Assigning An Executory Contract In A Chapter 11 Business Bankruptcy

There are times in a Chapter 11 case when the debtor wishes to assign a contract or lease to a third party.  The debtor, for example, may not be able to continue performing on the contract but may want to continue to see the contract or lease honored.  The first step in this process is for the debtor to assume the contract in accordance with Chapter 11 procedure.

Once this has been done, the debtor would need to provide some assurance of future performance of the contract by the person to whom the contract has been assigned.  This may be done by providing financial information about the assignee that demonstrates the ability to perform the contract, or, in the case of a default, the ability to compensate the other party to the contract in some meaningful way.

Under Section 365 of the Bankruptcy Code, however, certain contracts and leases cannot be assigned:  (1) contracts which by law prohibit assignment, and specify that a particular party only may perform the contract; (2) contracts that require the other party to lend money or credit to the the debtor, or issue securities to the debtor; and (3) non-residential real estate leases that have been terminated or have expired before the commencement of the case.

Keep in mind that just because a contract or lease has some provision written into it that appears to restrict or prohibit assignment, it doesn’t mean that such a clause would be binding on a bankruptcy court.  Contracts very often are full of terms and clauses that sound intimidating or appear to prohibit certain things.  And very often, these clauses are completely superseded by a bankruptcy filing.  Sometimes contracts can even have clauses in them that say one party can “terminate’ the contract in the event of an assignment.  Whether a bankruptcy court will uphold these clauses is an entirely different matter.  Remember, bankruptcy law can actually operate to rewrite the relationship between the debtor and other parties.  What matters is not what a creditor thinks, but what a bankruptcy court thinks.

Once a contract or lease has been assigned to a third party, the debtor and the estate are relieved from liability for any breach of the contract after an assignment.  It is a way of “shedding” the debtor’s obligation for a contract or lease that the debtor wishes to turn over to another party.  Once again, with the ability of a debtor to transfer or assign an executory contract or lease as part of a Chapter 11 reorganization, we see the tremendous power of the Chapter 11 process in enabling individuals and businesses to reorganize themselves back to profitability.

Read More:  Business Bankruptcy And Chapter 11:  Explaining The General Principles To Clients