Restructuring

Contributed by Cristine Pirro
If an executory contract is assumed and assigned by a debtor, can a chapter 7 trustee recover payments made by the debtor under the contract as a preferential transfer?  Judge Sontchi of the United States Bankruptcy Court for the District of Delaware recently confirmed that the answer is a definite “no.”
Before the debtors filed for chapter 11 bankruptcy protection, Almond Products, Inc. agreed to supply certain goods and services related to the debtors’ fuel systems businesses.  Under its supply agreement with the debtors, Almond was to supply all parts the debtors required at a specified rate during a specified period.  As of the petition date, the debtors owed Almond $518,786.00.
On the petition date, the debtors filed a motion seeking approval of bidding procedures for the sale of the debtors’ fuel systems business.  A few weeks later, the debtors filed a Notice of Filing Schedules to Asset Purchase Agreement, which contained as an exhibit a list of executory contracts to be assumed by the purchaser.  The supply agreement with Almond was excluded from that notice.  Shortly thereafter, the debtors filed a Notice of Debtors’ Intent to Assume and Assign Certain Leases and Executory Contracts and Fixing of Cure Amounts, which also omitted the supply agreement.
The debtors and Almond subsequently executed an amendment to the supply agreement to include the contract in the sale.  The amendment established the amount of Almond’s cure claim and provided that the debtors would use their best efforts to obtain court approval of the assumption and assignment of the supply agreement to the purchaser.  After entering into the amendment, the debtors filed (i) a Notice of Entry into Certain Cure Amount Agreements with Respect to Debtors’ Intent to Assume and Assign Certain Leases and Executory Contracts, which disclosed the agreement between the debtors and Almond, and (ii) a Notice of Filing of Amendment to Asset Purchase Agreement, which added the supply agreement to the asset purchase agreement schedules.  The court approved the sale motion and entered a sale order, after which Almond received payment in the amount of $367,385.57 (which was less than the full amount owed).
A few months later, the court converted the case to a chapter 7, and the chapter 7 trustee commenced a preference action against Almond under sections 547 and 550 of the Bankruptcy Code to recover payments made to Almond under the supply agreement in the 90 days preceding the petition date.
Almond asserted that, under established Third Circuit law, the trustee could not satisfy section 547(b)(5) of the Bankruptcy Code, which requires a finding that Almond received more than it otherwise would have received in a chapter 7 liquidation, because the transfers were made pursuant to an executory contract that had been assumed by the debtors.  The Third Circuit held in Kimmelman v. Port Authority of New York and New Jersey that section 547(b)(5) could not be satisfied if the executory contract at issue was assumed pursuant to a court order because “had the creditors not received the payments prepetition, they would have received amounts reflecting those sums, in any event, when the Bankruptcy Court approved the cures of assumed agreements.”  In applying Kiwi, a court must determine whether the contract is executory and whether it was assumed.  In the context of approval of a sale transaction (and absent, of course, a separate order authorizing assumption of such contract),a contract will not be considered assumed unless it was listed on the list of assumed executory contracts in the purchase agreement, and such list was filed when the sale order was entered and referred to in that sale order.
The trustee responded to Almond’s argument by first challenging that the supply contract was executory; if the contract was not executory, it could not be assumed and assigned.  Under the Countryman definition of an executory contract, which has been applied in the Third Circuit, both the debtor and Almond were required to be so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other.  The trustee argued that Almond had no obligation to continue providing supplies once the debtors failed to pay, and thus Almond had already completed performance.  The court found that the supply agreement reflected an ongoing requirement for the supply and purchase of parts.  The contract, therefore, was clearly executory.
The trustee also argued that the supply agreement had not been properly assumed and assigned even if it was executory.  Specifically, the trustee asserted that the debtors never actually amended the assumption and assignment notice even though they agreed to do so in the amendment to the supply agreement.  Filing the Notice of Entry into Certain Cure Amount Agreements, the trustee asserted, was not sufficient because (i) it did not actually request approval of the assumption and assignment of the supply agreement, and (ii) it was filed after the deadline to object to the assumption and assignment of contracts on the night before the hearing.  With respect to these arguments, the court found that the supply agreement was appropriately assumed and assigned by the debtors.  Although the agreement with Almond was not on the initial list of contracts to be assumed, the court did not view that as a problem because the initial list is always up in the air until the court approves the sale order.  The successful bidder determines which contracts it would like to assume, and usually does not do so until shortly before the sale hearing.  Further, although the debtor files the cure notice, such filing does not mean that the debtor included all of its executory contracts on that list.  The court found that because Almond was specifically listed in a notice, its agreement was attached to the sale order, and it was included in the list of contracts to be assumed and assigned attached to the asset purchase agreement, the supply agreement was veritably assumed and assigned.
The law is clearly established in the Third Circuit that prepetition payments a debtor made under a contract that it subsequently assumed are protected from recovery as a preference.  Nevertheless, because avoidance actions are often unsecured creditors’ sole source of recovery, it appears that enterprising estate representatives may continue to attempt to find loopholes so they can pursue claims for recovery.  Almond Investment demonstrates the importance, from a contract counterparty’s perspective, of making sure all procedural formalities are followed in connection with a debtor’s assumption of an executory contract to foreclose any subsequent attempts by parties with no stakes in the debtor’s business relationship with the contract counterparty to undo the effects of assumption.