Posted on December 8, 2008 by Jason Cornell, Esq.

Distributed Energy Decision Provides Analysis of Adequate Assurance and Executory Versus Non-Executory Contracts

 

Introduction

In a recent decision in the Distributed Energy Systems bankruptcy ("DES" or "Debtors"),  the Honorable Kevin Gross of the United States Bankruptcy Court for the District of Delaware provided a concise discussion of what is required for a debtor to assume and assign an executory contract.  DES filed a motion seeking to assume and assign contracts with ePower and Vestas Wind Systems to CB Wind Acquisition Corp ("CB Wind").  CB Wind previously purchased all of Debtors' assets. Due to what Debtors' termed a "scrivener's error,"  the ePower and Vestas contracts were not included in the schedules to the original asset purchase agreement.

ePower objected to the assumption of its contract on several grounds.  First, ePower argued that DES failed to prove CB Wind could provide adequate assurance of future performance.  Next,  ePower claimed that its contract was not an executory contract and therefore not subject to assumption and assignment under section 365 of the Bankruptcy Code.  Finally,  ePower argued that Debtors' failure to include its contract in the sale motion evidenced its original intent to reject the agreement. 

Application of the Business Judgment Standard

Turning first to the Bankruptcy Code, the Court recognized that section 365(a) allows DES to assume executory contracts provided it cures all defaults. The Court also recognized that the Debtors' decision to assume an executory contract receives "great deference" under the business judgment standard. The Court found that DES demonstrated proper business judgment through the "numerous concessions and [] ample consideration" DES received by assigning the ePower contract to CB Wind.

Adequate Assurance of Future Performance

Two factors supported the Court's finding that Debtors proved adequate assurance of future performance by CB Wind. First, the Court previously approved the sale of Debtors' assets to CB Wind and no other party in interest objected as to the Debtors' adequate assurance. Even though the lack of such an objection was not, on its face "proof positive of adequate assurance," the Court still found the lack of objection compelling. Besides the lack of objections from others, the Court found that the ePower contract did not require CB Wind to pay out money. Instead, the contract required CB Wind to seek funding from third parties.

Whether the Contract Is Executory

Citing the Third Circuit's decision in In re Columbia Gas System, 50 F.3d 233, 239 (3d Cir. 1995), the Court defined an executory contract as one where the obligation of the debtor and third party "are so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other." As to the ePower contract, the Court highlighted terms of the contract requiring "ongoing exclusive collaboration." Such collaboration included the parties continuing pursuit of wind and water-powered generators and provided the proof needed to convince the Court that the agreement was executory.

Intent to Reject Irrelevant

During the evidentiary hearing, substantial testimony was put forward regarding the Debtors' intent to reject the ePower contract. The Court found the issue of the Debtors' intent irrelevant "as the fact remains that the Debtors did not seek and the Court did not approve a rejection" of the contract. Further, the Court recognized the Debtors' ongoing right to assume and assign contracts through  plan confirmation.

Court Finds Vestas Contract Not Executory

For the reasons stated above, the Court found that the ePower contract was executory and subject to assumption and assignment. Using the same reasoning, however, led to a different result for the Vestas contract. Under the language of the contract, Vestas remains obligated to maintain the confidentiality of information, however, the Court found the Debtors did not have "any remaining obligations to perform and, therefore, the agreement is not executory." Having found that the contract was not executory, the Court further concluded that it lacked authority to approve assumption and assignment of the Vestas agreement.

Conclusion

It is always helpful for attorneys to have opinions like this one, addressing issues that frequently arise in bankruptcy proceedings (i.e. executory versus non-executory contracts). Like with other opinions discussed in this blog, courts often look to the language of the contract, versus the intent of the parties, when interpreting a contract.  Doing so provides what some consider a welcome level of predictability to business transactions.
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Posted on November 11, 2008 by Jason Cornell, Esq.

Shopping Centers Receive Preferred Treatment Under the Bankruptcy Code

Introduction

When a company files for bankruptcy, often it will reject some or all of its commercial leases. Alternatively, some debtors in bankruptcy choose to assume and assign their leases to third parties. By assigning its lease, the debtor is in essence selling its lease to the highest bidder. Large retailers who file for bankruptcy have the potential to generate substantial revenue through the assumption and assignment of leases.

History Behind Preferential
Treatment For Shopping Centers

Years ago, Congress recognized the potential risks landlords faced should a debtor in bankruptcy have broad discretion to assign leases. To address this concern, Congress included language in the Bankruptcy Code requiring a debtor to provide a landlord with “adequate assurance of future performance” that the party receiving the lease performs according to the terms of the lease.

In 1978, Congress increased the protections governing the assignment of shopping center leases. The 1978 revisions to the Bankruptcy Code were intended to not only protect the owners of shopping centers, but also protect the remaining tenants within a shopping center once a tenant files for bankruptcy. Congress had three primary concerns when a tenant in a shopping center filed for bankruptcy:

1. Reduce any hardship imposed on the landlord and tenant due to
a vacancy, or reduction in operation, due to the assignment of the
lease to a third party;

2. Increase the likelihood that the owner of the shopping center
receives rental payments for rent arising before and after the
assignment of the lease, and,

3. Insure that the tenant mix is not disturbed by the assignment
of the lease to a third party.

Heightened Protections
Provided To Shopping Centers

Under the Bankruptcy Code, before a tenant in a shopping center lease can assign the lease to a third party, the party acquiring the assigned lease must provide proof of its ability to pay rent and that the percentage rent due under the lease will not decline substantially. Further, the assignment of the lease cannot result in a breach of radius, location, use or exclusivity provisions in the lease, nor can the assignment disrupt the current tenant mix.

These additional requirements provide shopping center landlord’s with greater protection than other non-shopping center landlords who have a tenant in bankruptcy. In essence, the protections increase the likelihood that the terms and intent of the lease are satisfied. Equally important, the heightened protections for shopping center leases increase the likelihood that a landlord will receive payment under the lease. Interestingly, when amending the Bankruptcy Code, Congress chose not to define what constitutes a “shopping center.” Instead, courts must decide on a case-by-case basis after considering the facts presented.

What is a Shopping Center?

With Congress unwilling to define what constitutes a shopping center under the Bankruptcy Code, Courts have stepped in and applied a broad definition. Some of the factors that support a finding that a property is a shopping center include (i.) whether the leases are held by a single landlord; (ii.) the existence of a common parking area; (iii.) the existence of percentage rent provisions in the lease; and, (iv.) the inclusion of tenant mix requirements in the lease.

Notice that aside from a common parking area, the physical attributes of the property are not determinative of whether a property is a shopping center. Courts reject the idea that the physical features of a property determine whether the landlord will receive the additional protections afforded to shopping center leases. Instead, the intent of the parties, as expressed through the terms of the lease (i.e. the inclusion of percentage rent, joint waste removal, etc.) determine whether the lease is a shopping center lease.

Ways Landlords Can Receive The
Added Protections of “Shopping Center” Leases

Before a debtor can assign its lease, it must file a motion with the court seeking authority to assume and assign the lease. Once a landlord learns that its tenant intends to assign its lease, it should make sure that the party purchasing the lease can provide “adequate assurance” that the new tenant can satisfy the terms of the lease. If a landlord does not receive adequate assurance, it should consider filing an objection to the proposed assignment. Landlords whose lease satisfies some of the criteria of a “shopping center” should assert their rights to greater protection under the Bankruptcy Code. Doing so will improve the likelihood that the terms of the lease are met.
 

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