All for One and One for All The Assumption and Rejection of Multiple Intertwined Executory Contracts and Unexpired Leases

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Jul/Aug 1999

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On the Edge

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It is well recognized that pursuant to §365 of the Bankruptcy Code, a trustee or debtor may

assume or reject executory contracts and unexpired leases. While it is not unusual for a debtor

to have a variety of separate and distinct executory contracts and unexpired leases, there are

situations where the debtor has multiple intertwined executory contracts or leases. For

example, the debtor may have entered into a series of real estate leases or an equipment lease

with multiple schedules.

It is clear that the debtor has the right to examine each executory contract and unexpired lease

and to make an independent business judgment regarding the assumption or rejection of each

agreement. However, it is not as clear with multiple intertwined executory contracts whether

the debtor may assume some of the contracts while rejecting others. If two parties execute a

series of related leases, and the lessee subsequently files for bankruptcy protection, is the

debtor permitted to assume one lease and reject the others, or must the debtor either assume or

reject the leases as a whole?

Courts have reached differing results on this issue; some courts have found that multiple

agreements constitute a single contractual agreement that must be assumed or rejected in total,

while others have found that a single written instrument actually includes several separate

agreements and have permitted the assumption of some and rejection of others.

Whether a series of executory contracts or unexpired leases are treated as an indivisible unit

will not only influence a debtor's bankruptcy case, but may limit a debtor's chances for

successful reorganization. Section 365 establishes a structure under which a debtor may

evaluate the advantages and disadvantages of an executory contract or unexpired lease. If the

net performance on both sides would benefit the estate, the contract or lease should be assumed

and either performed or assigned. On the other hand, if the net performance on both sides would

be detrimental to the debtor's bankruptcy estate, the contract or lease should be rejected. 2

Norton, William L. Jr., Bankruptcy Law and Practice 2d. §39.1 (1997). Consequently, the

characterization of contracts or leases as indivisible units or separate agreements will affect

the net advantages or disadvantages of assumption or rejection of the agreements on a debtor's

bankruptcy estate, thus making such characterization of significant importance. This article

discusses the current state of the law concerning the ability of a trustee, or debtor, to assume or

reject executory contracts and unexpired leases where the contracts or leases are comprised of

multiple, and possibly related, agreements.

<h3>An Executory Contract or Unexpired Lease Must Be Assumed or Rejected in Its Entirety</h3>

It is generally recognized that a debtor must assume or reject an executory contract or

unexpired lease in toto. A debtor may not pick and choose among contractual provisions,

rejecting those it deems burdensome and accepting those it views as beneficial. Rather, a debtor

must assume or reject an executory contract or unexpired lease in its entirety. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Plitt

Amusement Co. of Washington Inc., 233 B.R. 837 (Bankr. C.D. Ca. 1999)</a>; <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Diamond Head Emporium Inc., 69 B.R. 487 (Bankr. D. Ha. 1987)</a>; <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Atlantic Computer Systems, 173 B.R. 844 (S.D.N.Y. 1994)</a>; <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Café Partners/Washington, 90 B.R. 1 (Bankr. D.C. Cir. 1988)</a>. This does not mean, however, that a debtor cannot assume one executory contract and reject

another, nor does this "all or nothing" requirement mean that every document denominated as a

"contract" or "lease" must be treated as a single, indivisible whole. Rather, as the case law

demonstrates, a contract or lease may actually consist of several distinct contractual

agreements subject to independent assumption or rejection by a debtor. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 5</a>.

Unfortunately, few courts have established a definitive test to effectively determine whether

a contract or lease in question should be treated as an indivisible unit or a severable

agreement. Only the Eleventh Circuit Court of Appeals in <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Gardinier, 831 F.2d 974 (11th Cir. 1987)</a> has developed a test to determine the composition of an executory contract or lease. In Gardinier, the court considered whether a provision to pay a brokerage commission,

contained within a purchase and sale agreement, constituted a separate and distinct agreement

subject to assumption or rejection pursuant to §365. In holding that the brokerage commission

provision constituted a separate agreement between the parties, the court identified three

factors it considered in determining severability: (i) whether the nature and purpose of the

obligations differ, (ii) whether the consideration for the obligations is separate and distinct,

and (iii) whether the obligations of the parties are interrelated.

<a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… the matter of In re Atlantic Computer Systems Inc., 174 B.R. 844 (S.D.N.Y. 1994)</a>,

the court was asked to approve a debtor's motion to reject the burdensome parts of equipment

leases with multiple schedules, while at the same time assuming the profitable leases. On June

30, 1988, the debtor, the lessor of computer equipment, entered into a master lease agreement

together with the first equipment schedule. At separate times during 1989, the parties entered

into five additional equipment schedules. At the time each additional equipment schedule was

executed, the parties also entered into separate "flexlease" agreements. The flexlease

agreements gave the lessee certain rights to early termination and upgrade of equipment. The

lessee, prior to the bankruptcy filing, had requested the debtor honor its obligation under the

flexlease. The debtor proposed a plan seeking to affirm the master lease and schedules, but

reject the provisions of the flexlease agreements. The bankruptcy court construed the various

leases to be separate contracts and confirmed the debtor's plan. On appeal to the district court,

the lessee argued that the lease agreements cannot be separated. The district court reversed the

bankruptcy court, relying on the established principles of New York contract law that

"instruments executed contemporaneously by the same parties, for the same purpose and in the

course of same transactions, are to be read and interpreted together." In confirming its

decision, the court also applied the three-part test set out in In re Gardinier and concluded that

the flexleases were not separate agreements. It is interesting to note that the court, in looking at

the transaction, specifically concluded that the master lease, the five separate equipment

schedules and the attached flexlease agreements were not one transaction. Instead, the court

concluded there were five transactions, comprised of the master lease, each schedule and the

accompanying flexlease agreement. Thus, in making its decision, the court looked at each

schedule, etc. as a separate group of contracts that it concluded was one agreement.

Numerous other courts have cited Gardinier and its three-factor test in determining the

severability of contractual provisions. Unfortunately, most courts have failed to uniformly

apply its factors, thus leading to disparate results. See <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Pollack, 139 B.R. 938 (Bankr. 9th Cir. 1992)</a> and <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re T&H Diner Inc., 108 B.R. 448 (D. N.J. 1990)</a>. Rather than decisions

based on the three-factor test, what has emerged is case law focusing on the intentions of the

parties at the time of contracting and, interwoven therein, a focus on the contemporaneous

execution of agreements as a manifestation of the parties' intent.

<h3>The Intent of the Parties at the Time of Contracting</h3>

The intent of the parties at the time of contracting is the most outcome-dispositive factor

in determining whether a contract or lease, consisting of several related agreements, should be

construed independently or as an indivisible whole for assumption and rejection purposes under

the Bankruptcy Code. An examination of case law evidences an emphasis by the courts on the

issue of whether, at the time of contracting, the parties to the contract or lease intended its

related agreements to be inextricably intertwined or inherently distinct from one another.

For example, recently, in In re Plitt Amusement Co. of Washington Inc., the bankruptcy

court was confronted with the issue of whether an unexpired lease constituted an independent

lease agreement such that it could be rejected by the trustee pursuant to §365. In Plitt, the

parties entered into a transaction involving six documents: a purchase agreement, a promissory

note, a security agreement and three non-residential real property leases. Following the

debtor's voluntary filing for relief under chapter 7, the trustee filed a motion seeking to reject

one of the three unexpired non-residential real property leases. In opposition to the trustee's

motion, a party asserted that the three leases, the purchase agreement and the promissory note

constituted one indivisible, non-severable transaction that the trustee must assume or reject in

its entirety. In determining that the non-residential real property lease qualified as a separate

lease that could be independently assumed or rejected by the trustee, the court began its

analysis by focusing on the six instruments in order to determine the intentions of the parties.

Following the same reasoning, the court in <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Harrell, 619 S.W.2d 528 (Tenn. 1981)</a> considered whether two agreements, executed simultaneously by the same parties,

constituted a single indivisible contractual agreement. In determining that the agreements were

distinct, the court focused on the intention of the parties at the time of contracting, stating that

if the parties truly intended the agreements to be construed together, all they had to do was say

so in the agreements. Their failure to do so evidenced a clear intention that the agreements be

viewed independently of one another.

Similarly, in <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Dynamics Corp. of America, 429 F. Supp. 341 (S.D.N.Y. 1977)</a>, the

court also focused on the intentions of the parties. Here, two parties simultaneously executed a

purchase agreement and a sales agreement. The purchase agreement set out the terms and

conditions for the transfer of land, buildings and manufacturing equipment. The sales

agreement addressed the production, sale and purchase requirements of the parties. A dispute

arose between the parties, calling into question whether the documents constituted a single

contract or separate contractual agreements. In holding that the agreements must be viewed as a

whole, the court stated that the issue of whether separate documents should be treated as a single

contract is governed by the intent of the parties manifested at the time of contracting. The court

found that in light of the circumstances prior to and contemporaneous with the execution of the

two documents there was no doubt that the parties intended that the documents constitute a

single, indivisible contract.

In In re Gardinier, the court emphasized the intent of the parties as well, employing its

three-factor test to ascertain whether at the time of contracting the parties intended the two

agreements in question to be construed conjunctively or independently of one another. In doing

so, the court noted that the fact that the terms of the transaction are set forth in one instrument

is not conclusive evidence that the parties intended to make only one contract; it is only a factor

in determining intent.

<h3>Contemporaneous Execution of Documents</h3>

An interwoven factor often used as evidence demonstrating the intentions of the parties to

an agreement at the time of contracting is the contemporaneous execution of documents.

Numerous courts have focused on the execution of agreements, holding that documents executed

contemporaneously by the same parties and for the same purpose must be construed as a single

contractual agreement. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Carvel Corp., 930 F.2d 228 (2d Cir. 1991)</a>; <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Clayton, 954 F.2d 645 (11th Cir. 1992)</a>; <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Ameritrust Co. N.A, 73 F.3d 1553 (11th Cir. 1996)</a>.

In In re Clayton, the court was confronted with the issue of whether a license agreement

and a restaurant lease, executed by the same parties at the same time, constituted two separate,

independent contracts or whether they were part of a single overall agreement. Following the

execution of the agreements, relations between the parties deteriorated, leading to the filing of a

lawsuit questioning whether the license and restaurant were separate agreements or component

parts of a franchise agreement. On appeal, the court of appeals determined that the license and

lease constituted one agreement, reasoning that where two or more documents are executed by

the same parties at or near the same time in the course of the same transaction, and concern the

same subject matter, they will be read and construed together. The court further provided that

such factors demonstrate that the parties intended the two documents be considered together.

In addition to the courts' desire to ascertain the intent of the parties, courts, as always,

are mindful of insuring that the results obtained comport with the principles of fair play and

justice for all involved. For example, in <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re East Hampton Sand & Gravel Co. Inc., 25 B.R. 193

(E.D.N.Y. 1982)</a>, the debtor, prior to its chapter 11 filing, had entered into an agreement with

a creditor to lease a parcel of real estate and purchase a concrete manufacturing business located

on the real estate. The debtor agreed to pay for the business with a portion in cash and the

balance evidenced by a promissory note. The lease agreement for the real estate provided that

non-payment of the note was an event of default. The debtor then sought to assume the lease

without paying the note. The court, in rejecting the debtor's position, stated: "The debtor

asserts that the rehabilitative spirit of the Bankruptcy Code allows for the severance of two

obligations upon assumption of the lease. The debtor argues that lease termination conditions,

which are unrelated to the payment of rent, frustrate federal bankruptcy policy by

unnecessarily encumbering a valuable asset which plays an important role in the debtor's

reorganization. This argument is not convincing. While it is recognized that within the context

of the reorganization this court has the equitable power to modify lease provisions if it would

benefit the estate and not significantly prejudice the lessor [citations omitted], equity will not

countenance the debtor's exercise of §365 to relieve itself of conditions which are clearly

vested by the contracting parties as an essential part of the bargain and which do not contravene

overriding federal policy."

The continued emphasis by the courts in ascertaining the intent of the parties, as part of

its analysis in determining whether or not multiple intertwined executory contracts or leases

may be assumed or rejected in whole or part, places a significant burden on the drafting of the

agreements. Therefore, careful drafting that takes into consideration the impact of the

provisions of §365 is critical.

Journal Authors

Jennifer Ancel

Jerald I. Ancel

Marlene Reich

Journal Date

Thursday, July 1, 1999 - 12:00