Executory Contracts Are Automatically Rejected Even if Unscheduled, Fifth Circuit Holds

On a topic where there is scant appellate authority, the Fifth Circuit held that a trustee cannot assume and assign an executory contract after the deadline for assumption has passed, even if the contract had not been scheduled and was unknown to the trustee.

The case involved a corporate debtor who knew it owned a patent license but failed to list the license in its schedules. However, there was no effort to conceal the license, Circuit Judge Patrick E. Higginbotham said in his October 29 opinion.

After the case converted from chapter 11 to chapter 7, the trustee sold all of the estate’s property. The sale occurred more than 60 days after conversion. Section 365(d)(1) provides in effect that an executory contract not assumed within 60 days of conversion “is deemed rejected.”

The sale agreement transferred all of the debtor’s property and listed the assets by category. Although the license fell within a category of transferred property, the license was not specifically listed because the trustee was unaware of the existence of the license. The sale-approval order provided that all executory contracts were assumed and assigned to the purchaser.

A year after the sale, a lawsuit ended up in bankruptcy court where the licensor of the patent license contended that the license was rejected and had not been sold to the purchaser. The bankruptcy judge agreed with the licensor and held that the license had been rejected automatically and could not have been sold. The district court agreed.

The Fifth Circuit affirmed, first holding that the license was an executory contract because material, reciprocal obligations remained outstanding on both sides. The erstwhile purchaser argued that there is an implicit exception to automatic rejection under Section 365(d)(1) when an executory contract is not scheduled and the trustee is unaware of the existence of the asset.

With one exception, there is no authority at the circuit level about exceptions to automatic rejection. In the lower courts, Judge Higginbotham said there is “sparse authority” and “no clear consensus.” He said some lower courts hold that a contract is not deemed rejected if the debtor has intentionally concealed the existence of the asset. That was not the state of facts in the case on appeal, he said.

When there has been no intentional concealment, Judge Higginbotham said that “some courts” have held that failure to schedule a contract does not prevent its automatic rejection. However, he cited a district court for holding that failure to schedule a contract tolls the deadline for assumption.

Judge Higginbotham followed a 1985 Ninth Circuit opinion decided under the former Bankruptcy Act: Cheadle v. Appleatchee Riders Association (In re Lovitt), 757 F.2d 1035 (9th Cir. 1985).

In Cheadle, the Ninth Circuit said that a trustee has an affirmative duty to investigate for unscheduled assets. Therefore, the appeals court found a conclusive presumption that unscheduled contracts are rejected in 60 days.

Because the Bankruptcy Code likewise imposes a duty on a trustee to investigate the debtor’s affairs, Judge Higginbotham decided that the reasoning of Cheadle “still applies.” “More to the point,” he said, Section 365(d)(1) “does not impose an actual or constructive notice requirement for when the sixty-day deadline applies.” He declined to “read such a requirement into the statute.”

“At a minimum,” Judge Higginbotham therefore held that “the statutory presumption of rejection after sixty days is conclusive where there is no suggestion that the debtor intentionally concealed a contract from the estate’s trustee.”

The purchaser argued that setting aside the sale amounted to a collateral attack on the sale-approval order.

On rejection, Judge Higginbotham said, the license ceased to be property of the estate, and there was nothing in the purchase contract or sale-approval order to suggest that the trustee was selling anything other than estate property. Therefore, the decision by the bankruptcy court was not a collateral attack on the prior sale-approval order but was “merely an interpretation of the bankruptcy court’s orders.”