Proposal #4: Clarifying the Option of
Court approval of a trustees request to assume a contract is a significant event: the
estate becomes obligated to perform or to find an adequate replacement to perform through its
right to assign. Any failure to do so will result in an administrative priority claim that must be paid
in full dollars ahead of all other general creditors, as opposed to the pro rata distribution that is
received by a party to a breached contract. The Code does not define assumption, but it seems
clear that assumption, in the absence of assignment, merely means that the debtor-in-possession
accepts the burdens and the benefits of a pre-bankruptcy contract. Due to the confusion already
inherent in section 365, it may be sensible to use terms that more precisely characterize the events
that they represent.
"Assumption" should be replaced in
with"election to perform" in section 365.
Reasons for the Proposed Change
This proposal would introduce the parallel concept to "breach" and would
replace problematic language with clear language. It would not affect the obligation to cure and
give adequate assurance of future performance under section 365(b), nor would it change the
implications of making this election. Thus, if the court approved the trustees election to
perform, the estate would be obligated to perform and any failure to do so would result in an
administrative claim. [ FN: See In re
Superior Toy & Manufacturing Co. , 78 F.3d 1169, 1172 (7th Cir. 1996); In re
Klein Sleep Products , 73 F.2d 18, 25 (2d Cir. 1996) (rejecting contract after assuming it will not
change administrative expense priority of resulting liabilities).] This would
be the case even if an assumed contract is rejected after a chapter 11 case is converted to a
chapter 7 liquidation. [ FN:
While clarifying the action being taken, this amendment would not address more specific
issues inherent in the election to perform or to transfer, such as the severability of contracts and
the special rules for personal services contracts. However, by distinguishing more sharply between
debtor-in-possession performance and assignment (or "transfer" [ FN: It may be sensible to rename this option as well.
Some commentators already have recognized that "assignment " in bankruptcy is not parallel to its
state law counterparts, for the Bankruptcy Code disregards the nonbankruptcy rule prohibiting the
delegation of duties if the original obligor does not remain liable. See Thomas H. Jackson &
Robert E. Scott, "On the Nature of Bankruptcy: An Essay on Bankruptcy Sharing and the
Creditors' Bargain," 75 Va. L. Rev. 155 (1989).] ) to another entity,implicit
would be the notion that the debtors ability to elect performance is independent of
whether the debtor could transfer its interest to another party. The postpetition debtor is not a
materially different legal entity from the prepetition debtor for purposes of performance, breach or
transfer of contracts. [ FN: In re
Leroux , 69 F.3d 608, 613 (1st Cir. 1995), citing H.R. Rep. No. 1195, 96th Cong., 2d Sess.
§27(b) (1980) and NLRB v. Bildisco & Bildisco , 465 U.S. 482 (1984). ]
Consistent with the majority of case law, the debtors election to perform would not be
contingent on a hypothetical finding that the contract would be assignable under nonbankruptcy
law. [ FN: Institut Pasteur v. Cambridge
Biotech Corp. , 104 F.3d 489, 493 (1st Cir. 1997) (ability to assume not dependent on whether
contract is assignable); In re Cardinal Industries Inc. , 116 B.R. 964 (Bankr. S.D. Ohio
1990).] This may require a clarifying amendment to section 365(c)(1),
which has elicited confusion on this point. [
FN: See In re West Electronics Inc. , 852 F.2d 79, 83 (3d Cir. 1988) (debtor
cannot assume contract if applicable law precludes assignment of contract, thus section 365(c)(1)
requires hypothetical assignment test).]
This proposal would not alter the economic considerations preceding a trustees
election to perform or transfer. The trustee should elect performance or transfer only if such
actions were likely to yield a net benefit to the estate, i.e., the value of the non-debtor
party's remaining performance is greater than the estate's costs of taking over the debtor's
remaining obligations. [ FN: Michael T.
Andrew, "Executory Contracts Revisited: A Reply to Professor Westbrook," 62 U. Colo. L. Rev.
1 (1991); Jay Lawrence Westbrook, "A Functional Analysis of Executory Contracts," 74 Minn. L.
Rev. 227 (1989) .]
Some might be concerned that any change in terminology will promote litigation. The
concepts of "assumption" and "assignment" have been less troublesome
than "rejection," and therefore a change may not be as justified in this situation.
However, "perform" is a more apt analogue to "breach," and would
provide a sensible and more readily comprehensible parallel structure to section 365.
The election to perform under a personal property lease in consumer cases has caused
confusion and raises special problems that are not addressed in this proposal. Trustees may be
reluctant to assume these types of leases if concerned about being held responsible on the leases.
The Consumer Bankruptcy Working Group may opt to consider whether the statute should
clearly establish that a chapter 7 consumer debtor independently can elect to continue lease