What this page covers
This page is a deep dive on the structural framework of 11 U.S.C. § 365. It walks through (1) what an "executory contract" actually is under the dominant Countryman definition, (2) the three operative choices a trustee or debtor in possession can make under § 365(a) — assume, assume and assign, or reject — and the legal consequence of each, (3) the requirement of court approval and the business-judgment standard most courts apply, and (4) the § 365(b)(1) cure-of-defaults condition that must be satisfied before a defaulted contract can be assumed.
Official citation: 11 U.S.C. § 365(a)–(b)
What is an "executory contract"?
The Bankruptcy Code does not define "executory contract." Congress left the term to the courts, and the definition that dominates is Professor Vern Countryman's: a contract is executory if the obligations of both parties are so far unperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other. See Vern Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn. L. Rev. 439 (1973).
In practice the Countryman test asks two questions on the petition date:
- Does each side still owe material, unperformed duties under the contract?
- If yes, would non-performance by either side excuse the other from performing?
If both answers are yes, the contract is executory and falls inside § 365. If only one side has remaining duties (for example, the debtor has finished delivery and only owes a money obligation to a vendor, or the vendor has finished delivery and only owes warranty coverage), most courts treat the contract as non-executory and outside § 365 — the remaining obligation becomes either an asset or a claim, handled under §§ 541 or 502.
Minority approach. A "functional" test, sometimes associated with the Third Circuit and academic commentary, asks whether assumption or rejection would benefit the estate, without strictly insisting that material obligations remain on both sides. The Countryman test remains the majority rule and is the safer starting point for any § 365 analysis.
Common examples of contracts that satisfy the Countryman test: unexpired real estate leases (rent due in exchange for continued possession), equipment leases, software licenses with ongoing payment and use rights, supply contracts with continuing delivery, franchise agreements, employment contracts, joint development agreements, and collective bargaining agreements (though those are governed by the specialized procedure of § 1113, not § 365).
The three choices under Section 365(a)
If a contract is executory and the petition date precedes its natural termination, § 365(a) gives the trustee (or, in a Chapter 11 case, the debtor in possession by operation of § 1107(a)) three options, subject to court approval:
1. Assume
The estate keeps the contract on its existing terms and becomes obligated to perform. Post-assumption, the counterparty's claim for any subsequent breach is an administrative expense under § 503(b) — meaning the breach must be paid in full ahead of general unsecured claims. Assumption converts what would have been a pre-petition unsecured claim into a first-priority obligation, so it is reserved for contracts the estate genuinely needs going forward.
2. Assume and assign
The estate first assumes the contract (curing defaults, providing adequate assurance) and then transfers it to a third party under § 365(f). Two notable features of § 365(f): anti-assignment clauses in the underlying contract are not enforceable against the estate (with narrow exceptions, including the personal-services exception of § 365(c)(1)), and the assignee must give the counterparty adequate assurance of future performance. Once assignment is complete, the debtor is no longer liable on the contract — § 365(k) extinguishes the debtor's residual liability, a meaningful departure from non-bankruptcy assignment law.
3. Reject
The estate walks away. Rejection is treated, under § 365(g), as a breach occurring immediately before the petition date. The counterparty's damages from rejection are therefore a pre-petition unsecured claim, dischargeable like any other. For unexpired real-property leases, § 502(b)(6) caps the rejection-damages claim at the greater of one year's rent or fifteen percent of the rent due for the remaining lease term (capped at three years). For employment contracts, § 502(b)(7) imposes a parallel one-year cap on severance.
Why rejection is the most common outcome. Most debtors enter bankruptcy because their cost structure is too heavy for their revenue. Rejecting unprofitable leases, money-losing supply contracts, and obsolete equipment leases is often the single most valuable move a reorganization can make. The legal magic of rejection is that it converts an expensive ongoing duty into a capped, dischargeable claim.
Court approval and the business-judgment standard
Section 365(a) requires court approval for any assumption or rejection. The vehicle is a motion under Federal Rule of Bankruptcy Procedure 6006, on notice to the counterparty and other parties in interest. The standard most courts apply is the "business judgment" test: the court will approve the trustee's or debtor in possession's decision unless it is shown to be the product of bad faith, whim, or caprice. See, e.g., NLRB v. Bildisco & Bildisco, 465 U.S. 513 (1984) (recognizing business-judgment standard for ordinary executory contracts even while imposing a heightened standard for collective bargaining agreements).
Business judgment is deferential. The court does not second-guess a colorable business rationale, and counterparties rarely defeat a rejection motion on the merits. The fights are typically about (1) whether the contract is in fact executory, (2) whether cure amounts under § 365(b)(1) are correctly stated, (3) whether the proposed assignee can provide adequate assurance of future performance, and (4) timing — especially for nonresidential real property leases governed by the § 365(d)(4) deadline.
The exception to ordinary business-judgment deference is contracts critical to a public interest, such as collective bargaining agreements (governed by § 1113's nine-element test) and retiree benefit plans (governed by § 1114). For those, Congress imposed a substantially higher burden.
Section 365(b)(1): cure of defaults
If a contract is in default at the petition date, the trustee or debtor in possession cannot simply assume it. Section 365(b)(1) imposes three conditions for assumption of a defaulted contract:
- Cure the default — or provide adequate assurance of prompt cure;
- Compensate the counterparty for any actual pecuniary loss resulting from the default — or provide adequate assurance of prompt compensation;
- Provide adequate assurance of future performance under the contract going forward.
The cure obligation reaches monetary defaults (back rent, missed installments, unpaid royalties) and most non-monetary defaults that are capable of being cured by performance. Section 365(b)(2) carves out a few default categories that the estate need not cure — for example, ipso facto clauses triggered by the bankruptcy filing itself, by insolvency, or by the appointment of a trustee. Penalty-rate provisions tied to non-monetary defaults that have not been performed are also typically not enforceable as part of the cure amount under § 365(b)(2)(D).
The cure amount is litigated frequently. The counterparty has a strong incentive to assert every conceivable arrearage; the estate has a strong incentive to dispute. Courts generally require the cure amount to be liquidated before the assumption order is entered, either by stipulation or contested hearing. Once the assumption order is entered, the cure amount becomes res judicata against the counterparty — later claims for additional pre-petition arrears are typically barred.
Adequate assurance is not optional. Even where defaults are fully cured, the estate must show that future performance is realistically achievable. For a struggling debtor with thin liquidity, the adequate-assurance showing is sometimes harder than the cure itself. Courts look at projected cash flow, the strength of the reorganization plan, any guarantees from third parties, and the historical performance of the debtor on the same contract.
Common pitfalls
- Treating a contract as executory when it is not. If only one side has remaining duties, § 365 does not apply; the remaining obligation is either property of the estate or a pre-petition claim. Mis-classifying it as executory can lead to a wasted motion and missed deadlines on the actual procedural posture.
- Missing the assumption deadline. Section 365(d)(1) imposes a 60-day deadline in Chapter 7 (extendable for cause). Section 365(d)(4) imposes a 120-day deadline (with one 90-day extension) for nonresidential real property leases in Chapter 11. Missing either results in deemed rejection by operation of law — an outcome that has destroyed reorganizations.
- Underestimating cure exposure. The full pre-petition arrearage must be cured to assume. Where the arrearage is large relative to the value of the contract, rejection is often the correct economic answer.
- Ignoring § 365(c). Some contracts are simply non-assumable when "applicable law" excuses the counterparty from accepting performance from someone other than the original debtor. Personal-services contracts and most non-exclusive patent and copyright licenses fall in this bucket. See the dedicated discussion on the IP licenses page.