Fifth Circuit Rules Surety Bonds Are Not Executory Contracts

As we have reported previously over the years, a key provision in the Bankruptcy Code is Section 365, a lengthy provision that addresses the disposition of executory contracts between the debtor and nondebtors in bankruptcy proceedings. Over many decades, Section 365 has been amended myriad times to address special contracts from real estate leases to equipment to aircraft leases. But the threshold issue that must be addressed by the court remains: Is the agreement at issue an executory contract that is subject to assumption or rejection in bankruptcy cases? In an era when the unprecedented real estate sector boom may be finally coming to an end given rising interest rates and a possible recession, the treatment of surety performance bonds and related agreements may become an area of focus. Surprisingly, until now, no federal circuit court of appeals had adjudicated whether a surety bond agreement is an executory contract. In an opinion issued by the U.S. Court of Appeals for the Fifth Circuit dated Aug. 11, in a case styled In re Falcon V, case no. 21-30668, the court held a surety bond is not an executory contract, and the debtor’s obligations under the bonds could not be enforced.

The Surety Bond Program and Bankruptcy Proceedings

According to the opinion, the debtor and its affiliates were engaged in oil and gas exploration and development. Pursuant to a “surety bond program,” an insurer had issued four irrevocable bonds guaranteeing the debtor’s performance to third parties primarily relating to plugging, abandonment and restoration of oil and gas wells. If the debtor failed to perform its obligations, the insurer would be required to either pay the third party an amount equal to the obligation or perform the obligations itself up to the amount of the bond. The total amount of the bonds was $10,575,000. The debtor was obligated to pay premiums to the insurer and to indemnify the insurer for any payments the insurer had to made under the bonds. The bonds also provided that the insurer’s obligations to the third parties would continue regardless of whether the debtor paid the premiums owed to the insurer.