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Business Bankruptcy Issues

Executory Contracts — What Are They And Why Do They Matter In Bankruptcy?

If you start talking to a bankruptcy lawyer, before long you’ll probably hear them use the term “executory contract.” Often they’ll act as though people use the term everyday.  The truth is that bankruptcy lawyers are just about the only lawyers – much less business people — who ever talk about executory contracts.  (I confess I do it too, but there’s a really good reason.)

So what is an executory contract? The concept is fairly simple. It’s a contract between a debtor and another party under which both sides still have important performance remaining.  Put another way, if either side stopped performing the contract it would be an actual breach of contract. 

Examples of executory contracts (and some common reasons why they might be executory) include:

  • Real estate leases (tenant has to pay rent/landlord has to provide space)
  • Equipment leases (lessee has to pay rent/lessor has to provide equipment)
  • Development contracts (development work required/payment required on milestones), and
  • Licenses to intellectual property (licensee can use only within scope of license/licensor must refrain from suing for licensed uses).

Having cleared up the definition, the next question is why executory contracts seem to matter so much in bankruptcy.  (The debtor even has to list them separately in its bankruptcy schedules.)

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Business Bankruptcy Issues

Automatic Stay Of Bankruptcy

One of the most fundamental protections for companies or individuals filing for bankruptcy is the automatic stay.  In fact, when someone says a company has sought "bankruptcy protection" they usually are referring to the "protection" of the automatic stay.  The automatic stay arises the instant a bankruptcy petition is filed.  It doesn’t matter whether the petition is a voluntary one filed by the company itself or an involuntary one filed by creditors seeking to force the company into bankruptcy. 

The automatic stay operates as a stay — really a statutory injunction — against almost all collection actions by creditors against a debtor and its property based on debts existing before the bankruptcy petition was filed.  It is called the automatic stay because this stay arises automatically when the petition is filed without the need for any court order.  Among the actions stayed are:

  • Lawsuits 
  • Repossessions of assets
  • Foreclosure sales
  • Collection calls and notices, and
  • The making of setoffs.

Creditors should make every effort to avoid a violation of the automatic stay.  Violating the automatic stay is serious business (even when the government does it).  This is especially true if the debtor is an individual.  Not only are actions in violation of the stay generally held to be void, but in some cases creditors can expose themselves to a claim for damages or even punitive damages.  

Creditors can ask the bankruptcy court for relief from the automatic stay, for example to allow a lawsuit to continue or a foreclosure sale to take place.  While such "relief from stay" is occasionally granted, more often the request is denied to give the debtor more breathing room to reorganize its business.  In any event, seek assistance from a bankruptcy attorney if you have questions about or need relief from the automatic stay.

Business Bankruptcy Issues The Financially Troubled Company

Buying Assets From An Insolvent Company — Balancing Risk And Reward

Insolvent or nearly insolvent companies can present an attractive opportunity to purchase assets on the cheap, or at least at a significantly reduced cost.  Of course, a buyer purchasing assets from a troubled company wants to be as sure as possible that it is buying only the target’s assets – and not also taking on all of the troubled company’s liabilities. This kind of specialized M&A deal raises issues that usually don’t come up when acquiring a solvent company and that aren’t always obvious at first. 

Several different strategies exist for balancing these risks with the potentially substantial rewards of a distressed asset acquisition.  Here is an overview of these issues.  A more extensive discussion focusing in particular on intellectual property assets, written by Cooley Godward intellectual property partner Gary Moore, can be found here.

Business Bankruptcy Issues The Financially Troubled Company

Preferences — How To Protect Yourself When Doing Business With A Financially Troubled Customer

It’s bad enough when you can’t collect everything you are owed because of a customer’s financial problems.  We’ve all faced that situation at one time or another.  Unfortunately, the U.S. Bankruptcy Code can add an entirely different wrinkle to the problem called a "preference."  (The word comes from the idea that your successful collection efforts enabled you to get preferred treatment over your customer’s other creditors that didn’t get paid.)  

Without some planning, an unhappy scenario can develop even if you aggressively move to collect the account.  If the customer files for bankruptcy, the customer’s bankruptcy trustee — or even the customer itself — may sue you to recover those payments you were lucky enough to collect, calling them preferences. 

There are defenses and, with some careful planning, you can act to protect yourself.  These range from waiting to ship new goods or provide new services until after you’ve received a payment to putting the customer on C.O.D. or other payment in advance arrangement.  Here are some pointers on minimizing the bankruptcy preference risk. 

Business Bankruptcy Issues Recent Developments

Will The New Bankruptcy Law Affect Your Business?

On October 17, 2005, the most significant revision to U.S. bankruptcy law in a generation took effect.  If you followed the media’s coverage of the new law before it became effective, you could easily have assumed that the changes were aimed only at consumers filing bankruptcy to get rid of credit card debt.  There is no question that the new law, called the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (bankruptcy lawyers just call it BAPCPA), was aimed at, and affects most significantly, individual consumers.  David L. Rosendorf of Kozyak Tropin & Throckmorton, P.A., in conjunction with the American Bankruptcy Institute, maintains an entire blog devoted to the new law’s changes and how it is being implemented.  His blog has a natural focus on those consumer changes.

However, the surprising news is that the new bankruptcy law changes also contained a host of provisions that will affect businesses.  Many bankruptcy lawyers (this one included) think the law will make it more difficult for some businesses to reorganize, which could end up reducing recoveries for unsecured creditors.  That said, other provisions in the new law benefit certain unsecured creditors.  For an overview of how the new law will affect businesses and their creditors, look here or here — and stayed tuned.