In this bankruptcy matter, we must decide whether certain terms in a class action settlement agreement constitute an executory contract under 11 U.S.C. Sec. 365 (1988). The Internal Revenue Service contended the settlement agreement was not an executory contract. Both the bankruptcy court and the district court1 agreed with the IRS, and the class members appealed. We will affirm.

The facts are undisputed. Columbia Gas System, Incorporated, its subsidiary, Columbia Gas Transmission Corporation (TCO), and their affiliates comprise a natural gas system which explores, produces, purchases, stores, transmits, and distributes natural gas. TCO is Columbia Gas System's principal gas purchaser from producers in the Southwest, Midcontinent, and Appalachia and operates extensive underground storage facilities.

On July 26, 1985, Enterprise Energy Corporation and two other companies filed a class action against TCO in the United States District Court for the Southern District of Ohio. The district court certified as a class2 the producers of natural gas in the Appalachian region who were parties to gas purchase contracts with TCO. The class comprised 2163 member producers who held 852 gas purchase contracts. TCO had invoked a price reduction under a cost recovery clause which formed the basis of their complaint.

The gas purchase contracts set the price for each unit of natural gas delivered to TCO at the maximum price permitted under the Natural Gas Policy Act of 1978 during the month of delivery. The class members alleged that TCO breached their gas purchase contracts by paying less than the maximum price after it invoked the cost recovery clause.

For five years there was extensive discovery. As trial loomed, the parties entered into a Stipulation of Proposed Class Action Settlement ("settlement agreement"), which the district court approved on June 18, 1991. Enterprise Energy Corp. v. Columbia Gas Transmission Corp., 137 F.R.D. 240 (S.D.Ohio 1991). Incidental to its approval under Federal Rule of Civil Procedure 23(e), id. at 248, the court issued an order stating in part:

f. Named plaintiffs, Class Members and defendant [TCO] shall now consummate and be bound by the Settlement.

g. Except for claims arising under the Settlement on behalf of Class Members or Columbia, and at such time as this Order of the Court approving the Settlement as final is non-appealable, named plaintiffs and all Class Members ... shall be deemed to release and forever discharge the defendant ... from any and all claims of the type asserted in this litigation relating to defendant's exercise of the cost recovery clause contained in the Class Members' gas purchase contracts at any time during the period commencing on or about July 10, 1985 and ending on or about July 10, 1991.

h. Jurisdiction is hereby retained as to matters related to the interpretation, administration and consummation of the Settlement as approved in this Order.

Id. at 252. The order became final and unappealable on July 18, 1991.

The settlement agreement required TCO to deposit $30 million into an escrow account "in settlement of, and as a full and complete discharge and release of TCO, for all of [the class members'] claims arising on or before January 1991." Enterprise Energy Corp. v. United States ex rel. IRS (In re Columbia Gas System, Inc.), 146 B.R. 106, 109 (D.Del.1992). TCO was to pay $15 million into escrow by March 21, 1991, and the other $15 million by March 23, 1992. This schedule was apparently set for TCO's convenience; TCO's duty to make the second payment was not contingent on the class members' performance of any of their obligations. TCO paid the first $15 million on time but then filed for bankruptcy.

Under the settlement agreement, class members were entitled to receive their share of the escrow monies only after they executed a release of claims and a supplemental contract. The settlement agreement stated "payments to individual Class Members out of the escrowed amounts will be contingent upon receipt by [TCO] of a duly executed release of all such Claims and a duly executed contract supplement...." J.App. at 57-58. While each class member had to execute a release to get payment from the escrow fund, the claims each held against TCO were to be extinguished (and they in fact were, see supra, district court order p g) by the court order accepting the settlement agreement.

The supplemental contracts were designed to implement amendments and clarifications of pricing and other terms concerning future gas deliveries to TCO. The settlement agreement established the terms of these contracts, including increasing the price TCO would pay to the class members. Because many class members relied on TCO as the principal purchaser of their gas, the supplemental contracts were important to them, a point made in the following exchange at oral argument before the district court:

The Court: So that ... supplying the supplemental agreements, contracts, was not just an option that [the class members] had. It was necessary for their continued operation?

[Counsel for the Class]: Exactly, your honor. Exactly.

Id. at 276.

By July 31, 1991, the class members involved in forty-one of the purchase contracts had completed the execution of the release and supplemental contracts and were entitled to their share of the escrow monies. But on that day, thirteen days after the settlement agreement had become final, TCO filed a voluntary Chapter 11 petition in bankruptcy in Delaware. On February 20, 1992, the class members filed a motion to compel TCO to assume or reject the settlement agreement under the Bankruptcy Code, 11 U.S.C. Sec. 365.3 TCO and the class members had agreed that TCO would assume the settlement agreement and jointly filed a proposed order.

After notice of the proposed order was sent to the proper parties, the United States filed an objection on behalf of the Internal Revenue Service, one of TCO's creditors.4 Finding the settlement agreement was not executory within the meaning of 11 U.S.C. Sec. 365, the bankruptcy court upheld the objection and denied the class members' motion.5

The class members appealed to the United States District Court for the District of Delaware. The district court held that the settlement agreement was a contract, but affirmed the bankruptcy court on the grounds the contract was not executory for purposes of Sec. 365. In re Columbia Gas, 146 B.R. at 113-14. Therefore TCO did not have the option of assuming or rejecting the settlement agreement. Id. at 114. This appeal followed.

We "exercise plenary review of the legal standard applied by the district and bankruptcy courts, but review the latter court's findings of fact on a clearly erroneous standard." In re Abbotts Dairies, Inc., 788 F.2d 143, 147 (3d Cir.1986) (citations omitted). "Because in bankruptcy cases the district court sits as an appellate court, our review of the district court's decision is plenary." Brown v. Pennsylvania State Employees Credit Union, 851 F.2d 81, 84 (3d Cir.1988); see also Universal Minerals, Inc. v. C.A. Hughes & Co., 669 F.2d 98, 101 (3d Cir.1981).

Jurisdiction in the bankruptcy court was proper under 28 U.S.C. Sec. 157(a) (1988). The district court had jurisdiction over the appeal from the final order of the bankruptcy court, id. Sec. 158(a), and we have jurisdiction over the appeal of the district court's judgment under 28 U.S.C. Sec. 158(d).

In this appeal, we must decide whether the settlement agreement was a contract, and if so, whether it was executory so that TCO could elect to assume or reject it under Sec. 365 of the Bankruptcy Code.

The IRS argues the settlement agreement is not a contract but a judgment of the court.6 It maintains "[s]ince the Settlement Agreement was merged into the court's judgment, it cannot be an executory contract within the meaning of Bankruptcy Code Section 365." Appellee's Br. at 32. The bankruptcy court apparently agreed, observing "there is authority to the effect that the phrase 'executory contract' should not normally be applied to a judicial order." J.App. at 178. While the bankruptcy court did not explicitly hold the agreement was a judgment, the cases it cited7 hold that where contracts have been reduced to judgment there is no "contract" remaining for purposes of Sec. 365. The district court, however, distinguished those cases, holding "[f]or bankruptcy purposes ... it is appropriate to treat the judicially approved settlement agreement in this case as a contract." In re Columbia Gas, 146 B.R. at 113.

At the outset, we should ask whether this settlement agreement would be considered a contract had there been no bankruptcy. Generally, application of the Bankruptcy Code does not change the attributes of a given legal relationship. Butner v. United States, 440 U.S. 48, 99 S. Ct. 914, 59 L. Ed. 2d 136 (1979). Thus, if the settlement agreement should be considered a contract under relevant nonbankruptcy law, it will be a contract in bankruptcy "[u]nless some federal interest requires a different result...." Id. at 55, 99 S.Ct. at 918.

Although settlement agreements may be judicially approved, they share many characteristics of voluntary contracts and are construed according to traditional precepts of contract construction. cf. Fox v. United States Dep't of Housing & Urban Dev., 680 F.2d 315, 319 (3d Cir.1982) (observing this point for consent decrees). In a nonbankruptcy context, we have treated a settlement agreement as a contract. See Halderman v. Pennhurst State Sch. & Hosp., 901 F.2d 311, 318 (3d Cir.), cert. denied, 498 U.S. 850, 111 S. Ct. 140, 112 L. Ed. 2d 107 (1990).

We see nothing special in this bankruptcy that counsels a different approach. The core of this settlement agreement was consensual obligations. The parties crafted the agreement and the court approved it. There is no judgment on the merits, a factor that distinguishes cases cited by the bankruptcy court. Furthermore, the rights and obligations of the parties do not derive solely from the court's judgment, but depend at least in part on the performance of the other party. What is especially significant in this case is that there remains an agreement that the debtor can breach which could give rise to a claim against it. Although we recognize that not all settlement agreements should be considered contracts, we believe the factors already enumerated are sufficient to consider this settlement agreement as a contract for purposes of Sec. 365. In this respect, we agree with the district court.

The heart of this dispute is whether the settlement agreement was executory on July 31, 1991, when TCO filed its bankruptcy petition. The term "executory contract" is not defined in the Bankruptcy Code, and the phrase does not indicate its intended scope.

The legislative history of Sec. 365 suggests a broad reading of "executory." Congressional reports stated "[t]hough there is no precise definition of what contracts are executory, it generally includes contracts on which performance remains due to some extent on both sides." H.R.Rep. No. 595, 95th Cong., 1st Sess. 347 (1977), reprinted in 1978 U.S.C.C.A.N. 5787, 5963, 6303; S.Rep. No. 989, 95th Cong., 2d Sess. 58 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5844.

Most courts have agreed that the definition suggested by the legislative history would cut too broadly, "since it is the rare agreement that does not involve unperformed obligations on either side." Mitchell v. Streets (In re Streets & Beard Farm Partnership), 882 F.2d 233, 235 (7th Cir.1989). As one commentator observed, "[a]ll contracts to a greater or less extent are executory. When they cease to be so, they cease to be contracts." Vern Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn.L.Rev. 439, 450 (1973) (citation omitted).

The language and legislative history of Sec. 365 having proved unavailing, courts and commentators sought to analyze the purpose of Sec. 365 in order to formulate a definition of "executory contract." Executory contracts in bankruptcy are best recognized as a combination of assets and liabilities to the bankruptcy estate; the performance the nonbankrupt owes the debtor constitutes an asset, and the performance the debtor owes the nonbankrupt is a liability. See Thomas H. Jackson, The Logic and Limits of Bankruptcy Law 106-07 (1986). The debtor (or trustee that has stepped into the debtor's shoes) may elect to assume an executory contract, in which case Sec. 365 mandates that the debtor accept the liability with the asset and fully perform his end of the bargain. 11 U.S.C. Sec. 365(b).

The debtor will assume an executory contract when the package of assets and liabilities is a net asset to the estate. When it is not the debtor will (or ought to) reject the contract. 11 U.S.C. Sec. 365(a). Because assumption acts as a renewed acceptance of the terms of the executory bargain, the Bankruptcy Code provides that the cost of performing the debtor's obligations is an administrative expense of the estate, which will be paid first out of the assets of the estate.8 11 U.S.C. Sec. 507(a)(1) (1988); University Medical Ctr. v. Sullivan (In re University Medical Ctr.), 973 F.2d 1065, 1078 (3d Cir.1992).

In cases where the nonbankrupt party has fully performed, it makes no sense to talk about assumption or rejection. At that point only a liability exists for the debtor--a simple claim held by the nonbankrupt against the estate, Jackson, supra, at 106--and "[t]he estate has whatever benefit it can obtain from the other party's performance and the trustee's rejection would neither add to nor detract from the creditor's claim or the estate's liability." Countryman, supra, at 451. Rejection is meaningless in this context, and assumption would be of no benefit to the estate, serving only to convert the nonbankrupt's claim into a first priority expense of the estate at the expense of the other creditors.9 Id. at 452.

Likewise, if the debtor has fully performed, the performance owed by the nonbankrupt is an asset of the bankruptcy estate and should be analyzed as such, not as an executory contract. Jackson, supra, at 107. Rejection of the contract at this point is no different from abandonment of property of the estate, an action taken only when the property is "burdensome to the estate or ... is of inconsequential value and benefit to the estate." 11 U.S.C. Sec. 554(a) (1988).

These considerations led us to adopt, as have many courts of appeals, the following definition of executory contract for purposes of Sec. 365: "[An executory contract is] 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 performance of the other." Sharon Steel Corp. v. National Fuel Gas Distrib. Corp., 872 F.2d 36, 39 (3d Cir.1989) (citing cases).

Thus, unless both parties have unperformed obligations that would constitute a material breach if not performed, the contract is not executory under Sec. 365. When it is the nonbankrupt party who has substantially performed so that its failure to complete performance would not constitute a material breach excusing performance of the debtor,10 the nonbankrupt party is "relegated to the position of a general creditor of the bankrupt estate." Marcus & Millichap Inc. v. Munple, Ltd. (In re Munple, Ltd.), 868 F.2d 1129, 1130 (9th Cir.1989). The time for testing whether there are material unperformed obligations on both sides is when the bankruptcy petition is filed. Collingwood Grain, Inc. v. Coast Trading Co. (In re Coast Trading Co.), 744 F.2d 686, 692 (9th Cir.1984) (holding contracts executory at time of petition can be assumed); Carlson v. Farmers Home Admin. (In re Newcomb), 744 F.2d 621, 624 (8th Cir.1984) (stating critical time to be when the petition was filed).

As we have noted, at stake is the relative priority11 of the claims of the IRS and the class members to TCO's assets in bankruptcy. If the contract is executory, TCO would assume it, and the $15 million TCO still owes would become an administrative expense of the estate. As an administrative expense, the class members' claims would fall into the category afforded highest payment priority. 11 U.S.C. Sec. 507(a)(1); University Medical Ctr., 973 F.2d at 1078. If the contract is not executory, the class members would have a general unsecured claim and would have lowest payment priority, and would be paid after the IRS's claim, which is seventh in priority regardless of the outcome of this dispute. 11 U.S.C. Sec. 507(a)(7) (1988).12

The contract was clearly executory on TCO's side when it filed for bankruptcy, a point both parties appear to accept. It had not paid the second $15 million into escrow, nor had it completed the administrative work necessary to authorize distribution of the escrow monies to those class members who had signed and executed releases and supplemental contracts. While the administrative details TCO still had to perform are arguably non-material (an issue we need not reach), the $15 million payment is unquestionably a material obligation,13 and TCO's failure to make the second payment certainly would constitute a material breach.

The materiality of the class members' unperformed obligations is a closer question. As we have noted, the obligations on both sides must be so far unperformed so that failure of either to complete performance would constitute a material breach excusing performance of the other. The class members had unperformed duties under the settlement agreement. Only 41 of the 852 contracts had been processed when TCO filed for bankruptcy, and the class members responsible for the remaining 811 contracts still had to execute releases and supplemental contracts in order to receive their shares of the escrow fund. It must be the contention of the class members that these obligations are sufficiently material that failure to perform would constitute a material breach of the agreement by the class members.14

In order to determine the materiality of the class members' obligations, we turn first to basic contract principles. There is a distinction in the law between failure of a condition15 and a breach of a duty: "Non-occurrence of a condition is not a breach by a party unless he is under a duty that the condition occur." Restatement (Second) of Contracts Sec. 225(3) (1981).16 This distinction between a condition and a duty (or promise) is important here. The Restatement makes clear that while "a contracting party's failure to fulfill a condition excuses performance by the other party whose performance is so conditioned, it is not, without an independent promise to perform the condition, a breach of contract subjecting the nonfulfilling party to liability for damages." Merritt Hill Vineyards, Inc. v. Windy Heights Vineyard, Inc., 61 N.Y.2d 106, 472 N.Y.S.2d 592, 460 N.E.2d 1077, 1081-82 (1984) (citing Restatement (Second) of Contracts Sec. 225). In this case, if the remaining obligations in the contract are mere conditions, not duties, then the contract cannot be executory for purposes of Sec. 365 because no material breach could occur.

The determination whether a contract term is a promise or condition is a problem of interpretation, so that "each case turns on its own facts...." E. Allen Farnsworth, 2 Farnsworth on Contracts Sec. 8.4, at 366 (1990). We are mindful that:

Interpreting a settlement agreement presents a question of contract law, in which [t]he primary object ... is to give effect to the intention of the parties. Absent clear language in the settlement agreement to resolve a dispute over the proper construction of a contract, a court may go outside the four corners of the contract and consider extrinsic and parol evidence presented by the parties. This requires the district court to then conduct fact-finding so that it may resolve the ambiguities inherent in the contract.... [But i]f the court finds that a contract is ambiguous and that extrinsic evidence is undisputed, then the interpretation of the contract remains a question of law for the court to decide.

Lumpkin v. Envirodyne Industries, Inc., 933 F.2d 449, 455-56 (7th Cir.), cert. denied, 502 U.S. 939, 112 S. Ct. 373, 116 L. Ed. 2d 324 (1991) (citations omitted).1.

With these principles in mind, we turn first to an analysis of the releases and then to the contract supplements. If a class member declined to execute a release, the settlement agreement provides that TCO retains that class member's portion of the $30 million. But the class member's cause of action against TCO on the gas purchase contract would not be revived. All such claims were extinguished when the district court's order became final on July 18, 1991.17

The language of the settlement agreement makes clear the parties intended to make execution of the releases a condition of payment rather than a duty: "[P]ayments to individual Class Members out of the escrowed amounts will be contingent upon receipt by [TCO] of a duly executed release.... If the amount allocated to a particular contract by Class Counsel ... is not finally distributed to that particular contract, then such Distributable Amount ... shall be returned to [TCO]...." J.App. at 57-58, 64-65.18

The parties specified that the class members' claims would be extinguished (as they in fact were) by the court order accepting the settlement agreement. Thus, the releases served no more than the administrative purpose of a condition to the class members' ability to get payment from the escrow fund.

The numerous references in the agreement stating a given clause as "Subject to final Court approval of the Settlement," or the equivalent, see pp 1, 2, 4, 5, 6, 7, 8, 9, 11, 12, 14, J.App. at 57-66, also demonstrate how the parties intended to allocate rights and duties in the contract. The "subject to" phrase was used largely to qualify TCO's duty to pay money, demonstrating that "final Court approval" was the linchpin of the contract for TCO because the heart of the exchange was extinguishing the class members' claims in exchange for money. The claims were extinguished upon final court approval and the parties made that event, not execution of the releases, key to the agreement.

The consequence of a class member's failure to execute a release supports this textual analysis. A class member who failed to execute a release would not get its share of the settlement fund, but TCO would still get the benefit of the class member's inability to sustain a cause of action. As the district court observed, "the parties seem to agree that if this case involved a simple exchange of money for execution of a release of all claims, there would be no question that the contract would not be executory." In re Columbia Gas, 146 B.R. at 114. Nor would any class member's failure absolve TCO from its duty to place the second $15 million into escrow, a duty which was to ripen on March 23, 1992, without regard to the actions of any class member. No failure on the part of the class members to execute a release under the settlement agreement could have created a material breach of the contract. Rather, the releases were a condition for each member to get its share of the settlement money.

The settlement agreement also required each class member to complete a supplemental contract for future gas sales to TCO. The question is whether that obligation is sufficient to constitute a "duty" as expressed in the Restatement section 225.

There is no indication that the supplemental contracts were designed to do more than take the terms of the global settlement agreement created by the class and TCO and apply them specifically to each class member. As such they were functionally ministerial duties; they did not, nor were they supposed to, alter the relationship forged by the settlement agreement. The terms of the supplemental contracts were expressly stated in the settlement agreement itself and were designed to be implemented with it. This demonstrates the supplemental contracts were intended to confirm, not to create, the new purchasing arrangement between TCO and the class members.

We agree with the district court that "executing the contract supplements will be little more than a perfunctory act utilizing preapproved terms and conditions. Obviously these ministerial acts are analogous to the execution of the release to be found in the settlement of any case." In re Columbia Gas, 146 B.R. at 114; see also Mitchell v. Streets (In re Streets & Beard Farm Partnership), 882 F.2d 233, 235 (7th Cir.1989) (holding unperformed delivery of legal title to be a formality rather than "the kind of significant legal obligation that would render the contract executory"); In re GEC Indus., 107 B.R. 491, 492 (Bankr.D.Del.1989) (holding seller's unperformed warranty obligations insufficient to make contract executory; buyer's administrative steps to submit claims for breach of warranty are merely procedural and do not make contract executory). An individual class member's failure to execute the supplemental contract would not constitute a material breach of the settlement agreement but rather would be the failure of a condition that would relieve TCO's obligation to pay that member its portion of the escrow monies.19

Further, TCO cannot really be concerned with whether a given class member executes a supplemental contract, as the main terms governing the future purchases were embodied in the settlement agreement itself. The supplemental contracts were more important to the class members (the obligors) than to TCO (the obligee). Class counsel made clear before the district court that the supplemental contracts were important to the class members. The supplemental contracts required TCO to pay higher prices than under the old contracts and thus benefitted the class, and the class even concedes the primary benefit of the contract supplements inured to the class members. Without more, it was unlikely that the parties intended that failure to execute them would be a breach by the class members.

Although, as the class members point out, the supplements were also designed to prevent future disputes and as such they presumably benefit TCO, we are convinced that on balance the obligation to execute the supplemental contracts is not sufficient to make the settlement agreement executory. Like the releases, the contract supplements were conditions to the class members' receipt of their portion of the settlement fund. Any class member's failure to execute the supplement would not constitute a breach of the settlement agreement.20

An examination of the purpose of Sec. 365 leads to the same result. The only functional difference between assumption and rejection in this case, were the contract to be considered executory, is that assumption would give the class a higher priority to the unpaid $15 million. In return TCO would gain nothing of value: the releases add no rights to the estate not already given by the district court's order, and the supplements provide only a marginal benefit to TCO. The Ohio District Court's order bound the class as a whole. Once the order became final and unappealable, all the class members were bound by it. Accordingly, the class members' failure to complete the tasks required for them to receive their money could not breach the agreement between the class and TCO, but could only serve as the failure of conditions precedent to their right to settlement monies. Assumption would not add assets to the bankruptcy estate. See In re Sudbury, Inc., 153 B.R. at 778-81 (holder unjustified in seeking first priority through executory contract provisions when pre-petition claim was not entitled to priority as administrative expense pursuant to 11 U.S.C. Sec. 503). The agreement is not an executory contract for purposes of Sec. 365.

For the reasons set forth, we will affirm the judgment of the district court.