Executory Contracts in Bankruptcy: Assume, Reject, or Assign

When a company or person files for bankruptcy, any contract where both sides still owe each other meaningful performance falls under a special rule. These are called executory contracts in bankruptcy, and 11 U.S.C. § 365 lets the debtor or trustee pick what happens to each one: keep it (assume), walk away (reject), or transfer it to someone else (assign). That choice shapes what the other party recovers, what the estate keeps, and how quickly everything has to be decided.

What Counts as an Executory Contract

The Bankruptcy Code doesn’t define the term. Courts have filled the gap, and most use the Countryman test: a contract is executory if both sides have enough left to do that either one walking away would be a material breach. A lease with rent still owed and space still being provided fits. So does a service agreement with ongoing work and ongoing payments, or a software license with continuing obligations on both sides.

If one side has already finished its part, the contract isn’t executory anymore. It becomes an ordinary asset or claim in the estate rather than something the debtor can assume, reject, or assign under § 365. A product that’s been fully paid for but not yet delivered, for example, would typically be handled as a claim.

Some circuits apply a more flexible approach, especially with multi-party contracts, looking at the practical effect on the estate rather than mechanically checking whether both sides still owe performance. For most straightforward two-party agreements the result is the same either way.

The Three Choices Under Section 365

For each executory contract, the debtor or trustee picks one of three paths. Assumption keeps the contract alive and commits the estate to perform going forward. Rejection walks away from it. Assignment transfers the contract to a third party, usually for cash that flows to the estate.

The choice is meant to be strategic. A below-market lease in a strong location is worth assuming. A service contract that costs more than it delivers is a candidate for rejection. A valuable franchise or license the debtor can no longer run may be worth assigning to a buyer. Each decision requires court approval, and the debtor has to show the choice serves the estate.

While the debtor is deciding, the counterparty sits in limbo. If it keeps providing goods or services to the estate after the filing date, it may be entitled to administrative expense priority for that post-petition performance, which is paid ahead of most other creditors.¹

What Assumption Requires

Assumption isn’t automatic. If the debtor is behind on the contract, § 365(b)(1) requires three things before the court will approve it. The debtor has to cure existing defaults or give adequate assurance that cure will happen promptly. It has to compensate the other party for actual financial losses caused by those defaults. And it has to provide adequate assurance of future performance.²

Cure means paying every dollar of missed payments, late fees, and accrued interest. Non-monetary defaults count too. Damage to leased property or a lapsed insurance requirement has to be addressed before assumption goes through.

Adequate assurance of future performance is where many assumption motions fall apart. Courts want hard evidence: financial projections, bank statements, new revenue streams, or documentation of secured funding. Vague promises don’t satisfy it. If the evidence falls short, the court denies the motion and the contract is typically rejected instead.

Ipso Facto Clauses Are Unenforceable

Many contracts contain clauses that automatically trigger a default or termination the moment one party files bankruptcy. These are ipso facto clauses, and § 365(b)(2) renders them unenforceable. The debtor doesn’t have to cure a default that exists only because of the bankruptcy filing itself, the debtor’s financial condition, or the appointment of a trustee.² The other side can’t point to the filing itself as grounds to end the contract if the debtor wants to keep it.

What Rejection Costs the Other Party

Rejection doesn’t erase the contract. Under § 365(g), the law treats it as a breach that occurred immediately before the bankruptcy petition was filed. That timing fiction converts the other party’s claim into a pre-petition obligation.²

The result is harsh for the non-debtor. Rejection damages are general unsecured claims, near the bottom of the payment hierarchy. The counterparty files a proof of claim for what the broken contract cost it, then competes with every other unsecured creditor for whatever remains after secured and priority claims are paid. Recovery is often a small fraction of the amount owed.

The Cap on Landlord Damages

Landlords face an added restriction. Under 11 U.S.C. § 502(b)(6), a landlord’s claim for damages from a rejected lease is capped at the greater of one year’s rent or 15 percent of the remaining lease term’s rent (but no more than three years’ rent), plus any unpaid rent that had already accrued before the filing or the date the landlord retook the property.³

Take a landlord with 10 years left on a $10,000-per-month lease. Fifteen percent of the remaining term is 18 months. Because that’s more than one year and less than three years, the cap is 18 months of rent, or $180,000, plus any back rent owed at filing. Theoretical lost rent of $1.2 million shrinks to a $180,000 unsecured claim, and even that may not be paid in full.

When a Contract Can Be Assigned

Assignment lets the debtor transfer a contract to a new party, often generating cash for the estate. Section 365(f) overrides most anti-assignment clauses. Even where the contract says it can’t be transferred without consent, the debtor can generally assign it after assuming it, as long as the assignee provides adequate assurance of future performance.²

Section 365(c) sets hard exceptions. Some contracts can’t be assumed or assigned at all:

Personal service and identity-dependent contracts, where non-bankruptcy law would let the other party refuse performance from anyone other than the original debtor. This typically covers personal service agreements, government contracts, and similar arrangements where the identity of the performer matters.
Contracts to make loans or extend credit to the debtor. A lender can’t be forced to keep lending after its borrower enters bankruptcy.
Nonresidential real property leases that were already properly terminated under state law before the filing. Once gone, they can’t be revived through assumption.²

Federal courts are split on how strictly the personal service exception applies. Some circuits use a hypothetical test, blocking assumption whenever applicable law would theoretically bar assignment to anyone, even if the debtor isn’t trying to assign. Others use an actual test, blocking assumption only when the debtor is actually trying to hand the contract to a new party. The circuit in which the case is filed can determine whether a debtor keeps a critical license.

Shopping Center Leases Get Extra Scrutiny

Section 365(b)(3) imposes heightened requirements when a debtor tries to assume or assign a lease in a shopping center. The assignee’s financial condition and operating history must be comparable to the debtor’s at the time the lease was originally signed. Any percentage rent the landlord receives can’t drop substantially. The assignment has to comply with existing lease provisions on permitted use, exclusivity, and radius restrictions. And the new tenant can’t disrupt the center’s tenant mix.²

Shopping centers depend on a curated blend of tenants, which is why these rules exist. Replacing a clothing retailer with a discount liquidation outlet might technically fit a general retail use clause but could drive off neighboring tenants. At the same time, courts won’t let landlords weaponize overly narrow use clauses as a backdoor anti-assignment tool. A restriction so tight that no realistic buyer could satisfy it may be unenforceable.

If You’re the Tenant or Licensee Facing Rejection

Rejection doesn’t always leave the non-debtor empty-handed. Two groups get specific protection in the Code.

Tenants When the Landlord Files

If you lease real property from a debtor and the trustee rejects your lease, § 365(h) gives you a choice. You can treat the lease as terminated and leave, or you can stay. If you stay, you keep your rights under the lease for the full remaining term, including any renewal options enforceable under state law. You keep paying rent, but you can offset against rent the value of any services or obligations the landlord stops providing after rejection.²

Many tenants don’t know this. A notice from the trustee that your lease has been rejected does not mean you have to leave. You have the right to stay and keep operating for the rest of your lease term. The tradeoff is that you can’t pursue additional claims against the estate for the landlord’s post-rejection failures beyond the rent offset.

Intellectual Property Licensees

Section 365(n) offers a similar option for IP licensees. If you license patents, copyrights, trade secrets, or other IP from a debtor and the trustee rejects the license, you can elect to keep your rights for the remaining license term. You continue paying royalties and give up certain setoff rights and administrative expense claims. But you don’t lose the IP your business depends on just because the licensor filed.²

The election doesn’t depend on the trustee’s cooperation. If you make it in writing, the trustee has to provide the IP or embodiments of it that your contract entitles you to and can’t interfere with your use.

Deadlines That Force the Decision

Time limits vary by chapter and contract type.

In a Chapter 7 liquidation, the trustee has 60 days from the order for relief to assume or reject each executory contract. Do nothing, and the contract is deemed rejected. The court can extend for cause, but only if the trustee asks within the original 60-day window.²

In Chapter 11 and Chapter 13 reorganizations, the debtor generally has until confirmation of the plan to decide on most executory contracts. Any party to a contract can ask the court to force an earlier decision, so the counterparty isn’t stuck in limbo indefinitely.²

Commercial real property leases have a tighter deadline of their own. Section 365(d)(4) requires the debtor to assume or reject a nonresidential lease within 120 days of the order for relief, or by the plan confirmation date, whichever comes first. If neither happens, the lease is deemed rejected and the debtor must immediately surrender the property. The court can extend by up to 90 days for cause, and any further extension requires the landlord’s written consent.²

The 120-day rule is one of the most consequential deadlines in business bankruptcy. In a retail or restaurant reorganization, missing it means losing the location, and losing the location can mean losing the business.

1
Office of the Law Revision Counsel. 11 USC 503 – Allowance of Administrative Expenses
2
Office of the Law Revision Counsel. 11 USC 365 – Executory Contracts and Unexpired Leases
3
Office of the Law Revision Counsel. 11 USC 502 – Allowance of Claims or Interests