Executory Contracts in Bankruptcy: Assumption and Rejection Rules
Executory contracts occupy a distinct and consequential position in bankruptcy proceedings, giving debtors and trustees the power to either honor or escape ongoing contractual obligations. Governed by 11 U.S.C. § 365, these provisions affect real estate leases, software licenses, supply agreements, and employment contracts alike. The rules for assumption and rejection determine which contractual relationships survive bankruptcy and which are treated as prepetition unsecured debts — a distinction that reshapes the financial landscape for debtors, creditors, and counterparties in every chapter of the bankruptcy code.
Definition and Scope
An executory contract is one in which material performance obligations remain due on both sides as of the petition date. The most cited articulation of this standard comes from Professor Vern Countryman, whose 1973 article in the Minnesota Law Review defined executory contracts as those "so far unperformed that the failure of either party to complete performance would constitute a material breach excusing the other party's performance." Bankruptcy courts across federal circuits have adopted this "Countryman test" as the dominant analytical framework, though the Bankruptcy Code itself does not define the term.
Unexpired leases are treated alongside executory contracts under § 365 and share the same assumption/rejection mechanics. The scope of § 365 extends to:
- Real property leases (commercial and residential)
- Personal property leases (equipment, vehicles)
- Intellectual property licenses (discussed in depth at Bankruptcy and Intellectual Property Licenses)
- Service contracts and supply agreements
- Employment agreements with non-compete or exclusivity provisions
- Collective bargaining agreements (subject to the additional requirements of § 1113)
Contracts that are fully performed on one side — such as a completed sale where only a payment obligation remains — are not executory and cannot be rejected under § 365. They are simply treated as prepetition debts subject to the claims process.
How It Works
The mechanics of assumption and rejection follow a structured sequence governed by the US Bankruptcy Court System and supervised by the presiding bankruptcy judge.
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Petition filing and automatic stay. Upon filing, the automatic stay freezes most creditor actions, including termination of executory contracts based solely on the debtor's financial condition or the filing itself — a protection codified at 11 U.S.C. § 365(e)(1), which voids ipso facto clauses in most contexts.
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Identification period. The debtor or trustee inventories all unexpired leases and executory contracts as part of the bankruptcy estate. Under the Bankruptcy Estate framework, § 541 pulls these contracts into the estate automatically upon filing.
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Decision deadline. The timeframe for assumption or rejection varies by chapter. Under § 365(d)(1), a Chapter 7 trustee has 60 days from the order for relief to assume or reject residential leases (or they are deemed rejected). For nonresidential real property leases in Chapter 11, § 365(d)(4) requires assumption within 120 days of the order for relief, extendable by 90 additional days upon court order, and further extensions require counterparty consent.
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Assumption requirements. To assume a contract, the debtor must: (a) cure all existing monetary defaults, or provide adequate assurance of prompt cure; (b) compensate the counterparty for actual pecuniary loss resulting from default; and (c) provide adequate assurance of future performance (11 U.S.C. § 365(b)(1)).
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Assignment option. A debtor may assume and then assign an executory contract to a third party — even over the counterparty's objection — if adequate assurance of future performance by the assignee is demonstrated. This is a critical tool in Section 363 asset sales.
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Rejection mechanics. Rejection is treated as a prepetition breach under § 365(g). The counterparty receives an unsecured damages claim, not an administrative expense. Rejection does not rescind the contract retroactively — it terminates performance obligations while converting the damages claim to general unsecured status.
Common Scenarios
Commercial real estate leases in Chapter 11. A retailer filing under Chapter 11 may reject unprofitable store leases while assuming leases on profitable locations. Landlords for rejected leases receive unsecured claims capped under § 502(b)(6) at the greater of one year's rent or 15% of the remaining lease term (not to exceed three years' rent). This cap, established in the Bankruptcy Code, limits landlord recovery significantly compared to full contract damages.
Software and technology licenses. When a licensor files bankruptcy, § 365(n) — added by the Intellectual Property Bankruptcy Protection Act of 1988 — gives licensees the right to retain their license rights even if the debtor-licensor rejects the license agreement. The licensee must continue royalty payments and cannot compel performance but preserves access to the licensed material.
Collective bargaining agreements. Rejection of a collective bargaining agreement requires a separate, heightened process under § 1113. The debtor must propose modifications, bargain in good faith with the union, and obtain court approval — a standard more demanding than ordinary executory contract rejection.
Supply and vendor agreements. Manufacturers in Chapter 11 routinely assume supply contracts necessary to ongoing operations while rejecting agreements with above-market pricing, converting supplier claims to unsecured status.
Decision Boundaries
The assumption-or-rejection decision is guided by the business judgment standard, which grants debtors broad deference if a rational business reason supports the choice. Bankruptcy courts applying this standard, as articulated in cases construing § 365, will rarely override a debtor's determination absent bad faith or gross abuse of discretion.
Assumption vs. Rejection — Comparative Framework:
| Factor | Assumption | Rejection |
|---|---|---|
| Effect on counterparty | Contract survives; defaults must be cured | Treated as prepetition breach; unsecured claim arises |
| Cure obligation | Required under § 365(b)(1) | None |
| Future performance | Debtor/assignee bound | Obligations extinguished |
| Administrative expense risk | Yes — post-assumption obligations are administrative | No |
| Counterparty consent | Not required if adequate assurance shown | Not required |
A critical boundary concerns non-assignable contracts. Where applicable law (state contract law, federal statute, or regulatory requirement) renders a contract non-assignable, that restriction survives bankruptcy for assumption-and-assignment purposes under § 365(c)(1) — though courts are split on whether this bar also prevents assumption by the debtor itself without assignment (the "hypothetical test" vs. "actual test" circuit split).
Counterparties seeking protection from prolonged uncertainty may file motions to compel the debtor to assume or reject within a specified timeframe under § 365(d)(2), giving courts discretionary authority to impose deadlines in Chapter 11 cases involving non-real-property contracts.
The plan of reorganization confirmation process is the final deadline: all executory contracts not previously assumed or rejected must be addressed in the reorganization plan or deemed rejected upon confirmation.
References
- 11 U.S.C. § 365 — Executory Contracts and Unexpired Leases, U.S. Code (GovInfo)
- 11 U.S.C. § 1113 — Rejection of Collective Bargaining Agreements, U.S. Code (GovInfo)
- Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), Public Law 109-8
- United States Courts — Bankruptcy Basics: Chapter 11
- United States Trustee Program — U.S. Department of Justice
- Intellectual Property Bankruptcy Protection Act of 1988, Pub. L. 100-506 (amending § 365(n))
- Federal Rules of Bankruptcy Procedure, Rules 6006 and 6007 (GovInfo)