Delaware Court Says “No” Implied Assumptions or Rejections

On Feb. 21, 2018, the Delaware Bankruptcy Court in Stanley Jacobs Production Ltd. v. 9472541 Canada Inc., et al.[1] ruled that debtors seeking permission to assume or reject a contract under § 365 of the Bankruptcy Code must file a motion to do so, and assumption or rejection “impliedly” through circumstances or by conduct does not suffice.

After the Delaware Bankruptcy Court authorized Old Thane to sell its assets (relating to consumer products sold in part through infomercials) to New Thane, the producer of an infomercial for Old Thane, pursuant to a pre-sale executory contract (the “production agreement”), sued New Thane to recover pre-sale royalties. The action was filed in federal court in the Central District of California, but because that court had determined that the court that had entered the sale approval order was best suited to determine whether the production agreement had been assumed and assigned by Old Thane to New Thane, the litigation was transferred to Delaware.

The producer argued that the production agreement had been assumed and assigned to New Thane pursuant to § 365 of the Bankruptcy Code, making New Thane liable for pre-sale royalties, because (1) the production agreement had been included, generically, among the contracts to be assumed and assigned as part of the sale,[2] and/or (2) New Thane’s post-sale conduct with respect to the producer and the production agreement was consistent with assumption and assignment. New Thane argued, simply, that the production agreement had not been assumed and assigned under § 365 because a motion seeking that relief, specifically and explicitly as to the production agreement, had not been filed, and no order so providing had been entered.

The Delaware Bankruptcy Court agreed with New Thane. It ruled, as a matter of “hornbook law,” that a motion is required and that a contract cannot be assumed and assigned by implication, circumstance or post-sale course of conduct. The bankruptcy court stated that reliance on post-sale conduct (including New Thane’s continued use of the fruits of the production agreement) as a substitute for a formal motion and order “would validate the hazy doctrine of implied assumption” — the logic of which gave the court “pause,” creating “uncertainty” and the potential need to “meddle in the fact-laden intricacies of transactions — sometimes well after the departure of a necessary party … to determine … ‘true intention.’”[3] The court also noted the absence of a cure of defaults under the production agreement as an indication that the production agreement had not been assumed and assigned.[4] Indeed, the producer sued New Thane in California to recover pre-sale royalties due under the production agreement, but it also was undisputed that notice of the bankruptcy and sale proceedings was not provided to the producer until after the sale closed. Thus, the absence of a cure could be considered as a possible supernumerary factor in the court’s ruling.

The bankruptcy court did discuss and reject, seemingly on their lack of merit, the producer’s course-of-conduct arguments, which included post-sale communications between New Thane and the producer about the calculation of royalties due and New Thane’s statements in pleadings filed in the California district court referencing “assumption” of the production agreement.[5] Given its holding, it seems that the court could have summarily rejected the producer’s course-of-conduct arguments without considering them on their merits (or lack thereof).

The producer also argued that the sale motion was, in fact, the motion required by § 365. However, the bankruptcy court stated that its entry of the sale order was not premised on the sale motion being an omnibus assumption-and-assignment motion and that the record did not show that Old Thane considered it to be such an omnibus motion.[6] The bankruptcy court also noted that if the sale motion had been posited as an omnibus assumption-and-assignment motion, the court would not have accepted it as such because it failed to meet the technical requirements for such a motion under Bankruptcy Rule 6006.[7]

While the court’s ruling was clear enough, what remains unclear perhaps is the status of the production agreement and the respective rights and obligations of the producer and New Thane thereunder. The court ruled that the production agreement was not assumed and assigned under § 365, but the opinion also states that it was not rejected. Thus, did the production agreement somehow “pass through” the bankruptcy, and, if so, what does that mean under the circumstances? Notwithstanding the requirements of § 365, was the production agreement in fact assigned to New Thane pursuant to the sale transaction not under § 365, but perhaps under state contract law? These questions are not addressed in the bankruptcy court’s opinion, but the court does suggest that “New Thane may not have a contractual right to benefit from its post-Closing use of the Production Agreement.”[8]

Nevertheless, the court’s order seems to go beyond the ruling expressed in the opinion that the production agreement had not been assumed and assigned to New Thane under § 365 of the Bankruptcy Code. The first page of the opinion states that the issue before the court was “whether an executory contract that was neither affirmatively assumed nor rejected was included and assigned in a sale transaction.”[9] The holding of the court, as expressed in the conclusion section of the opinion, was that “[t]he Court will deny the Motion, finding that Old Thane did not assume and assign the Production Agreement to New Thane.”[10] But the court’s order states that “New Thane is not liable for the alleged pre-Closing defaults because Old Thane failed to assume and assign the Production Agreement to New Thane.”[11]

Does that go too far? Even in the absence of a valid assumption and assignment under § 365 of the Bankruptcy Code, the producer, as the court itself suggests, nevertheless may be entitled to recover from New Thane for pre-sale royalties based on quasi-contract theories such as quantum meruit or unjust enrichment. Under the circumstances, the producer may wish (and arguably should be allowed) to pursue whatever claims it may have against New Thane not based on assumption and assignment under § 365 (whether pre- or post-sale), under quasi-contract or state law contract assignment theories of relief, or otherwise. Such questions, it seems, remain (or should remain) to be decided by the California district court.

However, in footnote 4 to its opinion, the Delaware Bankruptcy Court may have limited the producer’s options in this regard, as it declined to take up the California district court’s invitation to transfer the matter back to California after ruling, stating that, “[f]or the reasons which follow, the Court does not believe that it is necessary to transfer the action back….”[12] The producer has noticed an appeal from the Delaware Bankruptcy Court’s order, challenging the court’s ruling that a formal motion is required to either assume or reject a contract. This might also may flesh out what, if anything, the California district court may be asked to decide with respect to the producer’s and New Thane’s past and/or continuing obligations under the production agreement. Stay tuned.