restitution For Consumers
168. Sample Government Application for Permission to Disclose Grand Jury Records for Restitution Purposes
169. Sample Disclosure Order
170. Evaluating The "Amount Of Loss" In Odometer Fraud Cases
171. Opposition to Defense Motions re Due Process, Vagueness, "Van Liew" and "Minarik" Problems
172. Sentencing Guidelines Calculation
173. Sample Odometer Fraud Indictment
174. Sample Odometer Fraud Indictment
175. Eppes Declaration
176. Sample Government's Response to Defendant's Response and Objections to Presentence Report
178. Response To Objections To Presentence Report
179. Sample Government Alborz Memorandum -- Ninth Circuit
180. Sample Government Alborz Memorandum -- Fifth Circuit
181. Probation Letter for Convictions Where the Count of Conviction Occurred Prior to November 1, 2001
182. Probation Letter for Convictions Where the Count of Conviction Occurred in Whole or in Part After November 1, 2001
183. Sample Government's Reply to Defendant's Sentencing Memorandum (part 1)
184. Sample Government's Reply To Defendant's Sentencing Memorandum (part 2)
185. Jurisdiction Of The District Court
186. Reference Of Proceedings To The Bankruptcy Judges
187. Limitations Upon the Exercise of Bankruptcy Jurisdiction
188. Bankruptcy Jurisdiction -- Personal Jurisdiction
189. Bankruptcy Jurisdiction -- Venue
190. Bankruptcy Jurisdiction -- Appellate Jurisdiction
191. Termination Of Bankruptcy Jurisdiction
192. Sovereign Immunity -- 11 U.S.C. § 106(a)
193. Sovereign Immunity -- 11 U.S.C. § 106(b)
194. Sovereign Immunity -- 11 U.S.C. § 106(c)
195. Limits Of The § 106 Waiver Of Sovereign Immunity
196. Sovereign Immunity -- Seminole Tribe and State Sovereign Immunity
197. Bankruptcy Jurisdiction And Sovereign Immunity Statutory Addendum
201. Jury Trials In Civil Cases
202. Laches
203. Limitations Statutes Applicable to Suits Against the Government
204. Offset
205. Recoupment And Setoff
206. Priority for the Payment of Claims Due the Government
207. Counterclaims Against The United States
208. Counterclaim In Suits On Notes And Mortgages
209. Estoppel
210. Choice Of Law
211. Interest Recoverable By The Government
212. Interest Recoverable From The Government
213. Declaratory Actions
214. Injunctions
215. Mandamus
216. Reformation
217. Replevin
218. Rescission
219. Specific Performance
220. Attorney's Fees
221. Court Costs
222. Costs Recoverable By The United States
223. Costs Recoverable From The United States
224. Sample Letter -- Judgments And Stipulations
225. Sample Letter -- Back Pay Judgments
226. FMS Form 194 -- Judgment Fund Payment Request
227. Monitoring of Payment Agreements by the Department of Veterans Affairs Debt Management Center (DMC)
228. Memorandum From Attorney General -- Coordination of Parallel Criminal, Civil, and Administrative Proceedings
ENRD Resource Manual
Civil Rights Resource Manual

III. ASSUMPTION

A. Mechanics. Assumption of an executory contract is accomplished by motion of the debtor-in-possession or trustee, subject to objection by other creditors and court approval. A motion to assume an executory contract is a summary proceeding; it is not the place for prolonged discovery or a lengthy trial with disputed issues. In re Orion Pictures Corp., 4 F.3d 1095, 1098-99 (2d Cir. 1993), cert. denied, 114 S. Ct. 1418 (1994); In re F.W. Restaurant Assocs., Inc., 190 B.R. 143, 148 (Bankr. D. Conn. 1995) ("[C]ourt reads Orion to establish a preliminary 'likelihood of success' standard" in deciding issues related to debtor's motion to assume a contract. Thus, the court makes preliminary determinations concerning defaults and claims arising therefrom, but these determinations are not final, rather they are "collapsed into the 'business judgment' analysis."). The debtor has the burden of persuasion that the contract is (1) subject to assumption and (2) all the requirements of § 365 have been met. Generally, courts then require the nondebtor party to prove any defaults, which then shifts the burden back to the debtor to prove adequate "cure" of those defaults. In re Diamond Mfg. Co., Inc., 164 B.R. 189, 199 (Bankr. S.D. Ga. 1994). Although a debtor may provide for assumption of a contract in its plan of reorganization, § 1123(b)(2), at least one court has refused to allow that to satisfy § 365(a)'s requirements for motion and notice. In re Golden Triangle Film Labs, Inc., 176 B.R. 608, 610 (Bankr. M.D. Fla. 1994) (court was "unwilling to accept the proposition that the entry of an Order" confirming the plan satisfied § 365's requirements). Finally, some courts have held that filing of a motion to sell a contract under § 363 satisfies the requirements of § 365. In re Specialty Foods, Inc., 91 B.R. 364 (Bankr. W.D.Pa. 1988) ("[T]he Trustee filed a motion to sell which of necessity incorporates an assumption of the asset to be sold to the extent that the Trustee cannot sell an asset which he has rejected or abandoned."); In re Zacherl Coal Co., Inc., 15 B.R. 1001 (Bankr. W.D.Pa. 1981) (same). Denial of a motion to assume does not result in rejection of the contract. In re F.W. Restaurant Assocs., Inc., 190 B.R. 143, 149 n.8 (Bankr. D. Conn. 1995).

B. Standard of Review By Bankruptcy Court. A debtor's decision to assume an executory contract is subject to review under the "business judgment standard." See, e.g., In re Orion Pictures Corp., 4 F.3d 1095, 1099 (2d Cir. 1993); In re Gardiner, Inc., 831 F.2d 974, 975 n.2 (11th Cir. 1987); In re Health Science Products, Inc., 191 B.R. 895, 909 n.15 (Bankr. N.D. Ala. 1995) (Bankruptcy courts must approve a debtor's decision to assume or reject an executory contract "unless there is bad faith or a gross abuse of discretion." In other words, the court must decide "whether the decision of the debtor is so manifestly unreasonable that it could not be based on sound business judgment, but only on bad faith, whim, or caprice.").

C. Assumption Through Conduct. Whether a debtor-in-possession can assume a contract by conduct, without court approval, is subject to controversy. Compare In re University Medical Ctr., 973 F.2d 1065, 1075-79 (3d Cir. 1992); In re Whitcomb & Keller Mortg. Co., 715 F.2d 375, 380 (7th Cir. 1983); NCL Corp. v. Lone Star Bldg. Ctrs., 144 B.R. 170, 179 (S.D. Fla. 1992); In re Houbigant, 188 B.R. 347, 355 (Bankr. S.D.N.Y. 1995); In re Broaddus Hosp. Ass'n, 159 B.R. 763, 771 (Bankr. N.D.W.V. 1993); and In re Drexel Burnham Lambert Group, Inc., 138 B.R. 687, 712 (Bankr. S.D.N.Y. 1992) (all holding that assumption of an executory contract is not effective unless and until the court approves) with In re Frontier Properties, 979 F.2d 1358, 1365 (9th Cir. 1992) (court approval of stipulation that specifically provided for assumption of contract satisfies requirement for court approval under § 365(a)); In re Schleifer, 170 B.R. 283, 285 (Bankr. D.V.I. 1994) (where debtor remains employee during bankruptcy he assumes contract of employment and is bound by the statutorily defined conditions of that employment); In re Audra-John Corp., 140 B.R. 752, 755 n.7 (Bankr. D. Minn. 1992); In re Carlisle Homes, 103 B.R. 524 Bankr. D.N.J. 1988) (both holding that the debtor can assume a contract by communication of unequivocal intent to assume); In re Hodgdon, 54 B.R. 688 (Bankr. W.D. Wis. 1985) (contract may be assumed through conduct; conduct must be either express declaration of assumption or specific, unequivocal action leading to no possible conclusion other than assumption).

D. Timing of Assumption [§ 365(d)].

A. Mechanics.

C. Effect of Rejection. See § 365(g) and (h); see generally Michael T. Andrew, Executory Contracts in Bankruptcy: Understanding "Rejection", 59 U. Colo. L. Rev. 845 (1988).

Executory Contracts: Assumption and Assignment

Key Background Facts:

From Executory Contracts and Unexpired Leases :

An executory contract is one in which neither party to the contract has fulfilled its obligations.
Either the trustee or the debtor in possession ( DIP ) can either assume or reject an executory contract.
An executory contract not assumed is deemed rejected.
A contract cannot be enforced against the bankruptcy estate until it is assumed.
Assumption requires court approval.
An executory contract will be assumed if it has a net benefit for the bankruptcy estate; otherwise, it will be rejected.
ipso facto clauses , which stipulates the termination of the contract because of the party's financial condition or its filing of bankruptcy,
the payment of penalties for failure to comply with a non-monetary provision under the contract,
and default clauses due to failure to perform by a deadline, since the trustee needs enough time to evaluate the contract.
If the contract is in default, then the default must be cured and adequate assurance of future performance must be provided to the non-debtor party.
contracts that are not assignable under nonbankruptcy law,
contracts for loans or other extensions of credit,
and commercial leases that were terminated under nonbankruptcy law before the order for relief.
A trustee may decide to assign an assumed contract to a 3 rd party for money.
Because a contract must be assumed before it can be assigned, anything that bars assumption will also bar assignment.
The assigned party acquires both the rights of the debtor under the contract and the delegation of its duties.
Hence, the trustee must provide adequate assurance that the assigned party is reasonably likely to be able to perform under the contract.

The bankruptcy estate does not automatically assume the contracts of the debtor; therefore the contracts are not enforceable against the bankruptcy estate until they are assumed. The trustee or the debtor in possession ( DIP ) under Chapter 11 either assumes the contract, or rejects it. Under Chapter 7 , the trustee has 60 days after the order for relief (which, for voluntary petitions, is the bankruptcy filing date) to assume an executory contract. Under Chapter 13 , 12 , and 11 , contracts have to be assumed by the confirmation of the debtor's payment plan. In any case, the court can grant more time, if necessary. However, if the trustee does not assume a contract in the required time, then the contract is deemed rejected.

A contract will only be assumed if it has a net benefit to the bankruptcy estate and only with court approval. If the contract is assumed, then the bankruptcy estate takes the place of the debtor as a party to the contract. Consequentially, the bankruptcy estate must perform the obligations of the contract, but also receives its benefits.

However, the contract must be assumed cum onere , as they say — with all the burdens. The contract must be accepted in its totality except for ipso facto clauses (aka bankruptcy termination clauses ), which are clauses that are conditional on the party's financial status or bankruptcy. Most of these ipso facto clauses stipulate that the contract will be terminated if the party becomes either insolvent or files for bankruptcy. Ipso facto clauses are not enforced under bankruptcy, so the trustee still has the option of assuming a contract with an ipso facto clause.

Because the non-debtor party of an assumed contract has priority over other unsecured creditors of the estate, the decision to assume is generally postponed as long as possible, especially since the non-debtor party is required to perform until the decision to assume or reject is made. Postponing the decision allows the trustee to better assess whether assuming the contract will have a net benefit to the bankruptcy estate. However, the non-debtor party can petition the court to force an earlier decision.

Hence, another element of contracts that is modified are clauses requiring specific performance by a deadline. Bankruptcy extends some deadlines so that the trustee is given more time to evaluate the contracts. The non-debtor party cannot terminate the contract as a result of the delay.

Contracts in Default

A requirement for the assumption of defaulted contracts in is that the bankruptcy estate must cure any defaults of the contract, usually by making up for any missed payments by the debtor.

The estate must also compensate the non-debtor party for any damages resulting from the debtor's default. Any payments for damages or for performance under the contract have administrative priority . There is no limit on the amount of the claim except for real estate commercial leases for which a claim is limited to 2 years rent. Moreover, any payments received by the non-debtor party prior to the bankruptcy will not be treated as preferences .

To assume a contract in default, §365(b)(1) of the Bankruptcy Code requires that the trustee cure the default, remunerate the non-debtor party for any losses suffered because of the default, and provide adequate assurance of future performance under the contract.

However, §365(b)(2) stipulates that there are 2 types of default that do not have to be cured:

ipso facto clauses discussed above.
the failure to pay penalties that arose because the debtor failed to perform nonmonetary obligations under the contract, such as maintaining certain store hours.

Except for shopping centers, there is little guidance in the Bankruptcy Code about what constitutes adequate assurance of future performance . Generally, the courts will decide if the trustee has presented enough evidence of such assurance. However, the trustee does not have to provide adequate assurance if there is no default.

Non-Assumable Contracts

There are 3 types of contracts, specified by §365(c) , that are not assumable:

If a contract cannot be assigned, then it is not assumable. This provision does not depend on the terms of the contract but rather on its nature. For instance, if the contract called for the debtor to sing at a wedding, then obviously, the trustee cannot assume such a contract, since such a contract was agreed to because of the debtor's singing ability and not the trustee's.

But what if the bankruptcy administrator is a debtor in possession rather than a trustee? The courts have divided over the issue. Some courts stressed that the debtor in possession is a different legal entity than the debtor, hence, the contract was not assumable. The courts' reasoning has rested on a hypothetical test that asks not whether the debtor in possession can perform under the contract, but whether nonbankruptcy law would allow the assignment of the contract to a hypothetical 3 rd party. If not, then these courts have ruled that the contract is not assumable. Other courts have adopted the commonsensical approach that since the debtor and the debtor in possession are the same actual entity, then there should be no problem in allowing the contract to be assumed if it would benefit the estate.

To protect the unsecured creditors of the bankruptcy estate, the trustee or the DIP cannot assume any loans or other financing contracts for the debtor, even if the lender agrees to it. However, certain contracts whose primary purpose is other than giving a loan, such as leases or credit sales of goods or services, are assumable even though there is some extension of credit.

Sometimes the trustee wants to assume a valuable contract, but does not want to perform under it. In this case, the trustee may assume the contract, but then assign it to a 3 rd party for a fee. The assigned party acquires both the rights of the debtor under the contract and the delegation of its duties.

Because the trustee must assume the contract before assigning it, any limitation that applies to assumption also applies to assignment. The trustee may be able to assign the contract even if there are provisions in the contract against assignment unless it is clear that the contract requires something that only the debtor could uniquely supply, as noted above.

Furthermore, the trustee must provide adequate assurance that the assigned party is reasonably likely to be able to perform under the contract. This requirement is to reduce the likelihood that the assigned party will breach the contract, since, once assigned, §365(k) relieves the bankruptcy estate of all liability for any breaches by the assigned party.

11 U.S. Code § 365 - Executory contracts and unexpired leases

Section 365(b)(3) represents a compromise between H.R. 8200 as passed by the House and the Senate amendment. The provision adopts standards contained in section 365(b)(5) of the Senate amendment to define adequate assurance of future performance of a lease of real property in a shopping center.

Section 365(b)(4) of the House amendment indicates that after default the trustee may not require a lessor to supply services or materials without assumption unless the lessor is compensated as provided in the lease.

Section 365(c)(2) and (3) likewise represent a compromise between H.R. 8200 as passed by the House and the Senate amendment. Section 365(c)(2) is derived from section 365(b)(4) of the Senate amendment but does not apply to a contract to deliver equipment as provided in the Senate amendment. As contained in the House amendment, the provision prohibits a trustee or debtor in possession from assuming or assigning an executory contract of the debtor to make a loan, or extend other debt financing or financial accommodations, to or for the benefit of the debtor, or the issuance of a security of the debtor.

Section 365(e) is a refinement of comparable provisions contained in the House bill and Senate amendment. Sections 365(e)(1) and (2)(A) restate section 365(e) of H.R. 8200 as passed by the House. Sections 365(e)(2)(B) expands the section to permit termination of an executory contract or unexpired lease of the debtor if such 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 for the issuance of a security of the debtor.

Characterization of contracts to make a loan, or extend other debt financing or financial accommodations, is limited to the extension of cash or a line of credit and is not intended to embrace ordinary leases or contracts to provide goods or services with payments to be made over time.

Section 365(f) is derived from H.R. 8200 as passed by the House. Deletion of language in section 365(f)(3) of the Senate amendment is done as a matter of style. Restrictions with respect to assignment of an executory contract or unexpired lease are superfluous since the debtor may assign an executory contract or unexpired lease of the debtor only if such contract is first assumed under section 364(f)(2)(A) of the House amendment.

Section 363(h) of the House amendment represents a modification of section 365(h) of the Senate amendment. The House amendment makes clear that in the case of a bankrupt lessor, a lessee may remain in possession for the balance of the term of a lease and any renewal or extension of the term only to the extent that such renewal or extension may be obtained by the lessee without the permission of the landlord or some third party under applicable non-bankruptcy law.

Subsection (a) of this section authorizes the trustee, subject to the court’s approval, to assume or reject an executory contract or unexpired lease. Though there is no precise definition of what contracts are executory, it generally includes contracts on which performance remains due to some extent on both sides. A note is not usually an executory contract if the only performance that remains is repayment. Performance on one side of the contract would have been completed and the contract is no longer executory.

Because of the volatile nature of the commodities markets and the special provisions governing commodity broker liquidations in subchapter IV of chapter 7, the provisions governing distribution in section 765(a) will govern if any conflict between those provisions and the provisions of this section arise.

Subsections (b), (c), and (d) provide limitations on the trustee’s powers. Subsection (b) requires the trustee to cure any default in the contract or lease and to provide adequate assurance of future performance if there has been a default, before he may assume. This provision does not apply to defaults under ipso facto or bankruptcy clauses, which is a significant departure from present law.

Subsection (b)(3) permits termination of leases entered into prior to the effective date of this title in liquidation cases if certain other conditions are met.

Subsection (b)(4) [enacted as (c)(2)] prohibits the trustee’s assumption of an executory contract requiring the other party to make a loan or deliver equipment to or to issue a security of the debtor. The purpose of this subsection is to make it clear that a party to a transaction which is based upon the financial strength of a debtor should not be required to extend new credit to the debtor whether in the form of loans, lease financing, or the purchase or discount of notes.

Subsection (b)(5) provides that in lease situations common to shopping centers, protections must be provided for the lessor if the trustee assumes the lease, including protection against decline in percentage rents, breach of agreements with other tenants, and preservation of the tenant mix. Protection for tenant mix will not be required in the office building situation.

Subsection (d) places time limits on assumption and rejection. In a liquidation case, the trustee must assume within 60 days (or within an additional 60 days, if the court, for cause, extends the time). If not assumed, the contract or lease is deemed rejected. In a rehabilitation case, the time limit is not fixed in the bill. However, if the other party to the contract or lease requests the court to fix a time, the court may specify a time within which the trustee must act. This provision will prevent parties in contractual or lease relationships with the debtor from being left in doubt concerning their status vis-a-vis the estate.

Subsection (e) invalidates ipso facto or bankruptcy clauses. These clauses, protected under present law, automatically terminate the contract or lease, or permit the other contracting party to terminate the contract or lease, in the event of bankruptcy. This frequently hampers rehabilitation efforts. If the trustee may assume or assign the contract under the limitations imposed by the remainder of the section, the contract or lease may be utilized to assist in the debtor’s rehabilitation or liquidation.

The unenforcibility [sic] of ipso facto or bankruptcy clauses proposed under this section will require the courts to be sensitive to the rights of the nondebtor party to executory contracts and unexpired leases. If the trustee is to assume a contract or lease, the court will have to insure that the trustee’s performance under the contract or lease gives the other contracting party the full benefit of his bargain.

This subsection does not limit the application of an ipso facto or bankruptcy clause if a new insolvency or receivership occurs after the bankruptcy case is closed. That is, the clause is not invalidated in toto, but merely made inapplicable during the case for the purposes of disposition of the executory contract or unexpired lease.

Subsection (f) partially invalidates restrictions on assignment of contracts or leases by the trustee to a third party. The subsection imposes two restrictions on the trustee: he must first assume the contract or lease, subject to all the restrictions on assumption found in the section, and adequate assurance of future performance must be provided to the other contracting party. Paragraph (3) of the subsection invalidates contractual provisions that permit termination or modification in the event of an assignment, as contrary to the policy of this subsection.

Subsection (g) defines the time as of which a rejection of an executory contract or unexpired lease constitutes a breach of the contract or lease. Generally, the breach is as of the date immediately preceding the date of the petition. The purpose is to treat rejection claims as prepetition claims. The remainder of the subsection specifies different times for cases that are converted from one chapter to another. The provisions of this subsection are not a substantive authorization to breach or reject an assumed contract. Rather, they prescribe the rules for the allowance of claims in case an assumed contract is breached, or if a case under chapter 11 in which a contract has been assumed is converted to a case under chapter 7 in which the contract is rejected.

Subsection (h) protects real property lessees of the debtor if the trustee rejects an unexpired lease under which the debtor is the lessor (or sublessor). The subsection permits the lessee to remain in possession of the leased property or to treat the lease as terminated by the rejection. The balance of the term of the lease referred to in paragraph (1) will include any renewal terms that are enforceable by the tenant, but not renewal terms if the landlord had an option to terminate. Thus, the tenant will not be deprived of his estate for the term for which he bargained. If the lessee remains in possession, he may offset the rent reserved under the lease against damages caused by the rejection, but does not have any affirmative rights against the estate for any damages after the rejection that result from the rejection.

Subsection (i) gives a purchaser of real property under a land installment sales contract similar protection. The purchaser, if the contract is rejected, may remain in possession or may treat the contract as terminated. If the purchaser remains in possession, he is required to continue to make the payments due, but may offset damages that occur after rejection. The trustee is required to deliver title, but is relieved of all other obligations to perform.

A purchaser that treats the contract as terminated is granted a lien on the property to the extent of the purchase price paid. A party with a contract to purchase land from the debtor has a lien on the property to secure the price already paid, if the contract is rejected and the purchaser is not yet in possession.

Subsection (k) relieves the trustee and the estate of liability for a breach of an assigned contract or lease that occurs after the assignment.

Subsection (c) prohibits the trustee from assuming or assigning a contract or lease if applicable nonbankruptcy law excuses the other party from performance to someone other than the debtor, unless the other party consents. This prohibition applies only in the situation in which applicable law excuses the other party from performance independent of any restrictive language in the contract or lease itself. The purpose of this subsection, at least in part, is to prevent the trustee from requiring new advances of money or other property. The section permits the trustee to continue to use and pay for property already advanced, but is not designed to permit the trustee to demand new loans or additional transfers of property under lease commitments.

Thus, under this provision, contracts such as loan commitments and letters of credit are nonassignable, and may not be assumed by the trustee.

Subsection (e) invalidates ipso facto or bankruptcy clauses. These clauses, protected under present law, automatically terminate the contract or lease, or permit the other contracting party to terminate the contract or lease, in the event of bankruptcy. This frequently hampers rehabilitation efforts. If the trustee may assume or assign the contract under the limitations imposed by the remainder of the section, then the contract or lease may be utilized to assist in the debtor’s rehabilitation or liquidation.

The unenforceability of ipso facto or bankruptcy clauses proposed under this section will require the courts to be sensitive to the rights of the nondebtor party to executory contracts and unexpired leases. If the trustee is to assume a contract or lease, the courts will have to insure that the trustee’s performance under the contract or lease gives the other contracting party the full benefit of his bargain. An example of the complexity that may arise in these situations and the need for a determination of all aspects of a particular executory contract or unexpired lease is the shopping center lease under which the debtor is a tenant in a shopping center.

A shopping center is often a carefully planned enterprise, and though it consists of numerous individual tenants, the center is planned as a single unit, often subject to a master lease or financing agreement. Under these agreements, the tenant mix in a shopping center may be as important to the lessor as the actual promised rental payments, because certain mixes will attract higher patronage of the stores in the center, and thus a higher rental for the landlord from those stores that are subject to a percentage of gross receipts rental agreement. Thus, in order to assure a landlord of his bargained for exchange, the court would have to consider such factors as the nature of the business to be conducted by the trustee or his assignee, whether that business complies with the requirements of any master agreement, whether the kind of business proposed will generate gross sales in an amount such that the percentage rent specified in the lease is substantially the same as what would have been provided by the debtor, and whether the business proposed to be conducted would result in a breach of other clauses in master agreements relating, for example, to tenant mix and location.

This subsection does not limit the application of an ipso facto or bankruptcy clause to a new insolvency or receivership after the bankruptcy case is closed. That is, the clause is not invalidated in toto, but merely made inapplicable during the case for the purpose of disposition of the executory contract or unexpired lease.

2020—Subsec. (d)(3). Pub. L. 116–260, § 1001(f)(2)(A)(i) , struck out subpar. (A) designation before “The trustee”, “, except as provided in subparagraph (B)” after “such 60-day period” and subpars. (B) and (C). Prior to amendment, subpars. (B) and (C) related to extension of time for performance in case under subchapter V of chapter 11 where there was financial hardship due, directly or indirectly, to the coronavirus disease 2019 (COVID–19) pandemic and treatment of obligation as certain administrative expense, respectively.

Pub. L. 116–260, § 1001(f)(1)(A) , designated existing provisions as subpar. (A), inserted “, except as provided in subparagraph (B)” after “such 60-day period” and added subpars. (B) and (C).

Subsec. (d)(4). Pub. L. 116–260, § 1001(f)(2)(A)(ii) , substituted “120” for “210” in two places.

Pub. L. 116–260, § 1001(f)(1)(B) , substituted “210” for “120” in two places.

2005—Subsec. (b)(1)(A). Pub. L. 109–8, § 328(a)(1)(A) , inserted before semicolon at end “other than a default that is a breach of a provision relating to the satisfaction of any provision (other than a penalty rate or penalty provision) relating to a default arising from any failure to perform nonmonetary obligations under an unexpired lease of real property, if it is impossible for the trustee to cure such default by performing nonmonetary acts at and after the time of assumption, except that if such default arises from a failure to operate in accordance with a nonresidential real property lease, then such default shall be cured by performance at and after the time of assumption in accordance with such lease, and pecuniary losses resulting from such default shall be compensated in accordance with the provisions of this paragraph”.

Subsec. (b)(2)(D). Pub. L. 109–8, § 328(a)(1)(B) , substituted “penalty rate or penalty provision” for “penalty rate or provision”.

Subsec. (c)(4). Pub. L. 109–8, § 328(a)(2) , struck out par. (4) which read as follows: “such lease is of nonresidential real property under which the debtor is the lessee of an aircraft terminal or aircraft gate at an airport at which the debtor is the lessee under one or more additional nonresidential leases of an aircraft terminal or aircraft gate and the trustee, in connection with such assumption or assignment, does not assume all such leases or does not assume and assign all of such leases to the same person, except that the trustee may assume or assign less than all of such leases with the airport operator’s written consent.”

Subsec. (d)(4). Pub. L. 109–8, § 404(a) , amended par. (4) generally. Prior to amendment, par. (4) read as follows: “Notwithstanding paragraphs (1) and (2), in a case under any chapter of this title, if the trustee does not assume or reject an unexpired lease of nonresidential real property under which the debtor is the lessee within 60 days after the date of the order for relief, or within such additional time as the court, for cause, within such 60-day period, fixes, then such lease is deemed rejected, and the trustee shall immediately surrender such nonresidential real property to the lessor.”

Subsec. (d)(5) to (10). Pub. L. 109–8, § 328(a)(3) , redesignated par. (10) as (5) and struck out former pars. (5) to (9) which related to rejection of leases under which the debtor is an affected air carrier that is the lessee of an aircraft terminal or aircraft gate.

Subsec. (f)(1). Pub. L. 109–8, § 404(b) , substituted “provided in subsections (b) and” for “provided in subsection”.

Pub. L. 109–8, § 328(a)(4) , struck out “; except that the trustee may not assign an unexpired lease of nonresidential real property under which the debtor is an affected air carrier that is the lessee of an aircraft terminal or aircraft gate if there has occurred a termination event” before period at end.

Subsec. (p). Pub. L. 109–8, § 309(b) , added subsec. (p).

1994—Subsec. (b)(2)(D). Pub. L. 103–394, § 219(a) , added subpar. (D).

Subsec. (d)(6)(C). Pub. L. 103–429, § 1(1) , substituted “ section 40102(a) of title 49 ” for “section 101 of the Federal Aviation Act of 1958 (49 App. U.S.C. 1301)”.

Pub. L. 103–394, § 501(d)(10)(A) , which directed the substitution of “ section 40102 of title 49 ” for “the Federal Aviation Act of 1958 ( 49 U.S.C. 1301 )”, could not be executed because the phrase “( 49 U.S.C. 1301 )” did not appear in text.

Subsec. (d)(10). Pub. L. 103–394, § 219(b) , added par. (10).

Subsec. (g)(2)(A), (B). Pub. L. 103–394, § 501(d)(10)(B) , substituted “1208, or 1307” for “1307, or 1208”.

Subsec. (h). Pub. L. 103–394, § 205(a) , amended subsec. (h) generally. Prior to amendment, subsec. (h) read as follows:

“(h)(1) If the trustee rejects an unexpired lease of real property of the debtor under which the debtor is the lessor, or a timeshare interest under a timeshare plan under which the debtor is the timeshare interest seller, the lessee or timeshare interest purchaser under such lease or timeshare plan may treat such lease or timeshare plan as terminated by such rejection, where the disaffirmance by the trustee amounts to such a breach as would entitle the lessee or timeshare interest purchaser to treat such lease or timeshare plan as terminated by virtue of its own terms, applicable nonbankruptcy law, or other agreements the lessee or timeshare interest purchaser has made with other parties; or, in the alternative, the lessee or timeshare interest purchaser may remain in possession of the leasehold or timeshare interest under any lease or timeshare plan the term of which has commenced for the balance of such term and for any renewal or extension of such term that is enforceable by such lessee or timeshare interest purchaser under applicable nonbankruptcy law.

“(2) If such lessee or timeshare interest purchaser remains in possession as provided in paragraph (1) of this subsection, such lessee or timeshare interest purchaser may offset against the rent reserved under such lease or moneys due for such timeshare interest for the balance of the term after the date of the rejection of such lease or timeshare interest, and any such renewal or extension thereof, any damages occurring after such date caused by the nonperformance of any obligation of the debtor under such lease or timeshare plan after such date, but such lessee or timeshare interest purchaser does not have any rights against the estate on account of any damages arising after such date from such rejection, other than such offset.”

Subsec. (n)(1)(B). Pub. L. 103–394, § 501(d)(10)(C) , substituted “a right to” for “a right to to”.

Subsec. (o). Pub. L. 103–394, § 501(d)(10)(D) , substituted “a Federal depository institutions regulatory agency (or predecessor to such agency)” for “the Federal Deposit Insurance Corporation , the Resolution Trust Corporation, the Director of the Office of Thrift Supervision, the Comptroller of the Currency, or the Board of Governors of the Federal Reserve System , or its predecessors or successors,”.

Subsec. (p). Pub. L. 103–429, § 1(2) , which directed the amendment of subsec. (p) by substituting “ section 40102(a) of title 49 ” for “section 101(3) of the Federal Aviation Act of 1958 ”, could not be executed because subsec. (p) was repealed by Pub. L. 103–394, § 501(d)(10)(E) . See below.

Pub. L. 103–394, § 501(d)(10)(E) , struck out subsec. (p), which read as follows: “In this section, ‘affected air carrier’ means an air carrier, as defined in section 101(3) of the Federal Aviation Act of 1958 , that holds 65 percent or more in number of the aircraft gates at an airport—

“(1) which is a Large Air Traffic Hub as defined by the Federal Aviation Administration in Report FAA–AP 92–1, February 1992; and

“(2) all of whose remaining aircraft gates are leased or under contract on the date of enactment of this subsection.”

1992—Subsec. (c)(4). Pub. L. 102–365, § 19(c) , added par. (4).

Subsec. (d)(5) to (9). Pub. L. 102–365, § 19(b) , added pars. (5) to (9).

Subsec. (f)(1). Pub. L. 102–365, § 19(d) , substituted for period at end “; except that the trustee may not assign an unexpired lease of nonresidential real property under which the debtor is an affected air carrier that is the lessee of an aircraft terminal or aircraft gate if there has occurred a termination event.”

Subsec. (p). Pub. L. 102–365, § 19(e) , added subsec. (p).

1990—Subsec. (o). Pub. L. 101–647 added subsec. (o).

1988—Subsec. (n). Pub. L. 100–506 added subsec. (n).

1986—Subsec. (c)(1)(A). Pub. L. 99–554, § 283(e)(1) , struck out “or an assignee of such contract or lease” after “debtor in possession”.

Subsec. (c)(3). Pub. L. 99–554, § 283(e)(2) , inserted “is” after “lease” and “and” after “property”.

Subsecs. (d)(2), (g)(1). Pub. L. 99–554, § 257(j) , (m)(1), inserted reference to chapter 12.

Subsec. (g)(2). Pub. L. 99–554, § 257(m)(2) , inserted references to chapter 12 and section 1208 of this title .

Subsec. (h)(1). Pub. L. 99–554, § 283(e)(2) , inserted “or timeshare plan” after “to treat such lease”.

Subsec. (m). Pub. L. 99–554, § 283(e)(3) , substituted “362(b)(10)” for “362(b)(9)”.

1984—Subsec. (a). Pub. L. 98–353, § 362(a) , amended subsec. (a) generally, making minor changes.

Subsec. (b). Pub. L. 98–353, § 362(a) , amended subsec. (b) generally, inserting in par. (3) reference to par. (2)(B) of subsec. (f) of this section, in par. (3)(A) inserting provisions relating to financial condition and operating performance in the case of an assignment, and in par. (3)(C) substituting “that assumption or assignment of such lease is subject to all the provisions thereof, including (but not limited to) provisions such as a radius, location, use, or exclusivity provision, and will not breach any such provision contained in any other lease, financing agreement, or master agreement relating to such shopping center” for “that assumption or assignment of such lease will not breach substantially any provision, such as a radius, location, use, or exclusivity provision, in any other lease, financing agreement, or master agreement relating to such shopping center”.

Subsec. (c). Pub. L. 98–353, § 362(a) , amended subsec. (c) generally, substituting in par. (1)(A) “applicable law excuses a party, other than the debtor, to such contract or lease from accepting performance from or rendering performance to an entity other than the debtor or the debtor in possession or an assignee of such contract or lease, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties” for “applicable law excuses a party, other than the debtor, to such contract or lease from accepting performance from or rendering performance to the trustee or an assignee of such contract or lease, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties” and adding par. (3).

Subsec. (d). Pub. L. 98–353, § 362(a) , amended subsec. (d) generally, inserting in par. (1) reference to residential real property or personal property of the debtor, inserting in par. (2) reference to residential real property or personal property of the debtor, and adding pars. (3) and (4).

Subsec. (h)(1). Pub. L. 98–353, § 402 , amended par. (1) generally. Prior to amendment, par. (1) read as follows: “If the trustee rejects an unexpired lease of real property of the debtor under which the debtor is the lessor, the lessee under such lease may treat the lease as terminated by such rejection, or, in the alternative, may remain in possession for the balance of the term of such lease and any renewal or extension of such term that is enforceable by such lessee under applicable nonbankruptcy law.”

Subsec. (h)(2). Pub. L. 98–353, § 403 , amended par. (2) generally. Prior to amendment, par. (2) read as follows: “If such lessee remains in possession, such lessee may offset against the rent reserved under such lease for the balance of the term after the date of the rejection of such lease, and any such renewal or extension, any damages occurring after such date caused by the nonperformance of any obligation of the debtor after such date, but such lessee does not have any rights against the estate on account of any damages arising after such date from such rejection, other than such offset.”

Subsec. (i)(1). Pub. L. 98–353, § 404 , amended par. (1) generally, inserting provisions relating to timeshare interests under timeshare plans.

Subsecs. (l), (m). Pub. L. 98–353, § 362(b) , added subsecs. (l) and (m).

Pub. L. 116–260, div. FF, title X, § 1001(f)(2)(A) , Dec. 27, 2020 , 134 Stat. 3219 , provided that the amendment made by section 1001(f)(2)(A) is effective on the date that is 2 years after Dec. 27, 2020 .

Pub. L. 116–260, div. FF, title X, § 1001(f)(2)(B) , Dec. 27, 2020 , 134 Stat. 3219 , provided that:

Amendment by Pub. L. 109–8 effective 180 days after Apr. 20, 2005 , and not applicable with respect to cases commenced under this title before such effective date, except as otherwise provided, see section 1501 of Pub. L. 109–8 , set out as a note under section 101 of this title .

Amendment by Pub. L. 103–394 effective Oct. 22, 1994 , and not applicable with respect to cases commenced under this title before Oct. 22, 1994 , see section 702 of Pub. L. 103–394 , set out as a note under section 101 of this title .

Pub. L. 102–365, § 19(f) , Sept. 2, 1992 , 106 Stat. 984 , provided that:

Amendment by Pub. L. 100–506 effective Oct. 18, 1988 , but not applicable to any case commenced under this title before such date, see section 2 of Pub. L. 100–506 , set out as a note under section 101 of this title .

Amendment by section 257 of Pub. L. 99–554 effective 30 days after Oct. 27, 1986 , but not applicable to cases commenced under this title before that date, see section 302(a), (c)(1) of Pub. L. 99–554 , set out as a note under section 581 of Title 28 , Judiciary and Judicial Procedure.

Amendment by section 283 of Pub. L. 99–554 effective 30 days after Oct. 27, 1986 , see section 302(a) of Pub. L. 99–554 .

Amendment by Pub. L. 98–353 effective with respect to cases filed 90 days after July 10, 1984 , see section 552(a) of Pub. L. 98–353 , set out as a note under section 101 of this title .

Pub. L. 102–365, § 19(a) , Sept. 2, 1992 , 106 Stat. 982 , provided that:

JavaScript is turned off in your web browser. Turn it on to take full advantage of this site, then refresh the page.

Skip to content
Skip to main navigation
Skip to footer
Our Thinking
Publications

Assumption and Rejection of Midstream Contracts in Bankruptcy

The ability to assume or reject executory contracts is one of the primary tools used by debtors in a Chapter 11 reorganization. Where a debtor has a contract with a third party that is “executory”—meaning that ongoing performance obligations remain for both the debtor and the contract counterparty on the date of the bankruptcy filing—the debtor can choose to either assume or reject the contract under 11 USC § 365.

If a debtor chooses to assume the contract, it must cure all defaults under the agreement, and the agreement will “ride through” the bankruptcy unaltered. If the debtor rejects an executory contract, the rejection is treated as a breach by the debtor, and the counterparty to the contract is left with a claim in the bankruptcy for rejection damages caused by the breach. Generally, the standard applied by bankruptcy courts to determine whether rejection of an executory contract should be approved is low. Unless there is bad faith, a bankruptcy court will typically defer to the debtor’s business judgment that rejection is in the best interest of the estate.

In recent years, bankruptcy cases of oil and gas exploration and production (E&P) companies have given rise to litigation concerning the rejection of midstream contracts in bankruptcy. E&P companies may typically have long-term contracts with counterparties that perform midstream services, including gathering and transportation services. These contracts, if entered at times of higher commodity prices, may contain pricing terms that are uneconomic for the debtor at the time of filing, thereby prompting the debtor to seek rejection of the contract as a way to renegotiate pricing terms or seek such midstream service from another party. Rejection of these agreements can be very costly for the counterparty, particularly if the counterparty has expended significant capital upfront to construct gathering, pipeline, and other transportation systems.

Because many of these midstream contracts are written to convey to the counterparty certain real property rights, such as an easement or a dedication of oil and gas, counterparties faced with rejection have argued that the contracts “run with the land” and convey real property rights that cannot be rejected. As discussed below, cases that initially addressed this argument based a debtor’s ability to assume or reject the contract as a whole on whether the contract contained real property covenants. However, recent cases have taken a more nuanced approach. The Sanchez decision from the US Bankruptcy Court for the Southern District of Texas provides parties with a second level of analysis, distinguishing between whether an executory contract containing covenants that run with the land may be rejected (holding that it may) and the resulting effect on those rights granted to the counterparty under the contract that are not terminated by virtue of the debtor’s rejection.

Relevant Cases

The first leading case to address the “runs with the land” argument was Sabine Oil & Gas Corp. [1] In Sabine , a New York bankruptcy court, interpreting Texas law, found that certain gas gathering agreements did not contain real property covenants and therefore could be rejected by the debtor, a holding that was subsequently affirmed by the US Court of Appeals for the Second Circuit. Subsequently, in the cases of Badlands Energy, Inc. (Colorado bankruptcy court, applying Utah law) and Alta Mesa Resources, Inc. (Texas bankruptcy court, applying Oklahoma law), the bankruptcy courts found that the gas gathering agreements at issue did contain real property covenants and, therefore, could not be rejected. [2]

While the above cases each apply different state law, the basic analysis to determine whether the agreements contain covenants running with the land is the same and focuses primarily on three issues:

Do the covenants in the agreements “touch and concern” a real property interest?
Was there “privity” (horizontal and vertical) between the parties when the agreements were entered into?
Did the parties intend to create a real property covenant, i.e., that the agreements would “run with the land”?

If all three of these elements are present, then the court will find that the agreement contains a real property covenant.

Following these cases, a trio of cases decided in 2020 both more narrowly construed what constitutes a covenant running with the land and either suggested or found that even if a midstream contract does contain a covenant running with the land, it can still be rejected.

In Chesapeake Energy Corp. , [3] the court found that Chesapeake’s gas purchase agreement with the ETC Texas Pipeline did not contain a covenant running with the land under Texas law. Despite express contractual language stating that the parties agreed there was a “covenant running with the land,” the court found that there were other provisions indicating that the parties intended the contract to be personal in nature, including a liquidated damages provision providing for monetary damages and a provision acknowledging that the contract was a forward contract for the sale of gas. In dicta, the Chesapeake court (Jones, J.) also suggested that even if the contract did contain a covenant running with the land, it was not clear that this would preclude rejection.

In Extraction Oil & Gas , [4] a Delaware bankruptcy court found that certain transportation services agreements could be rejected even if they contained covenants running with the land, and that the rights of counterparties under those covenants would be satisfied through the claims process—thereby extinguishing any rights the counterparty had to enforce the covenants against the debtor or subsequent owners of the property to which the covenants attached.

In Southland Royalty Co. LLC , [5] another Delaware bankruptcy court (applying Wyoming law) found that a gas gathering agreement did not contain a covenant running with the land because the agreement related to “produced” gas (which constituted personal property) and therefore did not “touch and concern” the land. The Southland court also followed the decision in Extraction , finding that even if the agreement contained a covenant running with the land, the contract could still be rejected.

The Sanchez Decision

In a nuanced opinion parsing the ability of a debtor to reject an executory contract containing a covenant that runs with the land and the effect of that rejection, Judge Marvin Isgur of the US Bankruptcy Court for the Southern District of Texas ruled on May 6, 2021, that a midstream contract that includes covenants running with the land can be rejected. However, because rejection does not constitute termination but rather is deemed to be a breach of the contract by the debtor, Judge Isgur further held that the debtor’s rejection of the midstream contracts at issue would not strip the counterparty of dedication rights previously granted by the debtor. [6]

Judge Isgur’s analysis was guided by the US Supreme Court’s decision in Tempnology , [7] in which the court considered the effect of rejection on rights that cannot be rescinded by a breach of contract. In so holding, Judge Isgur distinguished his decision in Alta Mesa , in which he held that “[r]eal property covenants are not executory and are not subject to rejection.” [8] In Sanchez , Judge Isgur found that “[a]lthough real property covenants are not terminated by rejection, the existence of a real property covenant does not prevent a debtor from rejecting its executory obligations in a contract.” [9]

Sanchez teaches that the susceptibility of a contract to rejection is only the first part of the analysis; one must look next to the consequences of that breach. In Sanchez, certain real property interests—the dedication rights—had been conveyed to the contract counterparty. Judge Isgur held that while the contract could be rejected, such rejection “does not strip [the counterparty] of rights that would survive breaches outside of bankruptcy.” [10] The court reasoned that a “party who conveys a real property covenant does not recover the transferred property rights by merely breaching the contract. Likewise, when that party rejects the contract under § 365, those rights remain with the non-rejecting party.” [11]

While the Sanchez decision provides further clarity about the ability of a debtor to reject midstream agreements containing covenants that run with the land, the import of the retention of property rights by the counterparty is perhaps more murky. In the Sanchez case, the dedication survived rejection, but the pricing terms, including minimum volume requirements, did not. Accordingly, the debtor must continue to deliver to the gathering system, which provides the counterparty with rights superior to rejection damages, but the case provides no answer as to how much the debtor must pay for the services provided.

We should also note that this is not the last of the Sanchez decisions that could impact rejection analysis. A number of rejection issues remain, including integration and business judgment considerations, which will be addressed by Judge Isgur over the coming weeks or months, unless the parties are able to settle them first. It remains to be seen how debtors rejecting midstream agreements and contract counterparties will navigate practical considerations attendant to the rejection, and how this will impact the ability of counterparties to monetize their property rights on a go-forward basis.

[1] In re Sabine Oil & Gas Corp. , 547 B.R. 66 (Bankr. S.D.N.Y. 2016), aff’d , 567 B.R. 869 (S.D.N.Y. 2017), aff’d , 734 F. App’x 64 (2d Cir. 2018); Sabine Oil & Gas Corp. v. HPIP Gonzales Holdings, LLC , 550 B.R. 59 (Bankr. S.D.N.Y. 2016), aff’d , 567 B.R. 869 (S.D.N.Y. 2017), aff’d , 734 F. App’x 64 (2d Cir. 2018).

[2] In re Badlands Energy, Inc. , 608 B.R. 854 (Bankr. D. Colo. 2019); In re Alta Mesa Res., Inc. , 613 B.R. 90 (Bankr. S.D. Tex. 2019).

[3] In re Chesapeake Energy Corp. , 622 B.R. 274 (Bankr. S.D. Tex. 2020).

[4] In re Extraction Oil & Gas , 622 B.R. 608 (Bankr. D. Del. 2020).

[5] In re Southland Royalty Co. LLC , 623 B.R. 64 (Bankr. D. Del. 2020).

[6] In re Sanchez Energy Corp., et al. , Memorandum Opinion, Case No. 19-34508-MI (Bank. S.D. Tex., May 6, 2021) [Dkt. No. 1923]. This decision is currently on appeal.

[7] Mission Prod. Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652 (2019).

[8] Alta Mesa , 613 B.R. at 98.

[9] Sanchez Energy, Memorandum Opinion at 15.

[10] Id . at 17.

[11] Id . at 16.

Delaware Bankruptcy Court: No Implied Assumption of Executory Contracts in Bankruptcy

The ability of a bankruptcy trustee or chapter 11 debtor-in-possession ("DIP") to assume, assume and assign, or reject executory contracts and unexpired leases is an important tool designed to promote a "fresh start" for debtors and to maximize the value of the bankruptcy estate for the benefit of all stakeholders. However, the Bankruptcy Code and the Federal Rules of Bankruptcy Procedure ("Bankruptcy Rules") establish strict requirements for the assumption, assignment, and rejection of contracts and leases. The U.S. Bankruptcy Court for the District of Delaware addressed the consequences of failing to comply with those requirements in In re Dura Auto. Sys., LLC , 628 B.R. 750 (Bankr. D. Del. 2021). The court confirmed that the U.S. Court of Appeals for the Third Circuit—like the majority of other courts that have decided the issue—has rejected the doctrine of "implied assumption" of executory contracts in bankruptcy cases.

Assumption, Assumption and Assignment, and Rejection of Executory Contracts and Unexpired Leases in Bankruptcy

Section 365(a) of the Bankruptcy Code provides that, with certain exceptions delineated elsewhere in the statute, "the trustee, subject to the court's approval, may assume or reject any executory contract or unexpired lease of the debtor." The trustee's power to assume or reject is conferred upon a DIP under section 1107(a) of the Bankruptcy Code. Rejection results in a court-authorized breach of the contract, with any claim for damages treated as a prepetition claim against the estate on a par with the claims of other general unsecured creditors (unless the debtor has posted security). 11 U.S.C. § 365(g). Assumption of a contract requires, among other things, that the trustee or DIP cure all existing monetary defaults and provide adequate assurance of its future performance. 11 U.S.C. § 365(b).

One purpose of section 365(a) is to provide the debtor with "a reasonable time within which to determine whether adoption or rejection of the executory contract would be beneficial to an effective reorganization." Univ. Med. Ctr. v. Sullivan (In re Univ. Med. Ctr.) , 973 F.2d 1065, 1075 (3d Cir. 1992).

Bankruptcy courts will generally approve assumption or rejection of a contract or lease if presented with evidence that either course of action is a good business decision. See Mission Prod. Holdings, Inc. v. Tempnology, LLC , 139 S. Ct. 1652, 1658 (2019) ("The bankruptcy court will generally approve [the] choice [to assume or reject], under the deferential 'business judgment' rule."). Upon assumption, most kinds of executory contracts may also be assigned by the trustee or DIP to third parties under the circumstances specified in sections 365(c) and 365(f). In chapter 11 cases, except with respect to certain kinds of contracts (such as nonresidential real property leases, aircraft lease agreements, and commitments to a federal depository institutions regulatory agency), the trustee or DIP may decide to assume or reject at any time up to confirmation of a chapter 11 plan. However, any nondebtor party to a contract may seek to compel the trustee or DIP to assume or reject the contract prior to confirmation, in which case the bankruptcy court must decide what period of time is reasonable to make the decision. 11 U.S.C. §§ 365(d)(2), (d)(4), and (o). Pending the decision to assume or reject, the trustee or DIP is generally obligated to keep current on most obligations that become due under the contract postpetition. 11 U.S.C. §§ 365(d)(3) and (d)(5).

Bankruptcy Rule 6006 sets forth procedures governing the assumption, assumption and assignment, or rejection of executory contracts and unexpired leases. Rule 6006(a) provides that "[a] proceeding to assume, reject or assign an executory contract or unexpired lease, other than as part of a plan, is governed by [Bankruptcy] Rule 9014." Under Bankruptcy Rule 9014(a), the trustee or DIP must request the relief by motion filed with the bankruptcy court, with reasonable notice and an opportunity for a hearing provided to the contract counterparty.

Dura Automotive

In October 2019, automotive supply company Dura Automotive Systems, LLC and certain affiliates (collectively, "Dura") filed for chapter 11 protection in the Middle District of Tennessee. Venue of the cases was transferred shortly thereafter to the District of Delaware.

Prior to filing for bankruptcy, Dura contracted with Plasti-Paint, Inc. ("PLP") for the painting of auto roof rails under contracts ("PLP contracts") and related purchase orders. The PLP contracts allowed Dura to place weekly orders without having to issue new purchase orders. As a critical supplier, PLP continued to provide services to Dura under the contracts after the bankruptcy petition date.

In January 2020, Hain Capital Investor Master Fund, Ltd. ("Hain") purchased PLP's claims against Dura under the PLP contracts and all associated rights. Under the claims purchase agreement, if Dura assumed any of the PLP contracts, Hain was entitled to all cure amounts payable upon assumption.

In June 2020, the court approved the sale of substantially all of Dura's North American assets to Dura Buyer DNA, LLC (together with its assignees, including DUS Operating, Inc. ("DUS"), the "Purchaser"). As part of the transaction, which was closed in June 202, Dura assumed and assigned certain executory contracts to the Purchaser in accordance with section 365 and court-approved procedures. Under the sale agreement, the Purchaser was obligated to pay all of Dura's monetary defaults under the assigned executory contracts before the sale closed. Dura, however, never sought to assume and assign or to reject the PLP contracts.

After the sale, PLP rendered performance to the Purchaser under the PLP contracts but announced that it would soon modify its paint process. PLP and the Purchaser accordingly entered into a new contract in June 2020. The new contract substituted DUS as the contract counterparty but otherwise made no significant changes. However, the parties operated under the PLP contracts until September 2020, when PLP implemented its new paint process. The parties then used both the old and new contracts until December 2020, after which they began operating solely under the new contract.

In October 2020, Hain sought an order from the bankruptcy court compelling the Purchaser to pay it approximately $1.8 million to cure alleged defaults under the PLP contracts. Hain argued that, despite Dura's failure to formally assume and assign the PLP contracts as part of the sale transaction, the cure amounts were due under the doctrine of "implied assumption," based on Dura's conduct. According to Hain, Dura impliedly assumed the PLP contracts because: (i) the new contract between PLP and the Purchaser's designee DUS was substantially similar in purpose to the PLP contracts; (ii) the new contract was a continuation of the PLP contracts and the parties intentionally structured their dealings so that they could avoid paying Hain the cure amount; and (iii) DUS benefited from the PLP contracts without taking responsibility for paying the cure amount.

DUS countered that the bankruptcy court never approved Dura's assumption and assignment of the PLP contracts, and the Third Circuit, like many other courts, has rejected the concept of implied assumption.

The Bankruptcy Court's Ruling

The bankruptcy court denied Hain's motion.

Bankruptcy Judge Karen B. Owens explained that, because Dura neither sought nor obtained court approval to assume and assign the PLP contracts to the Purchaser, the contracts were not assumed and the Purchaser (or its assignee DUS) did not have to pay the cure amount required as a condition to assumption under section 365(b). Citing University Medical (Third Circuit precedent by which the bankruptcy court was bound), Judge Owens noted that the Third Circuit has rejected the implied assumption doctrine. Dura , 328 B.R. at 754. Although courts outside of the Third Circuit have permitted implied assumption, she wrote, they are "a small minority." Id.

In accordance with University Medical , Judge Owens emphasized, "'assumption must be approved. It cannot be presumed.'" Id. (quoting University Medical , 973 F.2d at 1077). In University Medical , she explained, the Secretary of the U.S. Department of Health and Human Services asserted that the unique circumstances of the Medicare Act should allow a contract to be assumed if performance continues after the petition date even without formal court approval. However, the Third Circuit refused to depart from the plain language of the Bankruptcy Code that mandates court approval for assumption of an executory contract. In so ruling, Judge Owens noted, the court of appeals stressed the importance of motion practice and court approval so that all of the pros and cons to the estate and stakeholders can be considered and an executory contract's status with respect to the estate can be finalized. Id. at 755 (citing University Medical , 973 F.3d at 1078-79).

According to Judge Owens, PLP voluntarily provided services after the sale until the new contract became effective, and there was "no motivation" to seek court approval to assume the PLP contracts and pay the cure amount after PLP sold its claims under the contracts to Hain. Instead, the parties focused on continuing PLP's critical services and finalizing the painting process and the new contract. In addition, Hain never requested court approval of assumption of the PLP contracts (as was its right under section 365(d)(2) and the claims purchase agreement) or attempted to stop the parties from continuing their dealings or from entering into a new contract, despite being aware that PLP was continuing to provide services.

Judge Owens rejected Hain's contention that section 105(a) of the Bankruptcy Code (providing that the court can "issue any order, process, or judgment that is necessary or appropriate to carry out the provisions" of the Bankruptcy Code) authorized a finding of implied assumption. This argument, she wrote, was rejected by the Third Circuit in University Medical and defies the plain language of the Bankruptcy Code and the Bankruptcy Rules. Id. at 756 (citing Law v. Siegel , 571 U.S. 415, 421 (2014) (holding that a bankruptcy court cannot use section 105(a) to override explicit mandates of the Bankruptcy Code)).

Finally, Judge Owens noted that Hain could pursue any claim it might have for breach of the claims purchase agreement outside of bankruptcy. Hain's claims under the PLP contracts, by contrast, would be resolved in due course in Dura's bankruptcy.

Dura Automotive demonstrates the importance of strict compliance with the rules and procedures established in the Bankruptcy Code and the Bankruptcy Rules for the assumption, rejection, and assignment of executory contracts and unexpired leases. Although a minority of courts have concluded that a contract or lease can be assumed under the doctrine of implied assumption, debtor and nondebtor contract parties (as well as other stakeholders in the bankruptcy case) are better served by adhering to the rules rather than leaving the fate of their interests under a contract or lease to the court's equitable discretion.

The decision also serves as a reminder that claims purchasers must be vigilant and proactive to ensure that their rights under a purchase or assignment agreement are preserved (e.g., by actively participating in the bankruptcy case or including an indemnity in the agreement.)

Marissa Alfano

May 2024 Newsletters

Business Restructuring & Reorganization

One Firm Worldwide ®

Singular Tradition of Client Service and Engagement with the Client
Mutual Commitment of, and Seamless Collaboration by, a True Partnership
Formidable Legal Talent Across Specialties and Jurisdictions
Shared Professional Values Focused on Addressing Client Needs

Before sending, please note:

ACC Communities

The Association of Corporate Counsel (ACC) is the world's largest organization serving the professional and business interests of attorneys who practice in the legal departments of corporations, associations, nonprofits and other private-sector organizations around the globe.

Executory Contracts in Bankruptcy (United States)

What is an Executory Contract?

Most courts define an executory contract as an agreement where "the obligations of both the bankruptcy and the other party are so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other." N.L.R.B. v. Bildisco & Bildisco, 456 US 513 (1984) ; Countryman , Executory License Agreements in Bankruptcy, 57 Minn. L. Rev. 439, 460 (1973) . Courts of Appeal in the Third, Fourth, Seventh, Eighth and Ninth Circuits use this "material breach" test. Some courts in the First, Sixth and Eleventh Circuits have used a more fluid "functional test." A long-term supply agreement, a franchise agreement, or most intellectual property licenses would usually be considered to be an executory contract. A promissory note, a completed sale or assignment, an expired agreement, an agreement effectively and completely terminated prior to the bankruptcy filing, or a single purchase order would typically not be an executory contract. Exclusive and perpetual licenses are sometimes argued to be more like a completed assignment for the rights and/or territory covered than an executory contract. However, any ongoing obligations on both sides, if material, will still be examined as part of the analysis of whether it is an executory contract or not.

How are Executory Contracts Treated Upon a Bankruptcy Filing?

Property interests of the entity or person filing bankruptcy becomes property of the bankruptcy estate upon a bankruptcy filing. An executory contract is property of the bankruptcy estate. Property of the bankruptcy estate is generally protected by the automatic stay . The automatic stay is a broad injunction which arises upon the filing of a bankruptcy petition that protects the property of the bankruptcy estate from the exercise of remedies by a creditor (e.g., proceeding to judgment or seizing assets) or a contract counterparty (e.g., termination or changing terms), absent obtaining relief from the automatic stay from the Bankruptcy Court. Section 365 of the Bankruptcy Code provides that clauses terminating an executory contract upon a bankruptcy filing or insolvency (so-called "ipso facto" clauses) are generally unenforceable.

Bankruptcy Cases Filed After Termination Notice Given but Before Cure or Termination Period has Expired

Executory contracts that are terminated prior to the filing of the bankruptcy petition do not become property of the estate. Moody v. Amoco Oil Co. , 734 F.2d 1200 (7th Cir. 1984) . But the termination "must be complete and not subject to reversal, either under the terms of the contract or under state law." Id. , at 1212. Thus, in situations where the nondebtor party to the contract has given its termination notice for the contract, and the debtor subsequently files for bankruptcy protection but before the cure or termination period has expired, courts may treat the underlying contract as an executory contract. In re Masterworks , Inc., 100 B.R. 149 (Bankr.D.Conn. 1989); In re C.W. Mining Co. , 422 B.R. 746 (10th Cir. BAP 2010) . Whether the default under the contract can be cured after the expiration of the cure period depends on the nature of the default, the phrasing of the notice of the default, and sometimes the court hearing the matter.

Limbo Period During Bankruptcy Case and Timing of Decision

The nondebtor counterparty to an executory contract is obligated to perform its obligations under the contract pending assumption, assignment, or rejection of that contract by the debtor (discussed below). In re Leslie Fay Companies, Inc. , 166 B.R. 802 (Bankr.S.D.N.Y. 1994) . If both parties owe each other money or credits, the nondebtor counterparty may have set-off, recoupment, and/or administrative freeze rights. A counterparty can file a motion to seek to compel an assumption or rejection of the contract but such relief is extremely difficult to obtain. 11 U.S.C. § 365(d)(2) ; In re Physicians Health Corp. , 262 B.R. 290 (Bankr.D.Del. 2001). Moreover, the counterparty's desire for certainty or for payment of unpaid prepetition amounts as a "cure cost" is generally not compelling to a bankruptcy court, which is typically more focused on the bankruptcy estate's attempt to reorganize or sell its assets.

In a Chapter 7 liquidation, executory contracts are generally rejected 60 days into the bankruptcy case absent special relief from the bankruptcy court. In a Chapter 11 case, there is no set time period to make the decision to reject or assume a general executory contract. Instead, absent an earlier rejection of an executory contract, which is burdensome and disfavorable to the bankruptcy estate, decisions on whether to assume or reject typically do not occur until a Chapter 11 plan is confirmed or until the division, assets or entity, which the contract relates to, is sold or liquidated generally.

A debtor may assume an executory contract by:

Obtaining an order from the bankruptcy court permitting assumption of such contract after notice and an opportunity for the nondebtor counterparty to be heard in the bankruptcy court, or Confirming a plan of reorganization, which provides for assumption of such contract upon the effective date of the confirmed plan.

The debtor must assume the executory contract in its entirety. Upon assumption, the bankruptcy estate becomes bound by the contract, and all amounts thereafter owed by the debtor under the contract will constitute administrative expense claims, which are generally entitled to be paid in full. If an executory contract is in default at the time the debtor seeks to assume the contract, assumption will not be permitted unless all monetary defaults are promptly cured, and adequate assurance of future performance of the debtor's obligations under the contract is provided. Section 365(c) of the Bankruptcy Code prohibits the assumption of an executory contract by the debtor without the consent of the nondebtor counterparty for contracts with respect to which applicable law excuses the nondebtor party from accepting performance from, or rendering performance to, a third party, such as certain personal services contracts, certain non-assignable governmental contracts and certain intellectual property licenses.

Upon assumption, the debtor may assign an executory contract to a third party provided there is adequate assurance of future performance by the assignee of the executory contract. It is the bankruptcy court that ultimately determines whether the proposed assignee meets the standards, not the nondebtor counterparty. Contractual limitations on the assignment of an executory contract are generally not enforceable in bankruptcy, with some exceptions. One such exception arises in contracts that are not assignable to third parties under applicable law and the party does not consent to such assumption or assignment. Otherwise, debtors sometimes are able to assign under market or otherwise favorable executory contracts at a profit.

Rejection of an executory contract is essentially the debtor's declaration that it will not perform its remaining obligations under a contract under which performance remains due from each party. Upon rejection, the debtor no longer can be compelled to perform the debtor's unperformed remaining obligations under the contract, leaving the counterparty with the sole remedy of a breach of contract damage claim against the bankruptcy estate, which ordinarily will constitute a general unsecured claim as of the petition date, which often is paid only cents on the dollar. Rejection of the executory contract by the debtor does not reverse or undo any transactions completed before the point of rejection. In addition, an executory contract cannot be rejected in parts and assumed in parts. In situations where the executory contract is found to form a part of a series of related agreements (which may be difficult to prove), all the agreements will be deemed to constitute a single integrated transaction, requiring that all of such agreements either be assumed or rejected as a group. In re Atlantic Computer Systems, Inc. , 173 B.R. 844 (S.D.N.Y. 1994); In re Grede Foundries, Inc. , 440 B.R. 497 (Bankr.W.D.Wis. 2010). Bankruptcy courts review the debtor's decision to reject an executory contract under the business judgment standard and generally do not consider the fact that rejection is damaging to the nondebtor counterparty to the contract.

Rights Against Persons or Entities Who are not Part of Bankruptcy Filing

The automatic stay and other bankruptcy protections are generally specific to the entity in bankruptcy. If your agreement has a broad insolvency clause, which includes bankruptcy filings and/or insolvency by affiliates as an event of default or termination of the agreement, and the particular counterparty to the agreement does not immediately file for bankruptcy, it may be possible to terminate the license based on the parent's or affiliate's insolvency or bankruptcy filing.

Section 365 of the Bankruptcy Code sets out the bankruptcy trustee's duties and powers with regard to executory contracts. It is a lengthy section with many details, subtleties and gaps. The Bankruptcy Code attempts to empower the trustee to take advantage of the rights and assets of the estate while affording some protection to the countervailing interests of the counterparty. Given the complexity of the section and the numerous possible outcomes of executory contracts in bankruptcy, effective advocacy can make a large difference in achieving optimal results. This QuickCounsel provides in-house counsel with a brief overview of the issues and considerations involved in executor contracts in bankruptcy.

Additional Resources

Executory Contracts in Bankruptcy: Navigating the Legal Ambiguities ( McKenna Long & Aldridge 2012) The Assumption Or Rejection of Executory Contracts in Bankruptcy - Are Commodity Contracts Within A Safe Harbor? ( Iowa State University Center for Agricultural Law and Taxation 2009) Executory Contracts -- What Are They And Why Do They Matter In Bankruptcy? ( Cooley LLP 2006) Executory Contracts And Unexpired Leases ( Bernstein-Burkley PC )

Published on October 1, 2012

IMAGES

Mortgage Assumption Agreement Pdf
Fillable Online 3 Assignment and Assumption Agreement Fax Email Print
Deed of Assumption Sample: Complete with ease
Delaware Bankruptcy Court: No Implied Assumption of Executory Contracts in Bankruptcy
Assumption Agreement Form

VIDEO

Executory contract explained
Key Issues to Consider in Retail Bankruptcies
Analyze Any Websites Domain, Article or Journal
ETA Legal Process
Unit 2 Contracts Procurement Assignment Level 6
Executed Contract & Executory Contract

COMMENTS

ASSUMPTION AND ASSIGNMENT OF EXECUTORY CONTRACTS: PRESERVING ...
A. What is an Executory Contract? The determination of whether a contract is executory is an age-old challenge in bankruptcy proceedings. The majority of courts addressing the issue have adopted the so-called Countryman approach, named after Professor Vern Countryman. Under the Countryman
60. Executory Contracts in Bankruptcy -- Assumption and Rejection
Assumption of an executory contract is accomplished by motion of the debtor-in-possession or trustee, subject to objection by other creditors and court approval. A motion to assume an executory contract is a summary proceeding; it is not the place for prolonged discovery or a lengthy trial with disputed issues.
Executory Contracts: Assumption and Assignment - thismatter.com
The requirements and legal effects of assumption and assignment of executory contracts under bankruptcy by the trustee or debtor in possession.
Assumption or Assignment of Executory Contracts and Unexpired ...
The debtor might assume contracts that it wants to keep or to assign to a third party, while rejecting those it finds unprofitable. Executory contracts are those in which both parties still have significant remaining performance obligations. Examples are supply contracts, purchase agreements, employment contracts and service contracts.
11 U.S. Code § 365 - Executory contracts and unexpired leases
Restrictions with respect to assignment of an executory contract or unexpired lease are superfluous since the debtor may assign an executory contract or unexpired lease of the debtor only if such contract is first assumed under section 364(f)(2)(A) of the House amendment.
Assumption and Rejection of Midstream Contracts in Bankruptcy
Where a debtor has a contract with a third party that is “executory”—meaning that ongoing performance obligations remain for both the debtor and the contract counterparty on the date of the bankruptcy filing—the debtor can choose to either assume or reject the contract under 11 USC § 365.
Delaware Bankruptcy Court: No Implied Assumption of Executory ...
The ability of a bankruptcy trustee or chapter 11 debtor-in-possession ("DIP") to assume, assume and assign, or reject executory contracts and unexpired leases is an important tool designed to promote a "fresh start" for debtors and to maximize the value of the bankruptcy estate for the benefit of all stakeholders.
Limitations on Assumption and Assignment of Executory ...
"executory." This article first explains how which contracts are considered executory and then delves into the conditions under which an executory contract may be assumed and, particularly, into the exceptions triggered by non-bankruptcy laws restricting assignment of contracts. It concludes that Congress intended to
Bankruptcy and the Anti-Assignment Acts: A New Approach to ...
To determine whether a government contractor may assume its government contracts, this Comment proposes applying a new test that: (1) examines each situation on a case-by-case basis; (2) emphasizes the totality of the circumstances; (3) and considers the nature of the contract in question.
Executory Contracts in Bankruptcy (United States ...
The debtor must assume the executory contract in its entirety. Upon assumption, the bankruptcy estate becomes bound by the contract, and all amounts thereafter owed by the debtor under the contract will constitute administrative expense claims, which are generally entitled to be paid in full.