The assumption and assignment of executory contracts raises many issues in Chapter 11 bankruptcies. One issue is whether the trustee can assume an executory contract, thus forcing the non-debtor party to accept performance from the debtor-in-possession. Section 365(c)(1) of the Bankruptcy Code (“Code”) attempts to resolve this issue by providing that a trustee may not assume or assign an executory contract when applicable law would excuse the non-debtor party from accepting performance from someone other than the debtor-in-possession. But courts relying on Section 365(c)(1) to resolve this issue have interpreted it in different ways, creating a split among the circuits.
One interpretation of Section 365(c)(1) employs the “hypothetical” test. Under this test, a court will not allow a debtor-in-possession to assume an executory contract “if applicable law would bar assignment to a hypothetical third party, even where the debtor-in-possession has no intention of assigning the contract in question to any such third party.” The other interpretation employs the “actual” test, which disallows “assumption by the debtor-in-possession only where the reorganization in question results in the non-debtor actually having to accept performance from a third party.” The United States Supreme Court has yet to resolve this issue.
Part I of this memorandum explains the current circuit split on the issue and how courts decide which test to apply. Part II discusses the options a court has when presented this issue for the first time, drawing in guidance from a Supreme Court case that relates to the issue. Part III explains the effects of the circuit split and the impact it has on a debtor. The memorandum concludes that until the Supreme Court rules on the issue or Congress amends Section 365(c)(1), the ability of a debtor to assume an executory contract upon filing bankruptcy will remain uncertain.