Abstract
This paper focuses on the treatment in bankruptcy of a debtor's executory contracts - contracts under which the debtor still owes (or is owed) performance at the time it files for bankruptcy. Under the bankruptcy laws of most countries, including the U.S., the bankruptcy trustee usually disposes of an executory contract in one of two ways: either by (1) assuming and seeking performance of the contract; or by (2) rejecting the contract, in which case any resulting damage claim is treated as a prebankruptcy unsecured claim and receives its ratable share of the assets available to pay unsecured claims. Since such unsecured claims are typically paid only a fraction of their face amount, a party injured by rejection usually receives less than full compensation. This approach is widely supported by U.S. bankruptcy commentators. The paper first explains how this ratable damages rule can give the bankruptcy trustee an incentive to reject contracts when performance would be efficient. It then shows that the manner in which the ratable damages rule is actually applied by U.S. courts tends to worsen the problem. The paper concludes by considering various arrangements for eliminating the distortion.
Highlights
This Article analyzes the treatment in bankruptcy of a debtor's "executory contracts"-contracts under which the debtor still owes performance at the time the debtor files for bankruptcy
That principle, which has been embodied in U.S bankruptcy law long before Section 365 was enacted' and is reflected in the treatment of executory contracts in other bankruptcy systems as well,[29] is broadly supported by bankruptcy scholars." The most commonly-given justification for the ratable damages" (RD) rule is that it implements the important bankruptcy principle of equality.[31]
The analysis offered below suggests that making executory contract rules more favorable to the bankruptcy estate need not undesirably increase the use of bankruptcy or make it more difficult for firms to enter into value-creating contracts
Summary
This Article analyzes the treatment in bankruptcy of a debtor's "executory contracts"-contracts under which the debtor still owes (or is owed) performance at the time the debtor files for bankruptcy. Under the laws of most countries, including the United States, the bankruptcy trustee generally disposes of an executory contract in one of two ways: she either 1) seeks performance of the contract; or 2) "rejects" the contract, in which case any resulting damage claim is treated as a prebankruptcy unsecured claim.'. Since such claims are typically paid only a fraction of their face amount, the usual consequence of rejection is that an injured party receives much less than full compensation.
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