When you file bankruptcy, a court-appointed trustee takes control of your assets, including outstanding contracts. The trustee, under court oversight, manages and controls your estate during the court proceedings. A judge must ultimately sign a final order closing the estate and approving the disposal of all assets and distributions.
Executory contracts are agreements that run into the future. For example, a one year apartment lease is executory because rents are due for a year after signing. A bankruptcy judge can approve the cancellation of your executory contracts meaning you do not have to fulfill your bargains. For example, the judge can allow you to legally break your one year apartment lease. The judge can also affirm executory contracts meaning your contracts stay in place despite the fact you have filed bankruptcy. A bankruptcy judge cannot force the counter-parties to your contracts to renegotiate terms, nor can he force them to accept newly modified terms.
Business Judgment Rule
The bankruptcy court must approve all contract cancellations and affirmations. Generally, the trustee must convince the judge it is in your best financial interests to affirm, or cancel, your contracts through bankruptcy. The judge uses the business judgment rule test when deciding whether to cancel or affirm your contracts. The overall goal of the business judgment rule is to consider the specific circumstances in your case when deciding what makes the most sense for your financial future.
Many contracts have clauses stating if parties file bankruptcy the agreements automatically terminate. For example, it is common to see a contract with language such as, "This agreement shall terminate, without notice, if either party files bankruptcy proceedings." Such clauses are not enforceable in bankruptcy court. Therefore, even if you see an automatic termination clause in an agreement, a bankruptcy judge has the power to affirm it and hold your co-party to its terms.