25: Executory Contracts –
overview, definition, rejection
© Charles Tabb 2010
Special type of property

All “property” of Dr passes into the
estate under 541(a)

And a K right is just one type of property

So why need a whole (very, very long)
section [365] dealing with executory Ks?
Why not just handle under 541?
Property tied to Liability

The problem is that the Dr’s bankruptcy
estate cannot simply sit back and enjoy
the “property” right under the K

That property right, the “asset” under a K
-- the Dr’s right to performance from the
Other Party -- is dependent on the Dr’s
reciprocal performance of the
countervailing liability
Worth it?

So the real question for a Dr’s bankruptcy
estate is whether it is worth the liability
to obtain the asset

Can’t have one without the other, or
would be grossly unfair to Other Party
Basic decision

Accordingly, the basic decision that
bankruptcy estate representative (Trustee
or DIP) must make is whether the value
to the estate of obtaining the asset is
worth taking on the correlative liability
If “yes”, then “assume” the K
 If no, then “reject” the K

Effect if assume

If estate chooses to assume, the basic legal
effect is that the estate itself “takes over”
the K from the Dr – steps into Dr’s shoes
 1st, the
performance of the Dr’s obligations
now are obligations of the estate, and thus =
admin expense

2nd, right to performance by Other Party is
property of the estate
Effect if reject

If decide to reject, which basically just
means not to assume, then effect is:
 1st, estate
is NOT liable on the K, and is
treated as = breach, which gives the
Other Party a general non-priority
unsecured claim in the bk case
 2nd, the
estate is not entitled to the Other
Party’s performance
Definition: what IS an Executory K?
Not defined in Code
 “Countryman” test:

◦ “contract under which the obligation of both the
bankrupt and the other party to the contract are
so far unperformed that the failure of either to
complete performance would constitute a
material breach excusing the performance of the
other”

Thus = “Material Breach” test
“material breach” rule in K law

The “material breach” rule in K law speaks
to the rights of an aggrieved party if the
other party defaults

1st, always have right to a remedy for breach

2nd, IF (i) the obligations of the aggrieved
party and the breaching party are
“dependent” on each other and (ii) the
breacher’s non-performance = material
breach, then the aggrieved party is also
EXCUSED from performing its obligations
K to buy a hat

Consider a very simple example: Dr & Pres.
Clinton have a K for DR to pay $5000 to
Clinton for a Razorback hat once worn by
Pres. Clinton
$5000
 If Clinton refuses to tender delivery of the hat,
does Dr still have to fork over the $5 grand,
and just sue for breach? Of course not!!
Why not have to pay?

Dr does not have to pay if Clinton
breaches b/c:
◦ 1st, the obligation of the buyer, Dr, to pay the
K price, and the obligation of the seller,
Clinton, to tender delivery are dependent – in
K parlance, called “constructive conditions of
exchange”
◦ 2nd, Clinton’s failure to tender delivery = a
material breach
The Countryman test

Functional

Asks if a bankruptcy reason would be
served by processing the case through the
assume-or-reject construct

E.g.  If estate wants to get asset, and
hasn’t yet itself performed, and the liability
is worth it, then will need to “assume”
Problem 8.1(a)
[Use $5k for Razorback hat instead]
 Facts:

◦ DR already paid Clinton the $5k for Hat
◦ Clinton has not delivered Hat when Dr files
bankruptcy

NOT an executory K – just an asset of
estate
◦ When Dr filed, already had the right to HAT,
that right becomes property of estate (541)
No bankruptcy function

Do not need to assume to get the asset, b/c
already have the right to the Hat, since Dr
paid Clinton already

Rejection would be nonsensical – no reason
for estate to forfeit the right to the asset,
nor to create a “liability” for “breach” when
in reality Dr did not breach
◦ And if did think did not want Hat for some
reason, could just “abandon” under 554
8.1(b)

Now assume that Clinton, and not the Dr,
had performed prior to bankruptcy:
◦ Clinton delivered hat
◦ Dr had not yet paid

NOT an executory K – now is just a
liability
◦ Clinton has a regular old bankruptcy “claim”
Again no bankruptcy function

Here again, no bankruptcy function or
purpose is served by treating as an
executory K and processing through the
assume-reject lens

Estate already has the asset (the Hat), so
does not have to “assume” to get it; if did
assume, would have the absurd result of
elevating Clinton’s claim to admin expense
priority
Problem 8.1(c)

Now BOTH parties have NOT materially
performed at time of Bk
◦ Clinton has not tendered delivery of Hat
◦ Dr has not paid

YES this IS an executory K – still have
both the “asset” and the “liability” in a
tentative state
Bankruptcy function

In 8.1(c), there is a necessary bankruptcy
function to be served from using the
assume-or-reject process

If estate wants the Hat (the asset), only way
it can do so is by “assuming” the K &
correlative liability (obligation to pay $5K)

If estate does not want the hat, will “reject”
the K, leaving Clinton with a “claim” for
breach and the estate hatless
Just do under 541 & CBOT?

Query, though, whether really necessary to
have the whole “executoriness” game &
separate section to deal with the special
type of property that is coupled with a
liability

Why not just treat this as a Chicago Bd of
Trade situation, and recognize that one of the
non-bk attributes of the “property” (viz., the
right to Clinton’s performance) is that it’s
only realizable if pay $5K to Clinton
Problem 8.1(d)

“Option” Ks do not work well under the
Countryman “material breach” test
◦ Assume that Dr has an option to buy the Hat
from Clinton for $5K, exercisable by Nov. 1, &
Dr files bankruptcy Oct. 15

Problem is that a decision not to exercise
the option is not a “breach” at all, much
less a “material” breach
Indeterminate …

Thus, if take “Countryman” test seriously, say ≠
“executory K”

Which would not be a big deal IF just treated the
option as property under 541
◦ And if estate wanted to exercise option, could do so

But what if say fact is ≠ “executory K” means that
estate cannot “assume” the option and thus
estate loses the right to exercise option when to
do so would be beneficial?
◦ That is just stupid and wasteful, for no reason
What decision should trustee make?

1. Assume the K
◦ Estate gets benefit Other Party’s performance,
liable on the K as admin expense

2. Assume, but then Assign, the K
◦ Estate gets profit from valuable K from
assignee, but not itself liable on the K (365(k))

3. Reject the K
◦ Estate not get asset, Other Party has claim

4. wait – do none of the above
The benefit of waiting …

As will discuss later, best play for the estate
during the pendency of the case may be to
wait and do nothing

Can force the Other Party to perform on an
interim basis, with current compensation as
admin priority
◦ But w/o getting stuck for sure with the total
liability on the K

See how market develops, what estate’s
needs are later on
Problem 8.2(a)


Rising market
Again using Clinton hat facts – assume that
while K price was $5K, now the going
market price for that Hat = $6K

Estate would want to assume
◦ is a valuable K – estate only obligated to pay $5k
to get an asset worth $6k
◦ Even if not need the Hat itself to reorganize,
estate can make money if assign the K – by dfn a
buyer would pay $6k to estate, which only has to
pay Clinton $5K – so estate makes $1K profit
Problem 8.2(b)

Opposite scenario – falling market
Now assume market price for the hat has
dropped to $4K from K price of $5K
And unsecured crs will only get 10% in bk

Estate would want to reject


◦ This is not a valuable K – to get the Hat by
performing K have to pay above market
◦ Clinton’s damages claim (= $1K, K-market) does
not offset savings from estate’s rejection “breach,”
since estate only pays him $100 (1/10 of $1K)
“¢ on $” skews efficient breach analysis

Note that outside of bk, a party’s decision
whether or not to breach in concept should
consider notions of “efficient breach” – and
that calculation must compare savings from
breach with cost if breach, including damages
have to pay

But that calculation IN bk is skewed to make
more Ks worthy of breach (and thus
rejection), from estate’s perspective, in
common case where only pay “¢ on the $”
Court approval

Trustee’s “assume or reject” decision is
subject to approval by the bankruptcy court,
365(a)
◦ As is assignment decision, 365(f)
◦ Overrules pre-Code “implied assumption” cases
– where held Tee’s performance indicated had
assumed

Exceptions: TIME limited decisions
◦ In ch 7 (365(d)(1)), or for nonresidential real property
lease (365(d)(4)), rejected automatically if Tee not act
within certain time period (60/120 days)
Timing rules

The parties’ interests conflict:
◦ Estate wants to wait as long as possible to make
final decision whether to assume or reject –
 preserve flexibility –
 not sure early in case whether should take on K
 in interim can make Other Party perform anyway
◦ Other Party wants fast decision
 If estate assumes, then gets defaults cured, has certainty
that all obligations K = admin expense
 Even if estate rejects, can better make alternate plans
Chapter 7

Trustee is only given 60 days to act,
365(d)(1)

If not assume within 60 days,
automatically rejected

If not sure, must get extension from court
within the 60-day period
Reorg cases

Trustee or DIP is presumptively given
until confirmation of the plan to decide,
365(d)(2)

If Other Party doesn’t like it, has to
persuade bk ct to enter an order forcing
an earlier decision by the estate rep
Nonresidential real estate leases

Special time-limited rule for decision as to
nonresidential real estate leases, where Dr
the lessee, 365(d)(4) –> 2005 amended

DIP only given 120 days to decide (if plan
confirmation comes before 120 days, go with
earlier confirmation date)

Extension? ONLY for max of 90 days –
unless non-debtor lessor consents
Impact of lease rule on retail bk

Many experts in bk field believe that the
limited time rule of 365(d)(4), as amended in
2005, has played a very significant role in
making it extremely difficult for large
retailers to reorganize

Don’t have time to work things out with
their lessors – and with absolute drop-dead
time of 210 days, at lessor’s mercy

E.g., Circuit City
rejection

As discussed before, “rejection” is the
trustee’s decision not to take on the K
for the estate, thus giving up the potential
asset and leaving the Other Party with a
claim for breach
standard for rejection

“rejection” grew conceptually out of
trustee’s power to “abandon”
burdensome property

Thus no doubt that a trustee can reject a
K that is burdensome to estate
Standard, cont.

But what if not = “burden,” BUT estate
could still do better by rejecting
◦ Which is very possible b/c of economic reality
that estate often will pay Other Party’s
damages in “¢ on the $” – i.e., in tiny little
“Bankruptcy Dollars” (think Monopoly money, but worse)

Also – any need to balance benefit to
estate from rejecting with HARM to
Other Party?
“Business Judgment” standard

General rule: approve trustee’s decision to
reject (or assume, of course) if satisfies the
business judgment rule
◦ In practice means always approve, unless trustee
made legal error as to what the effect of
rejection would be

Do NOT have to balance harm to other
party
◦ Except in rejecting collective bargaining
agreements
Problem 8.3

Facts:
◦
◦
◦
◦
◦
K: Clinton sell razorback hat to Dr, at $5k
Market price = $4k
Dr has resale K for $5,500
Bk dividend to unsecured crs = 50%
Clinton: if K rejected, may have to file bk
himself
 Ok, that’s unlikely, but often it isn’t – consider, e.g.,
some of the car dealers whose dealership Ks were
rejected by GM or Chrysler
◦ Trustee moves to reject
Other Party’s argument
Not a “burdensome” K to estate if
assumes – will still make a profit of $500,
even at above-market K price of $5k, b/c
have resale K at $5,500
and
 should balance slight benefit to estate
(that could make a slightly larger profit if
reject – see next slide) against enormous
harm to Clinton (have to file bk)

Why estate wants to reject

With K: make profit of $500 (pay Clinton K price
of $5k, sell for $5,500 under resale k)

If reject: make profit of $1,000 (buy on the
market for $4k, resell for $5,500, so + $1,500, but
pay Clinton $500 in damages [50% of his $1k
claim])

Note that only possible b/c “¢ on the $” means
estate does not suffer full cost of breach, but
captures full gain
◦ Outside of bk, not an efficient breach, b/c make net
$500 profit wither way – b/c have to pay Clinton $1k
Estate wins: business judgment rule

In problem 8.3, the estate wins under the
“business judgment” standard

Since by rejecting the estate will make
more money, court will approve trustee’s
decision to reject

Fact of projected calamitous harm to
Other Party (Clinton) is ignored
Effects of rejection

Start with basic premise – the trustee must
decide whether to assume or to reject an
executory K

And so, if is rejecting, means is NOT
ASSUMING

can deduce some effects of rejection from
the principle: “rejection = not assumption”
◦ Like “the opposites” game
Ramification of “not assumption”
 1st:
estate not liable on the K
◦ So in our hypo, bk estate does not have to pay
Clinton $5k
 2nd: estate
not receive benefits of K
◦ So also does not get the razorback hat;
Clinton is excused from performing
Rejection as “breach”

The 2nd fundamental principle that
dictates the effects of rejection is that
rejection is treated as an anticipatory
breach of the K
◦ Chicago Auditorium, 1916
◦ Codified 365(g)

Necessary to determine the specific
rights of the Other Party and the Dr
Ramifications: “rejection = breach”

Two legal effects flow from the principle
that rejection = breach
 1st
-- the Other Party has a claim in the
bankruptcy case
◦ Treated as if prepetition -- 365(g)(1), 502(g)
 2nd
– since has claim, discharge Dr’s
monetary liability under the K
But rejection is not MORE than breach

Many courts have treated rejection as
more than breach
◦ View rejection as = termination, rescission,
quasi-avoiding power

Allow estate to recover property could
not get back just by breaching

And deny Other Party benefit of postbreach equitable relief, such as injunctions
Ortiz

Facts:
◦ ‘Vicious” Victor Ortiz a professional boxer
◦ Ortiz 5-year K with Top Rank (promoter)
 Ortiz agree to fight set # bouts for Top Rank
 Top Rank pay Oritz guaranteed $ each fight
 Exclusivity – Ortiz fight only in TV bouts for Top Rank,
and no other fights w/in 90 days of Top Rank TV bout
◦ Ortiz file ch 7 Jan 2008
◦ Top Rank K “rejected” at day 60 under 365(d)(1)
◦ Ortiz then sought to enter agreement with
“Golden Boy Productions,” competing promoter,
but Top Rank “interfered” by telling GBP that its
exclusivity provision still in effect
Dr’s goal?

What did the Dr (“Vicious” Victor) hope
to accomplish by filing chapter 7 and
rejecting the K with Top Rank?
Rejection nix exclusivity?

Ortiz hoped that by rejecting the
promotional agreement with Top Rank, he
then could enter into a new promotional
agreement with Golden Boy, freed from
the constraints of the exclusivity
provision in the Top Rank K
Other Party?

Why did Top Rank object?

Top Rank argue that under governing state
law (Nevada), if Ortiz breached, Top Rank
would still be able to enforce the exclusivity
agreement against Ortiz, and Golden Boy, by
injunction

Thus, if Golden Boy wanted to sign Ortiz,
GB would have to pay Top Rank for the
privilege – in effect buy out its exclusivity
Bankruptcy court?


Held for Ortiz
Said effects of rejection were:
◦ Dr Ortiz no remaining obligations under K
◦ Top Rank limited to filing claim for money
damages against the estate
◦ Ortiz free to enter promotional K with anyone
(including Golden Boy) free of the Top Rank
exclusivity restrictions

Rationale:
◦ in effect, rejection as “breach” terminates K
◦ Under 365(g)(1), Top Rank ONLY has $ claim for
damages – no remaining equitable rights
Outside of bankruptcy?

Assume Ortiz never filed bankruptcy.
Instead, he just told Top Rank, in effect:
“get lost. I’m walking away from my
agreement with you, and signing with
Golden Boy. It’s been real. By the way, you
can watch me next Saturday on the HBO
fight of the week.”

Could Top Rank stop him?
Depends …

Maybe. Possible that Top Rank could get a negative
injunction to block Ortiz from violating the
exclusivity provision

Under state law will depend on:
◦ Reasonableness of exclusivity restriction
◦ Whether money damages are adequate
 Often look at special skill, uniqueness of person
 Speculative nature of consequential damages

Is IRRELEVANT to this inquiry that Ortiz breached -that is, he can’t be freed from an otherwise
enforceable equitable remedy for Top Rank just by
saying, “I breach”
Bankruptcy outcome the same
The District Court in Ortiz gets it right
 The correct analysis is:

◦ 1st – under 365(g)(1) and 502(g), the
rejection of the K gives rise to a “breach” of
the K, and that breach is deemed to occur
prepetition
 But that is ALL that those sections do for you!
 Don’t create a damages claim that would not exist
otherwise – just say = “breach”
 Nor do they say ONLY a damages claim
Analysis, cont.
◦ 2nd, under Nevada state law, does Top Rank
even have a right to enforce the exclusivity
provision via negative injunction, in the event
of a breach?
 ask, is it a “reasonable” restraint
 Are money damages adequate?
 District Ct remanded – Top Rank had not had
sufficient notice that issue would be litigated
Analysis, cont.
◦ 3rd, even if Top Rank would have an injunctive
right under Nevada law, is that equitable
remedy = “claim” under 101(5)(B)?
 Which depends on whether gives rise to a “right to
payment”
 In similar cases, involving personal service Ks,
courts have asked whether money damages are “a
viable alternative” or “adequate substitute”
Kurupt, the Dogg Pound, & Death Row
Example of this analysis
 Brown case cited in Ortiz
 K between rapper Ricardo Brown Jr.
better known as “Kurupt” (member of
the Dogg Pound) and Death Row Records


concluded under Calif law, Death Row did not
even have right to equit. remedy (step 2) b/c
Brown was not a “celebrity” when K formed
Equitable remedy as “claim”

under interaction of state law re granting
negative injunctions and “claim” definition
of Bankruptcy Code, typically would be
the case that when state law would grant
the injunction, it then would ≠ “claim” in
bankruptcy – b/c to get the state law
injunction, necessary to show that in fact
cannot adequately compensate in $
damages
Possible “fresh start” caveat

Having said that, though, is possible that a
bankruptcy court will try, if possible, to
find a compensable damages remedy in
lieu of the equitable remedy – and thus =
“claim” – if implicates the “fresh start”
policy
If “claim” then might discharge

Final step – if Top Rank’s remedy for
breach of the exclusivity provision does
give rise to a “right to payment” and is
thus a “claim” under 101(5)(B), then that
claim is subject to discharge

But the fact that the claim is discharged
arises b/c of the “claim” analysis, not b/c
of anything that is special about executory
Ks or any magical powers in 365(g)
What if Ortiz wanted to perform?
In case, Ortiz wanted to get out of
agreement with Top Rank
 What if, however, he filed chapter 7, and
wanted to keep the K?

Estate cannot assume
 1st, as
will discuss later, under
“assumption,” a personal service k such as
the one between Ortiz and Top Rank is
the sort of nondelegable K that the estate
cannot assume, under 365(c)(1)(A)
◦ Obviously the bankruptcy trustee can’t fight
for Top Rank!
◦ Nor can trustee sell that right to another
boxer
Post-petition wage exclusion

Furthermore, even if somehow the estate
could assume the K, in a chapter 7 the Dr
(Ortiz) would be entitled to the
postpetition payments attributable to his
postpetition labor
◦ The 2nd clause of 541(a)(6)
Estate has to reject in ch 7

Ortiz’s bankruptcy estate thus must reject
the K in a chapter 7 case
Rights Ortiz vs Top Rank?
That the estate rejects the K between Ortiz
and Top Rank does not necessarily tell us
what happens post-rejection to the K, as
between those two parties
 365(g)(1) tells us is a “breach”
 But we then ask – under state law,
what consequences? If Ortiz is ready,
willing & able to keep getting battered for
Top Rank, would Top Rank have any right to
terminate the K, even if technical “breach”?

today
Fyi – “Vicious” Victor Ortiz is fighting for
Golden Boy Promotions
http://www.goldenboypromotions.com/fig
hters/ortiz.php
 Which means what? – that Top Rank and
Golden Boy reached a settlement over
the rights to Ortiz
