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Dysfunctional Analysis Part 2

posted by Jay Lawrence Westbrook

Shutterstock_112522430Per Part 1 of this post, the word “executory” under section 365 of the Bankruptcy Code should be defined by its original, common law meaning per Williston: a contract in which some obligations remain. That common law definition was the one on the table when Congress originally adopted this ancient provision and there is no longer any justification for imposing the labyrinthine elements of executoriness on top of it. These additional executoriness requirements were developed by the courts in the olden days when court approval of AorR was not required and executoriness was a way to protect estates from trustee foolishness or carelessness. (See my old article for details at A Functional Analysis of Executory Contracts, 74 Minn. L. Rev. 227 (1989).)  During that time, the Countryman test did a brilliant job in greatly improving the policing of those failures. However, the Countryman test is not needed for that purpose now that court approval is required for AorR. It also does not solve the underlying problem, which is manipulation of the label “executory” in lieu of applying the statute as written to cover modern problems like options and licenses. The result is confusion and unpredictable injustice to estate and counterparty alike.

Under the form of Functional Analysis that I have suggested, the basic approach to AorR is taken from the words of the statute and is simplicity itself:

        Under state contract law, is this a contract in which some obligations remain to be performed (see the legislative history of the Code) and therefore is executory under the common law definition of the word?

        If so, the contract may be AorR; if not, section 365 does not apply but it may be treated under any other relevant provision of the Code (e.g., the avoiding powers).    

        If the contract may be AorR, will the net benefit to the estate from performance (assumption) exceed the net benefit from the estate’s breach of the contract (rejection)? The court should approve the course of action producing net benefit subject to the rules protecting counterparties (e.g., cure of defaults, section 365(b) (1)).

 We’re through. Let’s have lunch.

 There are some wrinkles and twists in certain cases. For example, if state law will permit the counterparty to get specific performance, one of two questions is usually raised:

  • Did the contract in effect transfer to the counterparty a property right which must be recognized in bankruptcy, unless the property right is subject to the avoiding powers?
  • Does state law give the other party the sort of equitable rights that cannot be satisfied by payment and therefore do not fit the definition of “claim,” and must be enforced (e.g., possible nondischarge of a covenant against competition)?

The discharge issue also illustrates the role of federal bankruptcy policy, which may or may not trump state rules in service of the overriding federal policy of discharge and the fresh start. Similar questions may arise as to other strong bankruptcy policies.

 Note I have not addressed the problems created under the anti-assumption provision of §365(c)(1).  That's a different issue, more a matter of policy than conundrum.


Graph image from Shutterstock


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