Executory Contracts After Tempnology

What Rejection Leaves Behind: Counterparty Rights Under § 365

Every rejection fight now starts from the same premise: "A rejection breaches a contract but does not rescind it. And that means all the rights that would ordinarily survive a contract breach, including those conveyed here, remain in place." After rejection "the counterparty retains the rights it has received under the agreement," and the rejection-as-breach rule "prevents a debtor in bankruptcy from recapturing interests it had given up" — an application of the axiom that "[t]he estate cannot possess anything more than the debtor itself did outside bankruptcy" Mission Product Holdings, Inc. v. Tempnology, LLC, 587 U.S. 370 (2019). The debtor can stop performing; what it cannot do is claw back what it already conveyed.

Negative covenants are where the rule bites hardest. PIRTEK USA, LLC v. Lager, No. 22-03042 (Bankr. N.D. Tex. Aug 11, 2022) let enforcement of a rejected settlement’s non-disparagement and confidentiality clauses proceed: "Merely refraining from action, as in the case of complying with the restrictive covenants at issue here, does not constitute affirmative performance under a contract," and courts have found that such compliance "does not constitute a debt or claim subject to discharge and that the restrictive covenant survives rejection." The remedy survives too — § 101(5)(B) "does not require creditors entitled to an equitable remedy to select a suboptimal remedy of money damages," and under the governing state statute, "[n]ot only is injunctive relief available under Fla. Stat. § 542.335, it is the preferred remedy."

But equitable relief is not automatic; sometimes rejection converts it to cents on the dollar. Mitsuwa Corp. v. Orama Hospitality Grp., Ltd., 601 B.R. 340 (Bankr. D.N.J. 2019) held that "the state law equitable remedy of specific performance falls within the Code’s definition of a ‘claim’" because "Congress anticipated that parties might have equitable remedies based on a debtor’s breach of an executory contract and provided a mechanism to convert those equitable remedies to claims for money." Where "a party’s right to an equitable remedy can be satisfied by monetary damages, a claim is a proper alternative," and "[s]pecific performance should not be permitted where the remedy would in effect do what § 365 meant to avoid, that is, impose burdensome contracts on the debtor" — so the counterparty’s repurchase option was reduced to a proof of claim, not a turnover order.

The operative line runs between rights the counterparty already holds and performance it still needs from the debtor. Licenses, property interests, and duties to refrain ride through rejection and can support an injunction; obligations that require the estate to act or spend convert to pre-petition claims. Counterparties should frame the surviving right as negative or possessory and be ready to show, under state law, why damages cannot substitute — debtors should show the opposite.