Assumption Under Section 365(c)(1) Creates Uncertainty for Debtors

(Excerpt) 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