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Understanding the concept of executory contracts

Many Washington state businesses that file bankruptcy petitions have ongoing legal relationships with other parties. Some contracts, such as a real estate lease, may be beneficial to the debtor, while others, such as a contract with a supplier, may be burdensome. The United States Bankruptcy Code refers to such agreements as "executory contracts," and it vests in the trustee important powers with respect to such contracts.

The bankruptcy code does not define the term "executory contract," but federal courts generally agree that an executory contract is an agreement that is binding on both parties and where the obligations of the parties are so far unperformed that a failure of performance would constitute a material breach of the agreement. Upon the filing of a bankruptcy petition, executory contracts become the property of the bankruptcy estate.

The trustee may either accept or reject executory contracts. If the trustee accepts, or "affirms," an executory contract, then both the debtor and the other party to the contract must continue to perform. If the trustee rejects an executory contract, the contract has no further legal effect. In both cases, the non-debtor party to the agreement can petition the bankruptcy court for relief from the trustee's decision. In a Chapter 7 proceeding, the trustee must make the election to affirm or reject executory contracts within 60 days of the filing. In a Chapter 11 filing, the decision is generally delayed until the debtor presents its plan of reorganization. In both cases, executory contracts must be either completely rejected or completely affirmed; partial rejections or affirmations are not allowed.

Dealing with executory contracts can be one of the most complex phases of the bankruptcy process. If the debtor plans to reorganize its debts under Chapter 11, some executory contracts may be affirmed while others are rejected. In a Chapter 7 liquidation, all executory contracts will be rejected or affirmed and assigned to third parties.

Source: Association of Corporate Counsel, "Executory Contracts in Bankruptcy," accessed on Nov. 13, 2017

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