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Non-Debtor Contract Counterparties in Bankruptcy

By By Adam L. Rosen and Christopher J. Rubino
February 25, 2013

Bankruptcy Code section 365 primarily concerns whether a debtor-in-possession or trustee may assume or reject executory contracts and unexpired leases (collectively, the “Contracts”) for the benefit of the estate, but the section often places the counterparties to those Contracts in the precarious position of being required to perform while running the risk that a debtor or trustee might not do so. Until a debtor decides whether to assume or reject a Contract, the terms of the Contract continue to bind the debtor and the counterparty. If the counterparty performs, it bears the risk that the debtor will reject the Contract and the debtor will be unable to pay the administrative claim owing to the counterparty for its post-petition performance. Courts generally struggle with this tension between protecting counterparties and protecting the bankruptcy estate prior to the assumption or rejection decision.

Counterparties have several available options depending on whether a pre-petition default exists under the Contract, and depending on the terms of the Contract. This article discusses how counterparties, as well as courts, react to situations where a counterparty seeks protection from the risks inherent in continued performance under a Contract with a debtor in bankruptcy.

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