It is helpful, every now and then, to receive a refresher on basic bankruptcy laws.
We have such a refresher—on executory contract rejection under § 365—in this recent opinion: In re Dandurand, Case No. 24-40401, South Dakota Bankruptcy Court (decided May 23, 2025; Doc. 192).
Facts
Debtor is the sole owner and operator of a Company that manufactures sunflower seeds, kettle potato chips, and pretzels. Company holds two lease-to-own options for the real property on which it operates.
Company has some tough luck:
- a fire burns down Company’s plant—and it takes two years for Company to get the fire insurance money;
- then, Company’s supplier has a listeria outbreak and a national recall—so, Company gets a new supplier but can’t get its products back on the shelves for several years;
- then, Company’s potato chip business starts growing rapidly, which creates cash flow problems; and
- a year later, Company owes over $800,000 to its new supplier, who is pressuring Company for a paydown—threatening a cut off from further supplies.
Private Equity firm wants to purchase Company. Because of increasing financial pressures on Company, negotiations begin.
Private Equity proposes a stock-purchase deal allowing Debtor to retain 10% of Company’s stock. Negotiations continue with Debtor unrepresented by counsel. A stock Purchase Agreement is drafted by Private Equity’s attorney—24 pages long—and is signed by Debtor within 30 minutes after first seeing it.
The Purchase Agreement would transfer 90% of Debtor’s corporate shares in Company to Private Equity in exchange for “$1.00 and other good and valuable consideration.”
The Purchase Agreement document has deficiencies. It, for example:
- does not contain the “Disclosure Schedules Summary” it purports to attach;
- does not include a financing plan that Private Equity is required to provide;
- is not dated;
- has a two-year non-compete restriction on Debtor that begins at closing; and
- contains some garbled language—e.g., Section 2.01 says:
- “…after the last of the conditions to Closing set forth in Error! Bookmark not defined.Error! Reference source not found. have been satisfied or waived.”
Private Equity demands that Debtor get a quitclaim deed from Landlord to the real property. But the lease-to-own options are not transferred to Private Equity.
The Purchase Agreement does not close. So, Private Equity sues Debtor in state court seeking specific performance of the Purchase Agreement.
In response, Debtor files this Chapter 11 bankruptcy. In the bankruptcy:
- Debtor schedules Private Equity as a creditor and as a party to an executory contract—the Purchase Agreement;
- Debtor moves to reject the Purchase Agreement; and
- Private Equity objects.
After an evidentiary hearing and written closing arguments, the Bankruptcy Court rules that the Purchase Agreement qualifies as an “executory contract” that Debtor can reject.
What follows is a summary of the executory contract discussion in the Court’s opinion.
Executory Contract Law
Under §365, the Purchase Agreement can be rejected, if it is an executory contract. This allows Debtor to decide whether the Purchase Agreement is a good deal for the bankruptcy estate.
–Burdens of Proof
Debtor has the burden of proving that rejection of an executory contract is in the best interest of the bankruptcy estate. Then, the burden shifts to Private Equity to prove that Debtor’s proposed rejection is “outside the parameters of what a rational and reasonable informed businessperson might select.”
–Founded on U.S. Constitution
Rejection of an executory contract under § 365 “is an incredibly powerful tool.”
And whether a contract is executory “is a question of federal law,” falling under the U.S. Constitution’s provision that Congress is to establish “uniform Laws on the subject of Bankruptcies throughout the United States.”
–Explained
An executory contract represents both an asset (the debtor’s right to the counterparty’s future performance) and a liability (the debtor’s own obligations to perform).
§ 365(a) enables the debtor in bankruptcy (or its trustee) to decide whether the contract is a good deal for the estate going forward:
- if so, debtor will want to assume the contract, fulfilling its obligations while benefiting from the counterparty’s performance; but
- if not, debtor will want to reject the contract, repudiating any further performance of its duties; and
- the bankruptcy court will generally approve the debtor’s choice, under the deferential “business judgment” rule.
Further, contracts for sale of corporate shares, where the shares were never transferred and payment was never made, can qualify as executory contracts.
Is Debtor’s Purchase Agreement an Executory Contract?
The Eighth Circuit Court of Appeals has adopted the “Countryman” test, which defines an “executory contract” as:
- “a contract under which the obligation of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other.”
–Performance Due on Both Sides
The parties agree that Debtor did not surrender any of Company’s corporate shares to Private Equity, so Debtor did not substantially perform under the Purchase Agreement.
The focus is on Private Equity’s obligations under the Purchase Agreement to determine if it is an executory contract.
–Substantial Performance v. Material Breach
The doctrine of substantial performance applies in determining whether a contract is executory. Substantial performance and material breach are interrelated concepts:
- substantial performance is the antithesis of material breach;
- i.e., if a breach is material, or goes to the essence of the contract, then (i) substantial performance does not exist, and (ii) further performance by the other party is excused.
Under the Countryman definition, the question is whether the obligations of the contracting parties “are so far unperformed” that a failure to complete performance would be a material breach:
- this question requires a comparison of performed obligations with unperformed obligations;
- “substantial performance occurs where less than full and exact performance is rendered, but where there is, nevertheless, sufficient performance to allow the breaching party the benefit of the bargain”; and
- when one party fully performs, the contract is not executory.
Further, courts will apply state law to determine the obligations of the parties to the contract which remain unperformed. In doing so:
- the courts look to the terms of the contract to determine whether each party’s obligations are materially breached or substantially performed;
- when a contract is clear and unambiguous and speaks to a subject, there is no need to go beyond the four corners of the contract—but when the language is ambiguous, the courts can look at other evidence to determine intent; but
- a contract “is not rendered ambiguous simply because the parties do not agree upon its proper construction.”
–Private Equity’s Performance?
Private Equity argues that the Purchase Agreement obligations are unambiguous and that Private Equity has substantially performed:
- that all Private Equity needed to do, to substantially perform, was pay Debtor the $1.00 purchase price and waive its own requirement of due diligence; and
- Private Equity has done both things.
The Court rejects such argument because Private Equity’s obligations under the Purchase Agreement are much greater, are substantial, and remain unperformed. For example, Private Equity:
- failed to formulate a financing plan for the Company; and
- failed to obtain control of the real estate before the Petition date.
–$1.00 Consideration?
The Court rejects Private Equity’s idea that it is entitled to purchase—for $1.00—90% of Debtor’s stockholder interest in Company
Debtor argues that the Purchase Agreement specifies “other good and valuable consideration”—beyond the $1.00—as part of the purchase price.
Debtor testifies that “other good and valuable consideration” includes Private Equity’s duty to quickly pay, (i) $500,000 to Debtor’s supplier, and (ii) debts owed to other vendors.
In testimony from it’s representatives, Private Equity acknowledges:
- knowing that $1.7 million was Debtor’s opening demand during negotiations;
- knowing, before signing the Purchase Agreement, about the options to purchase real estate;
- viewing acquisition of the real estate as an essential part of the transaction;
- knowing that only Company could exercise the real estate options;
- knowing that the real estate was worth twice as much as the $1,037,000 buyout owed to Landlord; and
- knowing that Company had grossed $10 million in revenue the previous year.
–Court Findings & Conclusions
The Court finds that the actual purchase price for the 90% stockholder interest is substantially greater than $1.00, adding that:
- Private Equity has never pointed to any part of the Purchase Agreement that defines “other good and valuable consideration”;
- it is unreasonable to suggest that Debtor’s $1.7 million purchase price offer would drop to $1.00 a few hours later that day; and
- the parties clearly intended the actual purchase price to be substantially greater than $1.00.
Regarding evidence, the Court declares:
- Debtor’s testimony is “more credible” than the testimony of Private Equity’s witnesses;
- the terms and provisions of the Purchase Agreement are “unclear and ambiguous in multiple sections”—allowing the Court to consider extrinsic evidence to interpret the Purchase Agreement; and
- since Private Equity drafted the Purchase Agreement, any ambiguity is to be construed against Private Equity and in favor of Debtor.
The Court finds:
- Debtor did not substantially perform under the Purchase Agreement, nor did Private Equity—i.e., both parties materially breached the Purchase Agreement; and
- so, Debtor may reject the Purchase Agreement.
–Business Judgment Test
The final question is whether Debtor’s rejection of the Purchase Agreement is proper under the business judgment test.
In the Eighth Circuit, the business judgment test initially requires the exercise of a sound business judgment showing benefit to the bankruptcy estate. The burden lies with Debtor to show such benefit; then, (absent a finding of bad faith or gross abuse of discretion) the Court will not interfere with Debtor’s business judgment.
In this case, (i) Debtor exercised sound business judgment by rejecting the Purchase Agreement, and (ii) such rejection is in the best interest of the bankruptcy estate. That’s because:
- Company is currently operating;
- Debtor has proposed a viable plan to continue paying creditors in full, using income from Company;
- Company has a past annual revenue of $10 million;
- Company has equity in real estate of over $1 million;
- with the rejection, Debtor will (i) retain 100% of Company’s unencumbered corporate shares, and (ii) continue receiving a salary from Company; and
- Debtor will be able to pay creditors under a plan of reorganization.
Therefore, the Court concludes:
- Debtor may reject the Purchase Agreement; but
- the rejection creates a pre-petition claim for Private Equity against Debtor; and
- the Court may determine Private Equity’s rejection claim as part of the bankruptcy process.
The Court’s ruling is, of course, on appeal.
Conclusion
Here is a “Thank you” to the In re Dandurand Court for its refresher on executory contract rejection laws under § 365.
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