The Bankruptcy Code does not provide a definition of the term “executory contract.” The majority of courts apply the “Countryman test” to determine if a contract is executory, which provides that a contract is executory if the obligations of both the debtor and the other contracting party are so far unperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other. See Countryman, Executory Contracts in Bankruptcy, 57 Minn. L. Rev. 439, 446 (1973); In re U.S. Wireless Data, Inc., 547 F.3d 484, 488 n.1 (2d Cir. 2008); Cameron v. Pfaff Plumbing & Heating, Inc., 966 F.2d 414, 416 (8th Cir. 1992); Sharon Steel Corp. v. Nat’l Fuel Distribution Corp., 872 F.2d 36, 39 (3d Cir. 1989); Collingwood Grain Inc. v. Coast Trading Inc. (In re Coast Trading Co.), 744 F.2d 686, 692 (9th Cir. 1984).
With respect to option agreements, the courts are split as to whether such contracts are executory. The majority of courts have held that unexercised options are executory contracts. See Colliers on Bankruptcy, 365.02[2][b] (16th. ed 2012); see also In re AbitibiBowater, Inc., 418 B.R. 815, 830-31 (Bankr. D. Del. 2009) (noting that “[n]umerous other courts have determined that contingent option agreements are executory when material obligations will arise on each side if the option is exercised.”); In re Kellstrom Indus., 286 B.R. 833, 834-835 (Bankr. D. Del. 2002) (citing majority-view cases); In re Simon Transportation Servs., 292 B.R. 207, 219-20 (Bankr. D. Utah 2003) (option contracts are executory); In re Elkowni, 318 B.R. 605, 608 (Bankr. M.D. Fla. 2004) (holding that option contract is executory under Countryman standard); In re Riodizio, Inc., 204 B.R. 417, 423 (Bankr. S.D.N.Y. 1997) (noting that “[m]ost courts . . . consider an option contract to be executory”); In re Hardie, 100 B.R. 284, 286-87 (Bankr. E.D.N.C. 1989) (stating that “option contracts are generally executory contracts until the option is exercised” and holding that option contract at issue is executory); In re A.J. Lane & Co., Inc., 107 B.R. 435, 437 (Bankr. D. Mass. 1989) (holding that option contract is executory under Countryman standard); Carlisle Homes, Inc. v. Azzari (In re Carlisle Homes), 103 B.R. 524, 535 (Bankr. D.N.J. 1988) (holding that option contract at issue is executory); In re G-N Partners, 48 B.R. 462, 466 (Bankr. D. Minn. 1985) (option contracts are generally executory until the option is exercised); and In re Waldron, 36 B.R. 633, 636-37 (Bankr. S.D. Fla. 1984), rev’d on other grounds, 785 F.2d 936 (11th Cir. 1986) (option contract was an executory contract which could be rejected under section 365). In re Hardie, 100 B.R. 284 (Bankr.E.D.N.C.1989), ruled that a purchase option that had not been executed was an “executory contract” subject to rejection by the debtors who were prospective vendors. See also, In re G-N Partners, 48 B.R. 462 (Bankr.D.Minn.1985); In re A.J. Lane & Co., 107 B.R. 435 (Bankr.D.Mass.1989); and In re Riodizio, Inc., 204 B.R. 417 (Bankr.S.D.N.Y.1997).
Unsecured Creditors’ Committee v. Southmark Corp. (In re Robert L. Helms Constr. & Dev. Co., Inc.), 139 F.3d 702, 706 (9th Cir.1998) rejected the proposition that options are, by definition, executory contracts. This case involved a debtor which retained an option to buy back certain real estate. The debtor’s plan provided that all executory contracts not listed were deemed rejected. The Notice of Assumption the debtor filed did not list the option. So if the option was executory, it would have been deemed rejected.
The court started its analysis by noting that a contract is executory if “the obligations of both parties are so unperformed that the failure of either party to complete performance would constitute a material breach and thus excuse the performance of the other.” For paid-for but unexercised options, this definition presents a problem. This is due to the fact that with an option, each side might have unperformed obligations, but they are contingent on the optionee’s decision to exercise the option. If it does, the optionor has a duty to deliver the property, and the optionee may have a duty to tender payment, depending on the mechanics of the option. But if the option is not exercised, nothing happens and neither party commits a breach. Id. at 706. The court stated that the appropriate analytical approach was the following:
[W]e look to outstanding obligations at the time the petition for relief is filed and ask whether both sides must still perform. Performance due only if the optionee chooses at his discretion to exercise the option doesn’t count unless he has chosen to exercise it. An option may on occasion be an executory contract, for instance, where the optionee has announced that he is exercising the option, but not yet followed through with the purchase at the option price.
The question thus becomes: at the time of filing, does each party have something it must do to avoid materially breaching the contract? Typically, the answer is no; the optionee commits no breach by doing nothing.
Id.at 706. See also, In re Bergt, 241 B.R. 17 (Bankr.D.Alaska1999) (nondebtor’s unexercised right of first refusal to purchase real property of debtor was not executory contract).
In In re National Financial Realty Trust, 226 B.R. 586 (Bankr.W.D.Ky.1998), the option agreement at issue was entered into by Chenoweth-Massie Partnership and the debtor. Post-petition, the debtor assigned the option to one Barnett. Upon Barnett’s attempt to exercise the option, Chenowith-Massie refused to comply arguing that the option agreement had terminated. Chenowith-Massie took the position that the option agreement was an executory contract that was not assumed, but rather rejected. Consequently, the assignment of the agreement to Barnett and his subsequent purported exercise of the option were without effect.
The court noted that an option agreement, which has been paid for but which remains unexercised at the time of the bankruptcy action, presents a slight twist on the ordinary contract. While each side may have unperformed obligations, they are contingent on the optionee’s decision to exercise the option. The unperformed obligations become due if, and only if, the optionee exercises the option. If the optionee does exercise the option, the duty then, at that point in time, arises on behalf of the optionor to deliver the property, and thus a reciprocal duty on behalf of the optionee to tender payment. Accordingly, if the option is not exercised, the unperformed obligations never become due and neither party commits a breach.
The contingent nature of the obligations arising from the option agreement make them distinguishable from the typical contract. The court stated that it needs to determine whether the option required further performance from each party at the time the petition was filed. Typically, the answer is no, as the optionee has generally fulfilled its only true obligation under the option by paying for it. Having fully performed its obligation, the optionee is literally incapable of breaching the agreement. The only unperformed part of the option agreement is the optionor’s obligation to keep the option open during the option period. Consequently, the agreement cannot be an executory contract as performance is due only by one side. The creation of any further obligations lies within the sole discretion of the optionee. See also, In re Robert L. Helms Constr. and Devel. Co, 139 F.3d 702, 705 (9th Cir.1998); In re America West Airlines, Inc., 179 B.R. 893, 896 (Bankr.D.Ariz.1995); and In re Giesing, 96 B.R. 229, 232 (Bankr.W.D.Mo.1989).
In In re Millennium Super Stop II, LLC, 569 B.R. 331 (Bankr.W.D.Mo.2017), a debtor moved to reject an amended option agreement as an executory contract and also sought leave to sell the effected property free and clear of the option rights possessed by its lessee/optionee. That court determined that under the Countryman test, when debtor breached the contract prior to bankruptcy by failing to perform under the option, the option was no longer executory for purposes of Section 365. Here, the optionee had fully performed under the option to the extent possible given debtor’s failure to perform and breach of the option. The optionee thus has no further duty to perform but rather holds a claim against debtor and the contract is no longer executory for purposes of Section 365. The court then went on to note, in the alternative, as follows:
Notwithstanding any of the above discussion, even if the contract option is executory and subject to rejection, [the optionee] is entitled to the protection of §365(i) which provides that [the optionee] has the right to retain possession of the Property. Section 365(i) provides that if the trustee rejects an executory contract for the sale of property and the purchaser is in possession, such purchaser may treat such contract as terminated, or may remain in possession of such real property. If the purchaser remains in possession, the purchaser shall continue to make all payments due under the contract, but may offset against such payments any damages caused by nonperformance of any obligation of the debtor. Further, §365(i)(2)(B) requires that the trustee shall deliver title to the purchaser in accordance with the provisions of the contract.
Id. at 339.
In In re Orama Hospitality Group, Ltd., 501 B.R. 340 (Bankr.D.N.J.2020), the option was a repurchase option associated with a liquor license. Here, the option had not been exercised prepetition, and remained open. In this regard, the court noted that an option may be an executory contract where the optionee has announced that it has exercised the option but not yet followed through with the purchase at the option price. Id. at 347. The court found the repurchase option executory, explaining as follows:
The repurchase option had not yet been exercised when the Debtor filed its bankruptcy petition. Even if the option had been exercised, the transfer of the license had not occurred. Section 13(b) of the CFS provides: “Both parties will fully cooperate so the closing can take place as soon as practicable following the exercise of the option. Thus, even if Mitsuwa had exercised the option pre-petition, both parties still had contractual duties to facilitate the transfer of the license which would have required commitments of time and money in the transfer process. If either party did not fulfill its duties, it would have been in material breach of the option to repurchase the license.
Id, at 347.
Matthew T. Gensburg
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