Executory Contracts in Chapter 7
An unexpired lease or executory contract gets special treatment in bankruptcy. You’ll likely get the option of “assuming” or rejecting it.
In our last blog post a couple days ago we introduced executory contracts and unexpired leases.
“Executory” means that neither party to the contract has fully performed, or executed, its commitments under the contract. It’s executory in that both parties have “something to be done or to happen before being fulfilled.”
An unexpired lease is an executory contract because both the lessor and the lessee must continue to perform. The lessor continues to provide the property being leased to the lessee, for which the lessee continues to make payments.
An Executory Contract/Unexpired Lease Is a Liability But May Have Net Financial Value
At the moment you file your bankruptcy case your contract/lease is both a liability and an asset.
It’s a liability because you are obligated to make payments into the future. You may even be behind on some payments at the time of filing.
But the contract/lease is an asset as well. Your lessor is providing something of value into the future, such as your occupancy of an apartment.
Whether the contract/lease has any NET value depends on its terms. If the terms are very favorable, if you’re paying much less for what you’re getting than is generally available, then under some circumstances your contract/lease could be sold because those great terms would be valuable to someone else.
For example, if you had 3 years left on an apartment lease costing $300 less per month than the current market rate, you could assign that lease to somebody else and get paid for it (assuming the lease was assignable).
But most contracts/leases have no net value simply because their terms likely just reflect market forces. You usually aren’t lucky enough to get into a contract/lease for significantly less than everybody else.
Now let’s see why all this can matter when you file a Chapter 7 “straight bankruptcy” case.
Chapter 7 Trustee’s Right to Assume or Reject a Contract/Lease
At the time you file your Chapter 7 case everything you own temporarily goes into your “bankruptcy estate.” Section 541(a) of the Bankruptcy Code. Practically speaking, most of the time you don’t lose possession or use of anything. And you get everything “back” when your case closes 3-4 months later. That’s because everything you own is usually “exempt,” or protected, from your creditors. If so then everything is also protected from the Chapter 7 trustee acting on your creditors’ behalf.
That “everything you own” that is part of your “bankruptcy estate” includes your executory contracts and unexpired leases. Again, those contracts/leases seldom have any net value. If yours does not, your trustee will have no ability to “assume” it on behalf of the “estate.”
Your Option to Assume or Reject
If your Chapter 7 trustee does not assume a contract/lease within 60 days of case filing, it’s considered rejected. Then, at least with personal property like a vehicle or furniture, you have the option of assuming the contract/lease yourself. You give written notice to the creditor/lessor as part of the bankruptcy paperwork. Then the creditor/lessor has the choice whether to agree or not to you assuming the contract/lease. Usually the creditor/lessor will be happy to continue making a profit on the contract/lease and so will agree.
If you don’t want to continue being bound by the contract/lease, you can reject it. That terminates the contract/lease, and your bankruptcy usually discharges (writes off) the debt.
Any executory contract or unexpired lease you have becomes property of your “bankruptcy estate” when you file a Chapter 7 case. The bankruptcy trustee then has the option of assuming or rejecting it. These contracts/leases seldom have any net value so almost always the trustee rejects it. This gives you the right to assume or reject it yourself. If you assume it, you get all its benefits and liabilities. If you reject it, you give up the contract/lease but usually do not owe anything on it any longer.