15 ALI-ABA Video Webcast Strategies for Corporate Reorganization Planning in Today s Credit Crunch May 5, 2009 Video Replay with Live Q&A Originally Presented January 9, 2009 Executory Contracts By Evelyn H. Biery Fulbright & Jaworski LLP Houston, Texas
16 2
17 TABLE OF CONTENTS Page I. INTRODUCTION... 1 II. OVERVIEW OF SECTION 365 OF THE BANKRUPTCY CODE... 1 III. DEFINING EXECUTORY CONTRACTS: CURRENT CIRCUIT VIEWS... 2 IV. BENEFITS AND BURDENS... 5 V. BUSINESS JUDGMENT TEST... 6 VI. ADMINISTRATIVE EXPENSE CLAIMS... 7 VII. TAX CLAIMS... 10 VIII. ASSIGNMENT... 13 IX. DEFAULTS... 14 X. REJECTION... 16 XI. TIMING... 19 XII. EXCLUDED CONTRACTS AND LEASES... 22 XIII. IPSO FACTO... 23 XIV. FORWARD AND FINANCIAL CONTRACTS... 25 XV. SECTION 556... 37 XVI. STATUTORY CONFLICTS BETWEEN SECTION 365 AND OTHER CODE SECTIONS... 38 XVII. BAPCPA S EFFECTS ON EXECUTORY CONTRACTS... 43 XVIII. SPECIAL ISSUES REGARDING COMMERCIAL LEASES... 49 XIX. SPECIAL ISSUES IN INTELLECTUAL PROPERTY... 60 75573215.5 -i-
18 EXECUTORY CONTRACTS: I. INTRODUCTION One of a debtor s most powerful tools in the bankruptcy process is the ability to end unprofitable financial relationships without many of the unpleasant consequences that usually follow from such breakups. Section 365 of the Bankruptcy Code permits a debtor to escape from certain unprofitable, burdensome contractual relationships while simultaneously maintaining profitable, beneficial contractual arrangements. Assuming a contract means that the debtor opts to become fully bound by its terms just as if bankruptcy had not intervened. The debtor may also assume and then assign the contract to a third party to generate value for its estate. Rejecting a contract means that the debtor refuses to be bound by the contract, leaving the nondebtor party with a claim for damages for breach of contract. The claim will be treated as a general unsecured pre-petition claim in the bankruptcy. Make no mistake: the ability to assume and assign or reject executory contracts is one of the main draws for a great many debtors whose ability to reorganize is hampered by burdensome contractual obligations. This paper recaps the current views on executory contracts and unexpired non-residential leases and highlights several interesting decisions that have called into question the mechanics of the Bankruptcy Code. II. OVERVIEW OF SECTION 365 OF THE BANKRUPTCY CODE The decision to assume or reject an executory contract is a matter within the sound business judgment of the debtor. See In re Taylor, 913 F.2d 102 (3d Cir. 1990). Once a debtor has established a sound business reason to assume a contract, the debtor must comply with the requirements of section 365 of the Bankruptcy Code. The major subsections of section 365 are as follows: 365(a): the basic rule regarding executory contracts and unexpired leases; 365(b): assumption of executory contracts and unexpired leases; 365(c): exceptions to non-assumable, non-assignable contracts and leases; 365(d): timing and obligation to perform; 365(e): invalidating ipso facto clauses; 365(f): assignment of assumed contract and leases; 365(g): effect of rejection as breach of contract or lease; 365(k): limitation of trustee liability for breach of assigned contract; 365(l): lessor s right to security deposit on assignment; 365(m): term lease includes any rental agreement for real property; 75573215.5
19 365(n): treatment of intellectual property rights when debtor is licensee; 365(o): contracts with federal depository institutions regulatory agency; and 365(p): leases of personal property. Section 365 is both substantive and procedural; it governs the assumption, assignment, and rejection of executory contracts or unexpired leases. 11 U.S.C. 365. It contains the general principles establishing the debtor s ability to terminate certain financial relationships as well as the rights of the terminated party against the debtor. Through a combination of negative restrictions, 1 affirmative requirements 2 and definitive obligations, 3 section 365 facilitates the debtor s fresh start without unduly penalizing the creditors expected to finance the costs of administration. See Pub. Serv. Co. of N.H. v. N.H. Elec. Coop., Inc. (In re Pub. Serv. Co. of N.H.), 884 F.2d 11, 15-16 (1st Cir. 1989) (stating that the Bankruptcy Code afford[s] breathing space to decide which contracts they wish to assume [or reject] ). III. DEFINING EXECUTORY CONTRACTS: CURRENT CIRCUIT VIEWS The Bankruptcy Code does not define executory contract, and definitional case law is best described as inconclusive. The classic definition of an executory contract has become known as the Countryman definition: a contract under which the obligation of both the debtor and the counterparty are so far unperformed that the failure of either of them to complete performance would constitute a material breach excusing the performance of the other. Vern Countryman, Executory Contracts In Bankruptcy, 57 MINN. L. REV. 439, 460 (1973). 4 The Countryman definition, which leaves considerable wiggle room as to what might constitute an executory contract, has been modified and supplemented by many courts in an attempt to articulate a standard that is less difficult to apply, with the predictable result that the standard depends on where you are. A few years ago, the First Circuit Court of Appeals consulted the legislative history of section 365 of the Bankruptcy Code and determined that Congress intended the term executory contract to mean a contract on which performance is due to some extent on both sides. See In re FBI Distrib. Corp., 330 F.3d 36 (1st Cir. 2003). In FBI Distribution, a former executive of Filene s Basement, who was terminated after rendering postpetition services, filed a claim seeking payment from the debtor for termination benefits allegedly owed her pursuant to a prepetition employment and retention agreement, claiming that the amounts owed to her were entitled to a first-priority administrative expense treatment. The debtor and the official committee of unsecured creditors objected. 1 The equitable balance is maintained throughout the section. For example, the trustee s ability to assume or reject is subject to certain limitations, but so is the ability of the lessor to compel performance. 2 The trustee is required to cure certain prepetition damages before assumption but is excused from performance where there exists a prepetition default. 3 Such obligations include the trustee s obligation to perform all obligations of the debtor under the lease in certain circumstances. 11 U.S.C. 365(d)(3) (2004). 4 Part II of Professor Countryman s article can be found at 57 MINN L. REV. 479 (1974). 75573215.5-2-