What is an executory contract?
How are they treated in the context of a bankruptcy?
What types of contracts are considered executory agreements?
In this article, we will break down the notion of “executory contract” so you know all there is to know about it!
We will look at what it means, its accounting and legal definition, executory contracts in real estate, what are non-executory contracts, executory contracts and unexpired leases as defined in Section 365 of the Bankruptcy Code, examples and more.
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What is an executory contract
An executory contract is a contract where the parties have not yet fully executed material obligations under their contract.
In other words, the performance of the contract is not completed on both sides.
Either the contractual obligations are not performed at all by either party or partially where they still have important obligations to perform in the future.
Should a party stop performing the obligations left to perform under the contract, the other party can pursue the matter for breach of contract.
A real estate lease is an executory contract.
A sale of good agreement where the goods have not been delivered to the purchaser and the purchase has not yet paid is an executory contract.
The term “executory contract” also appears in the U.S. Bankruptcy Code.
Section 365 of the Bankruptcy Code tilted Executory Contracts and Unexpired Leases, the law defines the mechanics with respect to how a bankruptcy trustee can manage a debtor’s executory contracts or unexpired leases.
To better understand what is an executory contract, let’s first define what does the term “executory” means.
According to the Cornell Law School’s Legal Information Institute, the meaning of executory is:
Something (generally a contract) that has not yet been fully performed or completed and is therefore considered imperfect or unassured until its full execution. Anything executory is started and not yet finished or is in the process of being completed in order to take full effect at a future time.
In other words, you can define executory contract as something that has not yet been completed and remains to be finished.
Executory contract definition
Now, let’s look at the executory contract meaning.
According to FindLaw, an executory contract is defined as:
Generally includes contracts or leases under which both parties to the agreement have duties remaining to be performed.
What is notable with this legal definition of an executory contract is that it’s a contract where the parties have obligations left to perform and any underperformance can result in a breach of contract.
Since both parties remain obligated towards one another, we can also say that the contract is an executory bilateral contract.
Executory contract types
What are the different types of executory contracts?
Let’s look at a few common types of executory agreements to get a better sense of the concept.
Executory contract accounting
According to the International Accounting Standards (IAS), an executory contract is a contract where neither party has fulfilled any executory obligations or have partially performed their obligations to a relatively equal proportion.
Under the IAS, the following contracts can be considered as “executory”:
- Continuing employment agreement
- Future delivery of services
- Purchase orders
Company A enters into a contract with Company B for the manufacturing and delivery of 10,000 plastic masks.
On the day the contract is signed, the contract is considered executory from an accounting perspective as neither party has performed any of their legal obligations.
The manufacturer has not manufactured the plastic masks and the purchaser has not paid for them.
Executory contract in real estate
In a real estate executory contract, the renter or tenant must pay rent in exchange for the landlord or property owner to provide use and access to the property, such as:
- Real estate leases
- Commercial leases
- Rental agreements
When a landlord provides a tenant with a place to live in exchange for rent or a landlord provides a commercial tenant with a storefront to operate a boutique, you have a contract that is executory.
A contract is considered to be a non-executory contract if one party has fully or substantially completed the performance of its obligation while the other party has yet to perform its obligations.
When one party has done what it was supposed to do under the contract and is expecting the other party to complete its obligations, the contract will not be considered as executory.
A contractor was hired to renovate your kitchen.
The contractor finishes the job and all that is left is for you to make the payment for the services and material.
Another situation where the contract will be non-executory is when the only obligation left by a party is to pay a sum of money for the value already received.
A consumer purchases a good from a merchant and the merchant delivers the goods.
The moment the merchant delivers the goods and awaits payment, the contract is no longer qualified as executory.
Executory contract bankruptcy
In the United States, under the bankruptcy law, executory contracts represent a type of contract where, at the time of bankruptcy, both parties have remaining obligations to perform.
In other words, when a person or company files a bankruptcy petition, a contract where the bankrupt had obligations to perform and expect performance from his or her counterparty is an “executory contract”.
An executory agreement is handled differently than general unsecured claims when someone goes bankrupt.
Here is why:
- A debtor has the option to accept the contract and perform the remaining obligations (assumption of contract) or refuse to perform the obligations (rejection of contract)
- In the meantime, the other party to the contract (non-debtor) must continue performing the obligations of the contract
If the debtor or trustee chooses to assume an executory contract following the bankruptcy filing, it must cure any default, including pre-petition defaults, under the contract, compensate the non-debtor for any actual losses suffered as a result of the breach and demonstrate that it can continue performing the obligations under the contract going forward.
If the debtor chooses to reject the executory contract, the contract will be considered as breached providing the non-debtor with the ability to seek damages.
The rejection damage a non-debtor can claim is limited however to pre-petition unsecured claims.
Under Chapter 11 of the U.S. Bankruptcy Code (USC) the law allows a debtor-in-possession (DIP) or a bankruptcy trustee the ability to assume or reject leases or executory contracts in an attempt to help the business reorganize or assign the contracts to generate value if possible.
The relevant section to consider Title 11 of the U.S. Code relating to “Bankruptcy”, Section 365 (11 U.S.C. § 365)
In Chapter 7 bankruptcy cases, the bankruptcy trustee must assume executory contracts within 60 days of the bankruptcy filing date without which the contract will be deemed as rejected.
Executory contract vs executed contract
What is the difference between an executory contract and an executed contract?
The executed contract definition is essentially a contract that has been signed by the parties and is a contract legally binding.
Typically, once a contract is executed, the parties must begin performing their obligations as mutually agreed upon in the contract.
A company wants to purchase a truck to deliver goods to its clients.
The company enters into a purchase agreement with a truck dealer to purchase a truck for $100,000.
The purchase agreement signed by the parties is an executed agreement and legally binding.
It can also qualify as an executory contract as, upon signature, the obligations are left to be performed by both parties.
On the other hand, an executory contract is a contract that has already been executed and some minor or partial obligations have been performed but the material and significant obligations remain to be performed.
A company wants to lease a truck to deliver goods to its clients.
The company and a truck dealership enter into a truck leasing agreement where the company agrees to pay $2,000 per month for the next three years to lease the truck.
This is an example of an executory contract as the company has a duty to pay rent and the truck dealership has a duty to allow the company to use the truck.
What is common with executed and executory contracts is that they are both legally binding contracts.
The parties have a legal duty to perform their obligations under an executory or executed contract failure of which they may be exposed to a breach of contract lawsuit or claim for damages.
Executory contract example
There are many examples of executory contracts.
We’ll provide you with a short list of executory contract examples to illustrate what they are:
- Real estate leases or rental leases
- Equipment leases
- Development contracts
- Intellectual property license
- Car leases
Real estate leases or rental leases
In a real estate lease or rental lease, the landlord has an obligation to provide a property or leased premises to the tenant while the tenant has an obligation to pay rent to the landlord to have the right to use the property.
An equipment lease can relate to anything, such as computers, mobile phones, tools, machinery or other types of equipment.
In this type of lease, the borrower rents the equipment and the renter has a duty to provide the equipment for a certain period of time.
In a development contract, you’ll have a contractor who will be responsible to build or develop something for the client and the property owner must pay when the development reaches certain pre-defined milestones.
Intellectual property license
In a license to intellectual property, the licensor provides a software, application or intellectual property and the licensee is responsible to pay for the use of the software or IP.
In a car lease, a car dealership or merchant provides the car or vehicle for a certain period of time to a consumer who is responsible to pay rent to be allowed to use the car and perhaps buy the car at the end of the lease.
Executory contract FAQ
What is executory contract
An executory contract is a contract between two or more parties where the essential terms of the contract remain to be fulfilled.
In other words, the parties have important and legally binding obligations left to perform allowing for the full and satisfactory completion of the contractual duties.
If one party executes its obligations under the contract and what is left is for the other party to complete its obligations, the contract will not be considered as executory.
An executory contract is when “both parties” have important and unfulfilled obligations left under the contract.
What are some examples of executory contracts
Here are some examples of executory contracts:
- Employment agreements
- Franchise agreements
- Sales and purchase agreements
- Supply agreements
- Rental agreements
- IP license
- Development agreement
- Car leases
- Apartment leases
- Long-term rental agreements
- Business contracts
- Insurance agreements
- Docking agreements
- Real estate sale contracts
What is executory contract in bankruptcy
Under US bankruptcy laws, an executory contract is a type of contract where the bankrupt and the other party (the potential creditor) have unfulfilled obligations remaining to be performed.
Executory agreements will get special treatment under the law as the debtor-in-possession (the bankrupt) or the trustee has the ability to:
- Assume the executory contract (allowing for the continuation of the contract)
- Reject the executory contract (resulting in a breach of contract)
The law enables a debtor or trustee to make such an election so they can better determine which contracts are best to keep and which ones are better to terminate in the context of a successful reorganization.
Are executory contracts enforceable
An executory agreement is an enforceable agreement.
The reason why it is called an executory agreement is due to the fact that the parties to the contract still have significant and material contractual obligations left to perform.
In a nutshell, the parties have not yet benefited from the full execution of the obligations expected under the contract.
Now, under the U.S. Bankruptcy Code Section 365, when a person goes bankrupt, the bankrupt or the designated trustee can choose to “assume” or “reject” executory contracts.
If the contract is assumed, then the parties continue executing their obligations as expected although the bankrupt must compensate for any default or cure any pre-petition breach.
If the contract is rejected, it will be considered as a breach and the non-breaching party can claim rejection damages in accordance with the law.
Is a car loan an executory contract
By definition, an executory contract is one where both parties have “not yet” executed, in substantial terms, their obligations towards one another.
In the context of a car loan, the lender has already fulfilled its obligation in full (to provide the money so you can buy a car).
It is only the borrower who has an obligation to pay back the sums borrowed.
This is a debt contract and does not qualify as an executory contract.
However, if you were dealing with a car rental agreement, then the contract could qualify as an executory contract.
In this context, the renter must provide a consumer with a vehicle and the consumer must pay rent for the entire duration of the car rental agreement.
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