An executory contract is a legal contract characterized by obligations that have not yet been performed on the part of one or more parties to the contract. A simple example of an executory contract is a lease agreement. The landlord is required to provide a premises to lease and the person leasing the premises must continue providing payments of rent. If either party stops performing, it is a breach of contract and the other party may have grounds for a suit. In cases where both have unperformed obligations, breach by one party can allow the other party to breach without penalty.
Many contracts are executory in nature. Executory contracts take on special meaning during bankruptcy proceedings and it is in this context that people most frequently discuss these types of contracts. It is important for people declaring bankruptcy, as well as creditors, to understand how executory contracts are involved in bankruptcy proceedings. For debtors who are not certain about their obligations, a bankruptcy lawyer or accountant can provide assistance.
When a person files for bankruptcy, the creditors are required to continue performing their part of executory contracts until the bankruptcy proceedings are complete. During the bankruptcy proceedings, the debtor decides whether to assume or reject the contract. If the debtor assumes the contract, the contract and its attached obligations will persist through the bankruptcy and the debtor must satisfy or “cure” the contract. For the creditor, this is good news, as it means that the debt will be made good, and it's also good news for the debtor, who will continue to be entitled to any services the creditor is performing.
By rejecting an executory contract during bankruptcy proceedings, the debtor indicates that he or she intends to breach the contract. The breach allows the creditor to sue for damages, but these damages are a form of unsecured debt, which means that the creditor must wait in line behind other creditors. Once an executory contract is rejected, it also frees the creditor from any obligations it has under the contract, which can be an advantage if the creditor had resources tied up in the contract which it can now apply elsewhere.
As with any legal contract, an executory contract should be examined closely to look for hidden surprises that might cause problems in the future. Both parties should make sure that they understand their rights and obligations under the term of the contract. If a claim does need to be made against such a contract, thorough knowledge of the terms and conditions can be very important to pursuing the matter successfully.