Stites & Harbison, PLLC

When the purchaser of goods or services under an executory contract with a non-debtor files bankruptcy, can the non-debtor party cease performance without violating the automatic stay? There is a stay violation risk based on court statements such as this statement:

During the post-petition and pre-acceptance period, an executory contract remains in existence and is enforceable by, but not against, the debtor-in-possession (citations omitted). Until an executory contract has been rejected, generally a non-debtor must continue to perform.

In re Pittsburgh-Canfield Corp., 283 B.R. 231 (Bankr. N.D. Ohio 2002). The court in In re Lucre, Inc., 339 B.R. 648, 659-660 (Bankr. W.D. Mich. 2006), however, offers non-debtor providers a much needed legal basis for insisting upon their contract rights:

What is pertinent to the other contracting party in a bankruptcy proceeding is the circumstances under which that party must continue to perform post-petition. Contract law, not Section 361, answers that question. Put simply, it is not enough for the trustee or debtor in possession to adequately provide for whatever post-petition performance the other party is to furnish under the executory contract. If there is also a material pre-petition breach by the debtor, for the pre-petition breach in and of itself justifies continued non-performance by the other party regardless of what the debtor may offer as post-petition "adequate protection." The trustee or debtor in possession must also cure the pre-petition default as part of a Section 365 assumption of the executory contract if it is to regain its right to demand performance from the other party. . . The mere commencement of the bankruptcy case and the attendant imposition of the automatic stay do not by themselves empower a debtor, as debtor-in-possession, to compel from the other party to an executory contract performance the day after the commencement of the bankruptcy case when the debtor had no right to compel that performance the day before. Consequently, it is illogical to contend that the non-debtor party's justifiable refusal to perform under an executory contract post-petition is somehow a violation of the automatic stay.

The court finds that if the debtor is in default pre-petition, then the non-debtor does not violate the stay by not performing. The case involves a substantial, admitted payment default. Other, lesser defaults might lead to different result. It makes sense to file a prophylactic stay relief motion (as the non-debtor did in Lucre). If the non-debtor does not perform without seeking a court declaration that it is not obligated to do so, and it turns out there is no default and that the failure to perform injured the debtor's operations, the liability of the non-debtor could be significant.