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What is an executory contract in bankruptcy?

As many businessmen in Vancouver have learned, dealing with a company on the verge of bankruptcy can be difficult. Payments for goods and services are often late or entirely non-existent, and the threat of a bankruptcy filing and the imposition of the automatic stay are constant threats. These risks are well known, but a lesser known risk can cause even more financial chaos -- the rejection by the trustee of an "executory contract."

The bankruptcy code gives both a trustee and a debtor-in-possession the power to accept or reject any executory contract or unexpired lease. Unfortunately, the bankruptcy code does not define the term "executory contract." Many courts have struggled with a definition, but no single definition has been adopted.

In its simplest terms, an executory contract in bankruptcy is a contract under which one or both parties have important duties to perform. Common examples of such agreements are real estate leases whose terms have not expired, equipment leases and supply contracts.

The purpose of the executory contract provision is to give the trustee or a debtor-in-possession the power to preserve the debtor's assets by terminating contracts that do not serve the debtor's interests. Unexpired real estate leases are the most common example of executory contracts. A debtor that leases its business premises may wish to keep the lease in force if it is trying to win approval for a plan of reorganization under Chapter 11. The landlord, however, may wish to terminate the lease if the debtor is in default. A trustee may not accept an executory contract that is in default without making satisfactory arrangements to cure the default.

This brief discussion of executory contracts is by no means a complete explanation of the many complexities that may spring from these agreements in a bankruptcy proceeding. Any business that has one or more contracts with a firm that is in dire financial shape may wish to discuss the situation with a knowledgeable bankruptcy attorney, who can provide advice on the issue of executory contracts.

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