An executory contract is a contract that has not yet been fully performed or fully executed.Mission Product Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652 (2019). It is a contract in which both sides still have important performance remaining. However, an obligation to pay money, even if such obligation is material, does not usually make a contract executory. An obligation is material if a breach of contract would result from the failure to satisfy the obligation. A contract that has been fully performed by one party but not by the other party is not an executory contract.See, generally, Countryman, Vern, "Executory Contracts in Bankruptcy: Part I" (1973). Minnesota Law Review. 2459. https://scholarship.law.umn.edu/mlr/2459 and "Executory Contracts in Bankruptcy: Part II" (1974). Minnesota Law Review. 2460.https://scholarship.law.umn.edu/mlr/2460.
Installment contracts Many installment contracts are commonly executory such as installment credit loans, period loan payments, mortgages, paychecks, and contracts for the delivery of goods or the performance of services over a period of time in discrete elements.
Missed deliveries under an installment have on occasion given rise to the legal question of whether they are indicative of a breach of contract, allowing the other party to terminate the contract, or whether the contract should continue. In the case of Maple Flock Co Ltd v Universal Furniture Products (Wembley) Ltd., decided in 1934,Maple Flock Co Ltd v Universal Furniture Products (Wembley) Ltd., 1 KB 148, 1934 Hewart LCJ used reasoning drawn from an earlier case, Freeth v Burr,L.R., 9 C.P. 208, 1874 and approved in Mersey Steel and Iron Company v. Naylor, Benzon and Co.:Mersey Steel and Iron Co v Naylor, Benzon and Co: HL, 9 A.C. 434, 1884, accessed 18 January 2021 “That the true question is whether the acts and conduct of the party evince an intention no longer to be bound by the contract". In applying this reasoning to a situation of a missed delivery, the court concluded that the main issues were (i) the ratio quantitively between the breach and the contract as a whole, and (ii) the degree of probability or improbability, that the omission might be repeated.Maple Flock Co v Universal Furniture Products (Wembley) Ltd: CA 1934, accessed 18 January 2021 In this case, the 16th delivery of flock out of 67 deliveries planned for the contract was defective: the ratio was low and the existence of a good quality control system confirmed that the defective provision was unlikely to be repeated.Termination for breach, page 8, accessed 18 January 2021Settlement Agreement Lawyers
In US bankruptcy law A common area where executory contracts are found is US bankruptcy law, where obligations exist for both parties to a contract at the time of a bankruptcy petition. In cases such as this, both the debtor, or the side that is filing for bankruptcy, and counterparty, or the side contracting with the debtor, may have to make further performance. At the start of a chapter 7, 12, 13, and sometimes 11 bankruptcy proceedings, a trustee (also known as a debtor in possession) is appointed to oversee the case. The trustee has the power to assume, reject, or assign an executory contract.
Assumption If the trustee chooses to assume an executory contract, the obligations of both the debtor and the counterparts are preserved by the bankruptcy process. A bankruptcy court must approve a debtor's decision to assume or reject an executory contract. However, because the Bankruptcy Code does not outline an official standard for determining a motion to assume or reject an executory contract, many courts will employ a business judgment test, which hinges on whether a debtor can show that its decision is an exercise of its sound business judgment and that the assumption of the contract or lease will benefit the debtor's estate. See In re MF Global Holdings Ltd., 466 B.R. 239, 242 (Bankr. S.D.N.Y. 2012)."Assumption, Assignment, and Rejection of Executory Contracts," (Practice Note, U.S. Federal) plus.lexis.com. Accessed 31 March 2024. If the debtor has already defaulted on the executory contract before filing for bankruptcy, it will be required to provide adequate assurance that it can perform the contract. The following factors are often used in the business judgment test.
Whether the debtor's financial data indicates its ability to generate an income stream sufficient to meet its obligations
The general economic outlook in the debtor's industry The presence of a guarantee The debtor's payment history Presence of a security deposit Evidence of profitability Plan that would earmark money exclusively for the landlord or non-debtor party Whether an unexpired lease is at, or below, the prevailing rate
Rejection If the trustee rejects the executory contract, there is a breach of contract as of the date of the petition, and the debtor is relieved from future performance. As a result of a rejection, the counterparty's claim on damages becomes classified as a general unsecured claim that arose before the bankruptcy filing. If a debtor wants to reject a contract, it must reject the contract in toto and cannot cherry pick a few provisions to reject.
Assignment If a debtor assumes an executory contract, such contract or lease may be subsequently assigned, subject to certain limitations. Prior to assignment, the debtor must provide adequate assurance of future performance by the proposed assignee to the non-debtor contract party regardless of whether the debtor is in default under such contract or lease. Usually, the debtor does not need to give adequate assurance for every term of an executory contract but rather those that are materially and economically significant. Fleming, 499 F.3d at 305. However, if the trustee decides to assign the executory contract, all of the assets of a debtor will go to a trust for liquidation and distribution to the creditors. Any assets that remain after the distribution will go back to the debtor.
Chapter 7 - Liquidation In a chapter 7 liquidation proceeding, a trustee must assume or reject executory contracts that involve an ordinary business purchase or sale of a security within 30 days of the date of order for relief. If the trustee does not take action within those 30 days, the contract is by default rejected.11 USCS § 744
Debtor strategies for drafting executory contracts Non-debtors are more likely to receive their consideration if they are able to terminate their executory contracts with a debtor before the debtor files for bankruptcy. This is because after the filing, the debtor has the option of rejecting or assuming the agreement and is not required to exercise this option before confirmation of a plan of reorganization. To protect their side of the contract, the non-debtor can consider adding protections to the language such as financial reporting requirements, financial covenants, and automatic termination provisions.
Counsel might also consider including a termination for convenience provision. Termination for convenience, otherwise known as at-will, provides a party with the right to terminate an agreement for any or no reason. In order to allow a non-terminating party to make alternative business plans and prepare to wind down its operations with the terminating party, most termination-at-will provisions require the terminating party to provide the other party with a certain number of days' advance written notice of its intention. However, as long as the terms comply with applicable non-bankruptcy law (such as the Uniform Commercial Code, if applicable), the parties are generally free to negotiate a short notice period, or the removal of any notice. When dealing with a distressed company, counsel for the non-debtor should balance the objective of a limited or no notice period for termination for convenience against other business objectives and needs."Drafting Strategies for Non-debtor Parties to Executory Contracts," (Practice Note, U.S. Federal) plus.lexis.com. Accessed 31 March 2024.
Intellectual property license executory contracts There are three types of intellectual property licenses: patents, copyrights, and trademarks. Contracts involving IP licenses in exchange for royalties are generally classified as executory contracts in the bankruptcy context, as the two parties owe each other continuing material obligations. The court will look at two factors in determining whether a license agreement is executory:
whether performance remains due on the part of both the licensee and the licensor such that the failure to perform by either party would constitute a material breach, and whether those remaining obligations are sufficient to show that the license is in fact an executory contract.INTELLECTUALLY BANKRUPT?: THE COMPREHENSIVE GUIDE TO NAVIGATING IP ISSUES IN CHAPTER 11, 21 Am. Bankr. Inst. L. Rev. 1, 31 March 2024
Patent licenses Patent licenses are typically executory in nature because both the licensees and the licensors generally have ongoing obligations. The licensee is continuously obligated to pay royalties to the licensor for the term of the license agreement, thereby making the agreement executory on the licensee's side. On the other side, the licensor is obligated to defend claims of infringement, provide a non-exclusive licensee with notice of patent infringement suits, refraining from licensing the intellectual property to other parties at a lower royalty rate, and indemnify the licensee for losses.
Copyright licenses Copyright licenses differ slightly from patent licenses. A copyright licensee will almost always retain the ongoing obligation to publish, distribute, account for and pay royalties for such distribution. However, a copyright licensor, unlike a patent licensor, will often lack ongoing obligations under the license beyond the implied or explicit covenant not to sue the licensee.
Under an exclusive license, the licensee receives an interest in the underlying copyright and the licensor will often lack ongoing obligations. Thus, exclusive licenses are not likely to be classified as executory contracts. Nonetheless, these licenses can still be considered executory if a copyright license was issued at a time when the work was expected to be revised or adapted. In this case, a licensor may also have ongoing marketing or software updating obligations, making the license executory.
Whether a copyright license is exclusive or non-exclusive may also impact its classification as en executory contract. Under exclusive licenses, the licensor usually does not have continuing obligations because the licensee gained an interest in the underlying copyright. Since non-exclusive licensees do not receive any ownership interest, almost all such licenses are considered executory contracts.
Trademark licenses In trademark licenses, both parties to the license agreement have ongoing obligations, making them typically seen as executory contracts. The licensor has the duty to ensure the quality of the trademark, check for infringement on behalf of licensees, enforce the trademark for the benefit of the licensee, and indemnify the licensee for any damages, expenses, and attorneys' fees.
Intellectual property in bankruptcy