An option to purchase real property is not an executory contract that a chapter 11 debtor can reject, according to Bankruptcy Judge Robyn L. Moberly of Indianapolis.
Prof. Jay L. Westbrook of the University of Texas School of Law would have reached the same result by invoking state law rather than relying on the so-called Countryman test for “executoriness,” which is not well suited for seemingly unilateral contracts.
The facts were simple. Before bankruptcy, the debtor sold a 30-year option to purchase a 70% interest in real property for almost $55,000. On exercise of the option, the purchaser would pay another $157,000.
The option was recorded among the land records, along with a mortgage in favor of the buyer.
In chapter 11, the debtor filed a motion to reject the option as an executory contract under Section 365(a).
In her October 23 opinion, Judge Moberly said that the Seventh Circuit has adopted the definition of an executory contract proffered by the late Harvard Law School Professor Vern Countryman. He defined a contract as executory if the obligations of both parties are so far unperformed that a failure by either to complete performance would constitute a material breach excusing performance by the other.
The holder of the option argued that the contract was not executory because it had no outstanding obligations on the filing date. The debtor countered by saying that both sides would have obligations should the holder exercise the option to purchase.
Judge Moberly said that the option would be an executory contract if, “at the time of filing[,] each party has material unperformed obligations.” She went on to say that she was “not persuaded” that the holder of the option had “a remaining obligation to elect on the option.”
Judge Moberly said that the holder’s “future obligations are contingent upon it actually exercising the option.” If the holder were never to exercise the option, she said that “nothing happens” and neither party would have committed a breach.
In short, Judge Moberly said that the holder of the option “had no material obligations on the date of the petition because it had not yet exercised its option.”
Countering the argument, the debtor contended that the holder of the option would be obliged to remove the recordings in the land records if the holder were never to exercise the option. Judge Moberly did not view the obligation as “material.” She said that “[m]ost agreements have some degree of unperformed obligations on both sides, [but] this does not render all agreements executory under § 365.”
Finding that the option was not an executory contract, Judge Moberly denied the motion to reject.
Observations
Prof. Westbrook previously told ABI that the “Countryman test has greatest difficulties with unilateral contracts like options because failure of the option holder to exercise is almost never a material breach, yet an option, of course, can be of great value, so any trustee would want to assume.”
With regard to the Indiana case, Prof. Westbrook told ABI that the power to reject under Section 365 “is not an avoiding power.” Rejection, he said, “is just a breach.”
In the event of breach, Prof. Westbrook would have analyzed the parties’ rights under state law. He noted that the court had not explored the holder’s right to specific performance (“equitable title”) under state law. He said that the recorded option could give rise to a right to specific performance that “would be a property right and would no doubt supersede any mere contract right and, of course, would be respected in bankruptcy just like a security interest or any other property right.”
In short, subject to the answers under state law, Prof. Westbrook might well have reached the same result without deciding whether the option was an executory contract. He would have allowed the option to ride through bankruptcy and believes that we should “lift a glass to the great scholar but move on from the Countryman test.”
When encountering questions about executory contracts, we recommend consulting Prof. Westbrook’s seminal article from 2017, Prof. Jay L. Westbrook and Kelsi S. White, “The Demystification of Contracts in Bankruptcy,” 91 Am. Bankr. L.J. 481 (Summer 2017).
Prof. Westbrook occupies the Benno C. Schmidt Chair of Business Law at the University of Texas School of Law.
An option to purchase real property is not an executory contract that a chapter 11 debtor can reject, according to Bankruptcy Judge Robyn L. Moberly of Indianapolis.
Prof. Jay L. Westbrook of the University of Texas School of Law would have reached the same result by invoking state law rather than relying on the so-called Countryman test for “executoriness,” which is not well suited for seemingly unilateral contracts.
The facts were simple. Before bankruptcy, the debtor sold a 30-year option to purchase a 70% interest in real property for almost $55,000. On exercise of the option, the purchaser would pay another $157,000.
The option was recorded among the land records, along with a mortgage in favor of the buyer.
In chapter 11, the debtor filed a motion to reject the option as an executory contract under Section 365(a).