What Happens When a Debtor Seeks to Reject a Right of First Refusal?

Print This Post Print This Post

Contributed by Rich Mullen

Questions often arise when debtors seek to reject a right of first refusal (“ROFR”).  Neither the Bankruptcy Code nor caselaw, however, provides consistent guidance on whether a ROFR is an executory contract subject to rejection under section 365(a) of the Bankruptcy Code and, if so, whether the non-debtor party may nevertheless specifically enforce its rights under the ROFR.  A recent opinion by Judge Walrath of the Bankruptcy Court for the District of Delaware, In re CB Holding Corporation, is but the latest attempt to tackle the puzzling world of ROFR’s.

CB Holding Corporation operated three chains of restaurants in the mid-Atlantic region.  After filing for chapter 11 protection, CB Holding sought to reject numerous leases, including a lease of real property owned by MBK Investments, LLC.  After the bankruptcy court approved the rejection of the leases, CB Holding sought to sell the liquor licenses associated with each of the leased premises.  MBK agreed to buy the liquor licenses associated with its premises for $151,000, but on the eve of the sale hearing CB Holding received a higher offer from a third party.  Opposing an auction, MBK argued that its lease contained a ROFR prohibiting CB Holding, after termination or expiration of the lease, from disposing of its liquor license if the license would cease to cover the leased premises unless CB Holding first offered to sell the liquor license to MBK at a price of $100,000.  The court ordered that the liquor license be sold at auction (where MBK was the successful bidder at $407,500), but reserved MBK’s right to argue about the enforceability of the ROFR.

Applicability of the ROFR

MBK argued that this case is similar to In re The Ground Round, where the First Circuit held that rejection of a lease was sufficient to trigger a requirement that a liquor license be returned to the landlord because the landlord held “something akin to a property right in something held by the debtor,” and “that right survives bankruptcy and remains enforceable to recover the property from the estate, except where that right is cut off by provisions of the Bankruptcy Code.”  Judge Walrath, however, dismissed MBK’s argument, stating that the court was “constrained to apply the literal language of the lease” and was “not persuaded by the analysis in the Ground Round case, which strained (or outright ignored) the actual language of the lease to come to a preferred result.”  The court stated that CB Holding’s rejection under section 365 of the Bankruptcy Code resulted only in a prepetition breach of the lease and did not constitute a termination of the lease.  The court went on to conclude that the ROFR was not applicable because it was only triggered by the termination or expiration of the term of the lease – neither of which had occurred.

“Executoriness” of the ROFR

MBK cited In re Robert L. Helms Construction and In re Bergt for the proposition that the ROFR was not an executory contract and could not be rejected.  The court also rejected this argument, concluding that the ROFR was executory in nature because the debtor was “obligated to give written notice to the landlord of any intent to sell the liquor license separate from the lease and to offer to sell the liquor licenses to the landlord for $100,000,” and the landlord was “required to accept the offer within thirty days of the notice.”  In doing so, the court joined a line of decisions that have held that a ROFR is an executory contract subject to rejection under section 365(a).

Interestingly, many of these cases either relied upon or were similar in reasoning to In re Coordinated Financial Planning Corp., which was later overruled by an en banc panel of the Ninth Circuit in Helms Construction.  In Helms Construction, the Ninth Circuit stated that a “[a] better approach . . . is to ask whether the option requires further performance from each party at the time the petition is filed” and found that, typically, the option would not be executory because the “optionee need not exercise the option – if he does nothing, the option lapses without breach.”

Specific Performance of the ROFR

Finally, MBK argued that the ROFR should be specifically enforced despite CB Holding’s rejection.  The court rebuffed this argument, however, by simply stating that it had already found Ground Round (which MBK relied upon) to be unpersuasive.  In doing so, it implicitly rejected the reasoning of Bergt, in which the Bankruptcy Court for the District of Alaska concluded that section 365 of the Bankruptcy Code “is not an avoiding power which repudiates, cancels or terminates the [ROFR],” and, therefore, the ROFR could be specifically enforced by the non-debtor party.

With courts taking such different stances on a debtor’s ability to reject an ROFR, it is difficult to reach a definitive conclusion as to these contractual rights.  In Delaware, at least, the issue seems fairly settled.  Moreover, some courts, including Judge Gerber of the Bankruptcy Court for the Southern District of New York, have found that a ROFR is an unenforceable restriction on an assignment of a contract under section 365(f)(1) of the Bankruptcy Code and have refused to enforce a ROFR when a debtor seeks to assume and assign a contract containing such a provision.  In re CB Holding Corporation is important precedent, but this is an area of the law that remains quite unsettled.