By Jay Lawrence Westbrook and Kelsi Marie Stayart, University of Texas at Austin School of Law
A traditional case law test has limited the application of bankruptcy contract rules to contracts that have a certain nearly mystical quality of “executoriness.” Contracts that fail the “Countryman” test are deemed not subject to those value-maximizing rules. Courts treat these contracts in a variety of ways, but often these contracts are removed entirely from the bankruptcy estate, destroying value and crippling reorganization efforts. These effects are especially serious with regard to less-traditional types of contracts, including IP licenses, options, and LLC operating agreements. The application of the test undercuts almost every policy underlying the Bankruptcy Code, including the fresh start and equal treatment of creditors. The test also gives judges an unpredictable and nearly unlimited discretion in resolving contracts often worth huge amounts of money.
Section 365 of the Bankruptcy Code allows a trustee or debtor-in-possession to assume or reject “executory contracts.” Assumption permits the estate to take on profitable contracts and make the contract counterparty perform, while elevating the counterparty to an administrative claimant. Rejection permits the bankruptcy estate to escape unprofitable or ill-advised contracts, leaving the contract counterparty with a damage claim payable in small Bankruptcy Dollars. The effect is to spread losses among all unsecured creditors while minimizing the overall loss. The existing approach prevents the achievement of these important results.
We propose an abolition of the requirement of “executoriness,” thus subjecting virtually all contracts to Section 365. In its place, we offer a simple approach to analyzing contracts in bankruptcy that aligns with and advances the fundamental principles of bankruptcy reorganization.
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