What Is An Executory Contract: Everything You Need to Know

An executory contract holds people to duties they've been assigned to a specific date laid out in the contract. It goes into effect when someone files for bankruptcy and stipulates that the two people that signed still have an obligation to meet. If the obligations are not met, it's a breach of contract. These types of contract are usually between a borrower, debtor, and another party.

Types of Executory Contracts

• Most licenses dealing with intellectual property, supply agreements that are long-term, and franchise agreements are executory contracts.
• A completed assignment or sale, an agreement that's completely terminated, an expired agreement, or anything of the like that's done prior to bankruptcy is usually not considered to be an executory contract.
• Licenses that are perpetual and exclusive are sometimes an executory contract, but you can make a case that they're a completed assignment for territory or rights. You have to examine other materials to determine whether the ongoing agreement fits the bill.
• Real estate leases are executory contracts, as tenants have to pay rent and, in exchange, the landlord provides them with a place to live.
• Equipment leases are executory contracts. Someone provides equipment and someone pays rent for that equipment.
• Development contracts where development work is requested and payment is given upon the completion of milestones are also executory contracts.
• Leases on vehicles and furniture that is rent-to-own are both kinds of executory contracts.
• Timeshare contracts and utility contracts, including internet and telephone service, are both executory contracts.
• Employment contracts and service and supply contracts are also executory contracts.

How Executory Contracts Work

When you enter into an agreement like a lease, you're paying for the right to use an item or property for an agreed-upon amount of time. It's a cheaper alternative to buying the property. While the lease is in effect, it's considered an executory contract.

The debtor, otherwise known as a bankruptcy trustee, in the agreement is the person who decides whether they “assume” (agree) or “reject” (refuse) to fulfill the obligations set out in an executory contract. The non-debtor party of the contract has to continue on as though bankruptcy has not been filed. If the debtor assumes the contract, then they have to pay their payments and other defaults in full and show that they can pay in the future.

If they choose, the debtor can assume the contract but assign it to someone else. That someone else is typically a buyer of the debtor's assets. If the debtor chooses to do this, they have to pay any defaults. The buyer then has to prove that they can perform the obligations of the contract in the future.

With the exception of leases for commercial real estate, you have 60 days from the filing of bankruptcy to reject or assume an executory contract. The only way to change the deadline is to go to the bankruptcy court. The rules of bankruptcy that govern executory contracts are pretty complex. If you're unsure whether your agreement is an executory contract, consult a bankruptcy attorney when the debtor files bankruptcy.

Issues You Can Face with an Executory Contract

Businesses that have an ongoing agreement with a debtor could deal with issues pertaining to prepetition executory contracts with the debtor. The Bankruptcy Code authorizes debtors to assume or reject contracts for bankruptcy, meaning they have the ability to retain contracts that are beneficial and abandon contracts that are burdensome.

The majority of courts will define an executory contract as an agreement where both parties need to complete unperformed obligations. If either party fails to meet these obligations, then it would constitute a material breach, which excuses the performance of the other.

Before anyone signs an executory contract, they need to read and thoroughly understand all terms and obligations contained in the contract. The terms and other legal jargon in such a contract can be confusing. You should talk to an experienced attorney in cases where you're having trouble understanding the intent of the contract. You don't want to enter into a contract that you don't understand or are unwilling to fulfill.

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