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Executory contract : what you need to know

May 1, 2022

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This article has been written by Nikunj Arora of Amity Law School, Noida. This article provides a detailed analysis of Executory Contracts along with a general overview of types of contracts and essential elements of a contract under the Indian Contract Act, 1872.

It has been published by Rachit Garg.

Table of Contents

Introduction

Any executory contract or unexpired lease may be adopted or rejected by a trustee under Section 365(a) of the United States Bankruptcy Code (“US Bankruptcy Code”). Section 365(c)(1) is, nevertheless, subject to an exception outlined in Section 365(a).

The trustee must obtain the consent of any non-debtor party to assume or assign any executory contract or unexpired lease, except where law prohibits the trustee from accepting or delivering delivery to anyone other than the debtor or debtor in possession. Accordingly, its rules forbid a debtor-in-possession from taking on an executory agreement without the prior consent of the non-debtor, if the assignment of the agreement is prohibited by applicable law. The non-debtor party is said to be protected by this provision when the contract relies on a specific individual or entity’s performance.

To the extent Section 365(c) pertains to patent law, the Ninth Circuit determined that the licensor’s consent to the assignment of a patent license was required. Due to the lack of consent from the licensor, the Court held that Section 365(c)(1) barred Catapult from assuming the patent license.

The Ninth Circuit addressed the above-mentioned question of whether a debtor-in-possession is barred from assuming a contract even if the debtor does not intend to assign it in In re Catapult Entertainment, Inc. 165 F.3d 747, and was the latest U.S. Court of Appeals case to tackle the issue.

Under Indian laws, executory contracts are those types of contracts which require both parties to fulfil their contractual obligations. In exchange for the promise made in such a contract, future consideration will be given. Two parties are typically involved in executory contracts. One is a debtor and the other is a borrower.

The Indian government enacted comprehensive legislation on corporate insolvency in 2016. Several laws existed before this legislation, by which creditors could enforce their rights against a debtor company. Furthermore, Indian bankruptcy laws lack a similar provision to Section 365 of the US bankruptcy code. Consequently, Indian courts/tribunals did not develop executory contracts or similar principles to adjudicate creditors’ claims against debtor companies.

This concept was mentioned by the Calcutta High Court in a winding-up case in 1963, and after this, there was no judgment around this term until 2016. This was considered of interest since it was unclear as to what extent the Indian Insolvency and Bankruptcy Code would apply to such contracts, if at all, and why.

Types of contracts under the Indian Contract Act, 1872

As executory contracts are a type of contract, the reader needs to be aware about every type of contract so as to figure out the significance of executory contracts specifically. A variety of contract types fall under the Indian Contract Act, 1872 (“Act”) which is further classified under different headings, such as based on formation, nature of consideration, execution, and validity.

Based on formation

Express contract

Any contract that involves any conversation or expression is called an express contract. Both offer and acceptance are expressed in these types of contracts.

Implied contract

An implied contract is one in which each party’s duty is unquestionably acknowledged without him or her having any say. This type of contract does not require dialogue or expression.

Quasi-contract

In a quasi-contract, the parties will not have any contractual relations, so no offer and no acceptance will take place. The law determines whether a quasi-contract exists. In sections 68 to 72 of the Act, the court describes situations in which a quasi-contract can be made.

Based on the nature of consideration

Bilateral contract

A bilateral contract is one in which consideration is moved in both directions. A party in this contract will deliver goods or services, and the other party will then pay money as consideration.

Unilateral contract

Known as a unilateral contract, these contracts provide consideration only in one direction.

Based on execution

Executed contract

The contract is considered executed once the task has been accomplished or the performance has been completed. In the case of a contract that has been executed lawfully, the contract comes under fulfilled contracts.

Executory contract

In this type of contract, the contractual obligations are being performed shortly and not immediately. The term executory contract applies to this type of contract.

Based on validity

Valid contract

A valid contract can be enforced in a court of law. For these contracts to be valid, certain requirements must be met as provided under the act.

Void contract

A void contract is any contract that does not comply with any of the features of a valid contract.

Voidable contract

A voidable contract is deficient only in terms of free consent. The contract is therefore one that is made under certain physical or mental pressure. A suffering party may choose to make it valid or void in the future. It is not free consent if it was obtained by coercion, undue influence, mistake, and misrepresentation (as defined under the act).

Illegal contract

The contract may be considered illegal if it involves an unlawful object. This makes the contract void. An illegal contract would be made for killing someone.

Unenforceable contract

Unenforceable contracts are those that have not been properly drafted and have not fulfilled all the legal formalities necessary to enforce them.

Essential elements of an Executory Contract

For an executory contract to be valid, it must contain the following components:

Offer and Acceptance: An offer and acceptance are the core of a contract. There is no contract unless an offer is made and approved. Under section 2(a) of the Act, a proposal is when one person expresses his will to do or abstain from doing something to gain the consent of another person to do or abstain from something.
Intent to create a legal obligation: There is no explicit clause in the Act, that requires the creation of legal obligations, but various rulings over the years have resolved the issue, making the intent to create legal obligations a significant requirement.
Consideration: According to section 25 of the Act, agreements without consideration are invalid. The concern must be genuine and not fictitious. A contract without consideration will become Nudum Pactum. The adequacy of this consideration must not be considered.
Competent To Contract: The law considers competent anyone who is of sound mind, has reached the age of 18 and is not otherwise excluded from avoiding a contract. Contracts made by minors are unenforceable from the beginning, and they do not entail any liability.
Free Consent: Consent must be free for a legal contract to be enforceable. According to Section 13 of the Act, when two additional parties agree on the same issue, they are said to have mutual consent and binding to an agreement. It is also referred to as ‘Ad idem Consensus’.
The object of the contract: The unlawful consideration is explained under Section 23 of the Act. If the court determines that the object of the contract is dishonest against public policy or the intent of the contract, then it will be deemed improper.
Not void-ab-intio: Under the Act, few contracts are explicitly deemed void.

Overview of Executory Contracts

What is an Executory Contract?

Executory contracts are those in which the parties have not yet fulfilled all their material obligations. In simple words, both sides are not performing their obligations under the contract.

There is either no performance of contractual obligations by either party, or partial performance with important obligations yet to be fulfilled. The other party can sue the non-performing party for breach of contract if they stop performing the obligations they are required to perform under the contract.

Consideration in an executory contract takes the form of a promise to perform or an obligation. Executory contracts, as their name implies, present a future performance of the consideration. These promises cannot be readily fulfilled right away.

Taking an example of a lease agreement between lessor and lessee, a lease cannot meet all of the conditions immediately. Instead, they have to be met over time. Another example can be when a person decides to give tuition classes to students. Eventually, the person will receive a certain amount of money as a fee when the month begins. As the person must still fulfil his/her promise, the contract is not executed, and, therefore, is an executory contract.

For a deeper understanding of an executory contract, the meaning of the term ‘executory’ shall be understood. The term is defined as follows by Cornell Law School’s Legal Information Institute:

“Something (generally a contract) that has not yet been fully performed or completed and is therefore considered imperfect or unassured until its full execution. Anything executory is started and not yet finished or is in the process of being completed to take full effect at a future time.”

In simple words, these contracts still need to be completed and have not been completed yet.

FindLaw defines an executory contract as:

“Generally includes contracts or leases under which both parties to the agreement have duties remaining to be performed. (If a contract or lease is executory, a debtor may assume it or reject it.)”

Interestingly, according to the above-mentioned legal definition, an executory contract involves an agreement with obligations left to be performed, and any underperformance is considered a breach of the agreement. Because both parties remain obligated to each other, the contract can be considered executory bilateral.

Types of Executory Contracts

Typically, the following are the two types of executory contracts:

Unilateral contracts

This type of contract is one-sided. It typically occurs when only one party makes a promise, which is open for anyone to fulfil. A contract will only come into existence when the promise is fulfilled.

For example, a person lost his watch in a playground. In this case, he decided to offer a reward of Rs 1000/- to anyone who can find and return his watch. Here, only the person is involved in the deal and no other party. When someone finds the bag and returns it, he must pay the stated reward. Therefore, it is a unilateral contract.

Bilateral contracts

Bilateral contracts, on the other hand, involve two parties. A bilateral contract is the most commonly known and encountered type. In this situation, both parties agree to the terms of a contract, thus creating a legal relationship. It is also referred to as a ‘reciprocal contract’.

A time frame to carry out bilateral contracts is usually agreed upon by both parties. Consider, for example, in the case of a house sale contract. Initial down payment is made, and the balance is to be paid at a later date. Ownership of the house passes from the seller to the buyer. The seller agrees to deliver the title in exchange for the sale price. Hence, it is a bilateral contract.

Executory contracts may take many other forms, such as:

Rental lease: In a tenancy agreement, the tenant pays the landlord rent; the landlord provides living space.
Equipment lease: The borrower is responsible for renting the equipment borrowed, and the renter is responsible for providing the equipment.
Development contract: Building owners make payments to contractors when milestones are reached, and contractors perform tasks on behalf of building owners.
Car lease: The consumer pays the dealership lease payments in return for obtaining the car.

Difference between an Executed Contract and an Executory Contract

Different forms of contracts exist, one of which is ones based on performance. This type is determined by whether the contract is complete or still to be completed. In light of this, executed contracts and executory contracts are known as such.

Executed contracts are contracts that have been signed by the parties and thereby become legally binding. A contract is typically enforceable once it is executed. Once that has been done, the parties will have to perform their obligations as outlined in the contract.

Execution of a contract between two or more parties occurs when one or both of the parties has fulfilled their promise to forbear in some way. What it means, in essence, is that whatever terms are stated in the contract have been fulfilled. The contract has, therefore, been said to be executed.

For example, a cup of coffee is bought by someone from a coffee shop, and such a person buys the coffee from the said shop in exchange for cash. Therefore, there has been an executed contract. It has been observed that there has been compliance by both parties.

It is common for promises to be made and then fulfilled immediately after an executed contract is signed. It is often the case when purchasing goods or services. As a rule, the date of execution of the contract is immediate, so there is no confusion about it.

On the other hand, as discussed above, executory contracts are those contracts that specify a future date at which the terms will be met. Once signed, however, both contracts are considered executed agreements. The clauses of the agreement are then must be followed by both parties in accordance with their legal obligations.

Difference between Past, Present (Executed) and Future (Executory) consideration

Section 2(d) of the Act recognises three kinds of consideration, such as past, executed, and executory. The section says that when at the desire of the promisor, the promisee or any other person:

has done or abstained from doing, (the consideration is Past.)
does or abstains from doing, (the consideration is Executed or Present.)
promises to do or to abstains from doing, (the consideration is Executory or Future.)

Past consideration

Any consideration for a promise made in the past is known as past consideration, i.e., the consideration for the promise was given before the promise was given. It is necessary that at the time the act constituting consideration was done, must have been done at the desire of the promisor.

According to English law, past consideration is no consideration. A promise in lieu of a past act is deemed to be the only expression of gratitude for the benefit already received, rather than any consideration motivating the other side to make the promise.

Executed consideration

When one of the parties to the contract has performed his part of the promise, which constitutes the consideration for the promise by another side, it is known as Executed consideration. Performance of the promise by the other side is the only thing now to be done.

For example, a person (suppose Rahul) makes an offer to reward anyone who finds his lost watch and brings the same to him. Another person (suppose Kunal) finds his watch and delivers it back to Rahul. When Kunal does so, that amounts to both the acceptance of the offer, which results in a binding contract under which Rahul is bound to pay the stated amount(reward) to Kunal, and also simultaneously give consideration of the contract. Thus, the consideration, in this case, is ‘Executed’.

Executory consideration

When one person makes a promise in exchange for the promise by the other side, the performance of the obligation by each side to be made subsequent to the making of the contract, the consideration is known as Executory.

For example, Rahul agrees to supply a bulk of goods to Kunal and in return, Kunal agrees to pay for them on a future date, hence, this makes the case for Executory consideration.

Executory Contract under US Bankruptcy Law

In order to determine whether a contract is executory under Section 365(a) of the US Bankruptcy Code and can, therefore, be assumed or rejected, can be a complicated and long process. Continuing obligations under a trademark license agreement are not sufficient to make it executory, according to the Eighth Circuit Court of Appeals in this decision.

In Lewis Bros. Bakeries, Inc. v. Interstate Brands Corp. (In re Interstate Bakeries Corp.), Appellate Case (2014), Interstate Bakeries entered into an asset purchase and trademark licensing agreement with Lewis Bros Bakeries. Lewis Bros bought facilities, equipment, and other tangible assets needed to produce a line of bread products.

The license agreement gave it exclusive rights in the Chicago area for using and marketing certain brand names for those products. The agreements formed a single transaction and made substantial references to one another. A bankruptcy petition filed by Interstate Bakeries sought to convert the licensing agreement into an executory contract. Lewis Bros then argued that the licensing agreement shall not be executory.

A panel of the bankruptcy court, and a district court agreed that this licensing agreement was executory since it required Lewis Bros to achieve specific product quality control standards and limited the geographic area within which it could use the trademarks.

In addition to these requirements, the agreement required Interstate Bakeries not to use those same brands when operating within Lewis Bros territory, to maintain and defend the trademarks, and to report any third-party trademark infringement that occurred.

Furthermore, during its rehearing, en banc, the Court of Appeals reversed the above decision, holding that the licensing agreement was only one part of the transaction and needed to be considered in conjunction with the purchase agreement as part of a single general agreement.

Therefore, the parties had substantially performed their obligations when viewed as a whole under their overall agreement. As a comparison, the remaining obligations that remain for Lewis Bros and Interstate Bakeries after the closing, which mostly prohibit the parties from taking certain actions, rather than obligate them to take any, were simply too small to be considered material.

Executory contracts are so significant in bankruptcy proceedings since the US Bankruptcy Code allows bankruptcy trustees, and debtor-in-possessions, to reject executory contracts or leases if doing so would be in the best interest of the bankruptcy trustee or debtor-in-possession.

A provision that prohibits or restricts such rejections in executory contracts or leases is void. Counterparties to executory contracts and leases with one party in bankruptcy may face the following things:

Financially distressed businesses will sometimes enter into executory contracts or leases with an unknowing counterparty to achieve a strategic advantage. A Chapter 11 proceeding of the US Bankruptcy Code is then filed after the unsuspecting non-debtor counterparty has taken some significant performance or action, and the debtor-in-possession can extract significant modifications to the agreement which is a better solution than rejection.
Upon rejection of an executory lease or contract in bankruptcy, the non-debtor counterparty has only the right to file an unsecured claim for damages. Moreover, the Bankruptcy Code severely limits the number of rent damages that can be claimed for leases of real property, etc.

Indian Courts’ take on an Executory Contract

As a result of the judgement dated May 21, 2020, the High Court of Delhi ruled that the doctrine of frustration under Section 56 of the Indian Contract Act, 1872 (“Act”) is inapplicable to lease contracts since its application is restricted to executory and not executed contracts.

In this case, the following issues were involved:

To what extent does Section 32 of the Act apply to the matter?
Does Section 56 of the Act apply to only executory contracts and not executed contracts?
Whether temporary non-use of the premises will invalidate the lease?

According to the High Court, a landlord-tenant relationship may take on a variety of forms. The relationship is primarily governed by contracts and laws. Contractual terms determine if there is a force majeure clause or if any other condition allows for the waiver or suspension of monthly payments.

The issues will, however, be determined by the law of the state if the contract does not exist at all or there is no force majeure clause. According to Section 32 of the Act, where a pandemic occurs, like the ongoing Covid-19 outbreak, other parties would be able to claim a waiver or non-payment of the monthly amounts under contracts that include a force majeure clause.

Due to the absence of a rent agreement or lease deed between the two parties, the High Court dismissed the appeal as inapplicable under Section 32 of the Act. Consequently, the case falls under the provisions of the Delhi Rent Control Act, 1958, and tenancies do not fall under Section 56 of the Act.

Due to an eviction order against them, the Appellants are not ‘Lessees’. Therefore, the Appellants’ request for suspension of rent is liable to be rejected in so far as it is clear from the submissions made that they are not intending to surrender the leased premises while invoking the doctrine of suspension of rent based on a force majeure event. According to the court, in light of the lockdown, some postponement or relaxation in the schedule of payments may be allowed due to the inability to suspend rent.

In Fertilizers and Chemicals Travancore Limited v. Annam Steels Pvt. Ltd. and Others, the court held that the contract of sale would be created if an offer is accepted as contemplated in Section 5 of the Act.

Generally, a contract of sale is where a seller grants the buyer title to the goods or agrees to grant it to them. It would be considered an agreement to sell the property if the transfer is to be made in the future or subject to certain conditions being met.

As opposed to this, if the goods are transferred, it is a sale. A contract of sale can be viewed as both a completed sale and an agreement to sell. As a simple agreement to sell, a contract may be a mere offer-and-acceptance-based agreement that remains as an executory contract and does not transition into a sale where the goods are transferred to the purchaser.

What happens if you breach an Executory contract?

It may be a breach of contract for either party if it fails to perform its contractual obligations of the prescribed contract. For example, if a person fails to make the required payments as per the executory agreement with a vehicle dealership company, such person is said to have breached the contract. It will then be possible for the dealership to seize her vehicle and pursue civil court action to collect any unpaid payments.

Conclusion

Executory contracts can take several forms, including a franchise agreement, long-term supply contract, etc. However, executory contracts do not usually include a contract that has expired, a sale that has been completed, a promissory note, a single purchase order, etc.

Exclusive licensing and perpetual licensing are sometimes treated more like completed assignments of rights or territories rather than executory contracts. To determine whether or not an agreement is executory, any ongoing obligations of the parties must be taken into account.

Executory contracts are legally enforceable even if the terms of the said contract are not fulfilled immediately. Therefore, it is imperative that you should all your contractual obligations that have been made in the contract. Generally, the use of these contracts is especially beneficial when purchasing the most expensive items. In such a case, it is easier for consumers to pay for items over time instead of having to make one large payment upfront.

References:

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Executory contract : what you need to know

Introduction

Types of contracts under the Indian Contract Act, 1872