Fifth Circuit Embraces Flexible Approach To Countryman Test Of Executoriness In Bankruptcies Involving Multiparty Contracts

• Published date: 08 December 2022
• Subject Matter: Corporate/Commercial Law, Insolvency/Bankruptcy/Re-structuring, Insolvency/Bankruptcy, Contracts and Commercial Law
• Law Firm: Jones Day
• Author: Mr Dan Prieto and Mark Douglas

Whether a contract is "executory" such that it can be assumed, rejected, or assigned in bankruptcy is a question infrequently addressed by the circuit courts of appeals. The U.S. Court of Appeals for the Fifth Circuit provided some rare appellate court-level guidance on the question in Matter of Falcon V, L.L.C., 44 F.4th 348 (5th Cir. 2022). The Fifth Circuit affirmed lower-court rulings determining that a surety contract was not executory because the surety had already posted irrevocable surety bonds and did not owe further performance to the debtors.

In so ruling, however, the Fifth Circuit adopted a flexible approach to the "Countryman test" for executoriness in cases involving multiparty contracts. According to the Fifth Circuit, courts "should apply the Countryman test to multiparty contracts in a flexible manner that accounts for the various obligations owed to all of the parties, rather than focusing exclusively on the flow of obligations between the debtor and the creditor."

Assumption and Rejection of Executory Contracts and Unexpired Leases

Section 365(a) of the Bankruptcy Code provides that, with certain exceptions delineated elsewhere in the statute, "the trustee, subject to the court's approval, may assume or reject any executory contract or unexpired lease of the debtor." The trustee's power to assume or reject is also conferred upon a chapter 11 debtor-in-possession ("DIP") under section 1107(a) of the Bankruptcy Code. Rejection results in a court-authorized breach of the contract, with any claim for damages treated as a prepetition claim against the estate on a par with the claims of other general unsecured creditors (unless the debtor has posted security with the non-debtor counterparty). 11 U.S.C. ' 365(g). Assumption of a contract requires, among other things, that the trustee or DIP cure all existing monetary defaults and provide adequate assurance of future performance. 11 U.S.C. ' 365(b).

A bankruptcy court will generally approve assumption or rejection of an executory contract if presented with evidence that either course of action is a good business decision. See Mission Prod. Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652, 1658 (2019) ("The bankruptcy court will generally approve [the] choice [to assume or reject], under the deferential 'business judgment' rule."). Upon assumption, most kinds of executory contracts may also be assigned by the trustee or DIP to third parties under the circumstances specified in sections 365(c) and 365(f). In chapter 11 cases, except with respect to certain kinds of contracts (such as nonresidential real property leases, aircraft lease agreements, and commitments to a federal depository institutions regulatory agency), the trustee or DIP may decide to assume or reject at any time up to confirmation of a chapter 11 plan. However, any nondebtor party to a contract may seek to compel the trustee or DIP to assume or reject the contract prior to confirmation, in which case the bankruptcy court must decide what period of time is reasonable to make the decision. 11 U.S.C. ' 365(d)(2), (d)(4) and (o). Pending the decision to assume or reject, the trustee or DIP is generally obligated to keep current on most obligations that become due under the contract postpetition. 11 U.S.C. ' 365(d)(3) and (d)(5).

Definition of "Executory"

The Bankruptcy Code does not define "executory." Based on the legislative history of section 365, the U.S. Supreme Court concluded in a 1984 decision that "Congress intended the term to mean a contract 'on which performance is due to some extent on both sides.'" NLRB v. Bildisco & Bildisco, 465 U.S. 513, 522 n.6 (1984) (quoting H.R. Rep. No. 95-595, 347 (1977); S. Rep. No. 95-989, 58 (1978)).

However, because nearly all contracts involve some unperformed obligations on both sides as of the bankruptcy petition date, many courts have adopted the more restrictive definition proposed by Professor Vern Countryman, who in 1973 defined an "executory" contract as "[a] contract under which the obligations of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other." See V. Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn. L. Rev. 439, 460 (1973); see also V. Countryman, Executory Contracts in Bankruptcy: Part II, 57 Minn. L. Rev. 479 (1974); see generally Collier on Bankruptcy ("Collier") ' 365.02 (16th ed. 2022) (citing cases).

Thus, according to this approach, unless both parties have unperformed obligations as of the bankruptcy petition date that would constitute a material breach if not performed, the contract is not executory. See In re Columbia Gas Sys. Inc., 50 F.3d 233, 239 (3d Cir. 1995); accord In re Bennett Enterprises, Inc., 628 B.R. 481 (Bankr. D.N.J. 2021) (a contract for the sale of a...