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Understanding executory contracts in bankruptcy

Many Kentucky businesses that file a petition for bankruptcy are often party to one or more contracts under which the parties have not fulfilled all of their obligations. A common example is a commercial lease whose term has not expired. In such a situation, the debtor must continue to pay rent, and the landlord must continue to allow the debtor to occupy the space. What happens to these contracts in a business bankruptcy proceeding?

A contract that has duties and obligations that are either ongoing or unfulfilled as of the filing of the bankruptcy petition are called "executory contracts." The Bankruptcy Code permits the debtor to either reject an executory contract or assume the contract. If the debtor rejects the contract, its remaining terms and conditions are canceled. In the case of a commercial lease, for example, means that the debtor must terminate occupancy of the leased premises. If the debtor decides to assumes the contract, the parties continue with performance under the terms of the contract as written.

A debtor who wishes to assume an executory contract must make a motion with the bankruptcy court seeking approval of the assumption. If such a motion is not made within the deadline prescribed by the Bankruptcy Code, the contract is automatically deemed to have been rejected. If a timely motion to assume is filed by the debtor, creditors may object to the proposed assumption on several grounds. The debtor must prove (a) that the contract is subject to assumption and (b) that the contract is not in default. A creditor who wishes to be freed from the agreement, say a landlord who rents space to the debtor, can object to the assumption. If the debtor's decision to assume the contract reflects reasonable business judgment, and if the objections are unavailing, the court will approve the assumption.

The decision to assume or reject an executory contract can involve a number of complex factors, especially if a business is party to several such agreements. Anyone with questions about the assumption or rejection of an executory contract may wish to consult a lawyer who is experienced in bankruptcy matters. Such a consultation can provide a useful analysis of the consequences of assumption or rejection and how such an action may relate to other bankruptcy issues facing the debtor or creditors.

Source: United States Department of Justice, U.S. Attorneys' Manual "60. Executory Contracts in Bankruptcy -- Assumption and Rejection," accessed on May 19, 2017

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