Bankruptcy’s Effect on Contracts

When a debtor, which is either the person or the entity that has filed for bankruptcy protection, has exchanged promises with another prior to filing a bankruptcy petition, and the duties associated with these promises extend beyond the date that the bankruptcy was commenced, the subject of these promises may be either an executory contract or unexpired lease. While leases are usually easier to identify, what constitutes an executory contract has been the subject of much litigation. The Bankruptcy Code does not define the term “executory contract,” however, probably the most widely-accepted definition is the following which was provided by Vern Countryman: “a contract under which the obligation of both the [debtor] and the other party to the contract are so far underperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other.”² As will be illustrated below, an executory contract is both an asset and liability. Suppose that ABC Company paid a feed supplier $230 which promises to give ABC Company a ton of feed corn in one week. ABC Company files a bankruptcy petition under chapter 7 of the Bankruptcy Code. ABC Company’s $230 is gone, however, the trustee has the right to collect one ton of feed corn which is an asset of the bankruptcy estate. This is not an executory contract. By providing payment, ABC Company had completed its obligation, and the only remaining obligation was that of the supplier to provide the feed corn.