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New Jersey Court Holds Specific Performance Can Leave Contracts Non-Executory
A New Jersey Bankruptcy Court recently rejected a motion to deny a written agreement in accordance with Bankruptcy Code section 365. The court held that a court’s request of specific performance made under a contract was non-executory and non-rejectable. The following examines the potential repercussions of this case, the role of section 365, and what it could mean for the future of bankruptcy law.
The Role of Section 365
Section 365 of the Bankruptcy Code allows the trustee of a bankruptcy firm to either assume or reject a firm’s executory contracts. Contracts are considered to be executory if partially performed. For example, if a contract requires a seller to deliver goods to a firm and a seller delivered the goods before becoming insolvent, a contract is viewed as not executory. Section 365 also allows a bankruptcy estate to either assume an executory contract and perform the debtor’s obligations under that contract if it would be profitable for the estate or to reject the contract if performing is not profitable.
It is important to note, however, that courts have not come to an agreement about the consequences of rejecting a contract. This question often involves courts asking whether rejection is the equivalent of a breach of contract or if it terminates all of a counterparty’s rights. The United States Supreme Court even questioned this dilemma in the 2019 Mission case.
More specifically, Section 365 states that if a default occurs in an executory contract or unexpired lease of a debtor, a trustee is not permitted to assume the contract unless the trustee cures or provide assurance that the trustee will cure the default, compensates, or provides assurance that the trustee will compensate a party other than the debtor involved in a contract or lease, or provide adequate assurance of future performance under a contract or lease.
The Code leaves some questions answered. For example, the phrase “executory code” is not defined in Section 365. Under state law, an executory contract refers to an agreement that is unperformed by either side. In the world of bankruptcy, every creditor’s claim is an executory contract. The actual application, however, is more limited. Bankruptcy law views an executory contract as any agreement where the obligation of both the creditor and debtor is unperformed to such a degree that failure to complete an obligation under the agreement constitutes a material breach that excuses the performance of another.
The Court’s Ruling in the Case
The court began with the determination that the sale contract was not underperformed to the extent that either party’s inability to satisfy its obligation constituted a material breach of contract. Instead, the court found that a request ordering specific performance leaves party duties created by contracts non-material acts that provide the opportunity to satisfy court orders.
The court also noted the power of other courts to see to their own requests if agents fail to perform as expected or requested. This means that a contract of specific performance erases any outstanding duties of parties named in a contract.
After a court requests the parties perform a contract, the parties do not hold obligations under a contract and the contract is consequently non-executory. Because executory contracts can be either taken on or rejected, sales contracts cannot be rejected. The court then held that the contract was not executory because at the time of the petition, neither involved parties had a duty that was underperformed to the degree that not performing represented a breach that was material in nature.
The court also found the purchaser’s duties were fulfilled at the time that it placed the entirety of the purchase price into the designated bank account. The purchaser’s duty to release these funds at the time of closing was classified as ministerial and as a result insufficient to leave a sales contract executory. The court noted that conditions in a contract based on third-party acts does not leave a contract executory. The court then noted that the City Council’s approval of the transfer did not represent an obligatory action for the performance of the contract.
The court further noted that even if a sales contract was executory, the court would deny the manager’s motion because the purchaser would not be forced to reject the damage claim. Furthermore, the court found that in situations requiring specific performance, money damages did not represent an inadequate remedy for the purchaser. Because this finding prevents a purchaser from establishing a bankruptcy claim, the purchaser would not be able to obtain a distribution in the manager’s bankruptcy reorganization. If the court permitted the manager to deny the sales agreement, several undesirable consequences would occur including that the other party would lose its alcohol license and not be able to recover as a creditor during bankruptcy proceedings.
The Repercussions of the Case
This case emphasizes the importance that various parties including debtors be careful and engaged when deciding what contracts are either capable of being taken on or rejected to the powers granted to debtors by section 365. Despite the potential broadness of a debtor’s powers, various factors can limit the rejection of a contract.
As this case demonstrates, a court order requiring specific performance might preclude rejection. As this case teaches, a court order requiring specific performance might preclude rejection. Furthermore, if the only material acts in a contract necessitate performance by third parties, contracts can be deemed non-executory. Even if payments or other acts are viewed as material terms, certain arrangements can help in probative determinations about whether a contract is executory. The case’s outcome also emphasizes the possibility that courts will evaluate the impact of a contract’s rejections in making an assessment about whether equitable consideration prevents rejection.
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