An Order Directing Specific Performance Means the Contract Is Not Executory

Once there is an order directing specific performance of a land sale contract, the contract is no longer an executory contract subject to rejection under Section 365(a), according to Bankruptcy Judge Terry L. Myers of Boise, Idaho.

In his June 12 opinion, Judge Myers also held that an award of specific performance is not a “transfer” and therefore does not give rise to a preference under Section 547.

A couple owned a ranch that they put up for sale in two parcels at an “absolute auction with no minimums or reserves.” The couple committed to convey the properties free and clear of encumbrances, including $550,000 in mortgages. The high bids at auction totaled less than $500,000.

The buyers and the sellers signed land sale contracts, but the sellers later notified the buyers that they would not close. So, the buyers sued, and the state court issued a decision declaring that the buyers were entitled to specific performance.

Six days after the decision in state court, the sellers filed a chapter 13 petition and removed the state court suit to bankruptcy court. On application by the sellers, Judge Myers modified the automatic stay and remanded the suit to state court, although he stayed enforcement of state court orders.

On remand, the state trial court entered judgment compelling the debtors to convey the properties by warranty deed free and clear of encumbrances. Later, the Montana Supreme Court affirmed.

Back in bankruptcy court, the debtors filed a chapter 13 plan calling for Judge Myers to reject the land sale contracts as executory contracts under Section 365(a).

Judge Myers held that the characterization of the land sale contracts as executory contracts “is incorrect.” In deciding whether a contract can be rejected, he said there is a distinction in the Ninth Circuit between performance and a tender of performance.

Although there had only been a tender of performance by the buyers, Judge Myers held that “there is no executory contract” in cases where “specific performance has been ordered prior to bankruptcy.” Citing a bankruptcy court decision from Texas, he said that any remaining performance was “merely ministerial” following a decree for specific performance. The fact that the decision in state court was not reduced to judgment until after bankruptcy “does not make a difference,” he said.

Barred from rejecting the land sale contracts as executory contracts, the debtors next argued that the decision in state court, just a few days before bankruptcy, was a voidable preference because the decision was a “transfer.”

To have a preference, there must be a “claim,” Judge Myers explained. In turn, he said, a “claim” means there must be “a right to payment,” given the definition of “claim” in Section 101(5).

There can be a claim, Judge Myers said, if the right to specific performance may be satisfied alternatively by an award of monetary damages. However, the contract gave the buyers an election between reclaiming their deposits or seeking specific performance if the sellers failed to close. The creditors, the judge said, had elected specific performance. 

Saying the equitable remedy of specific performance is not a “claim,” Judge Myers ruled that the buyers did not have a claim and thus were not “creditors.” There could be no preference in the absence of a transfer to a creditor, under Section 547(b)(1).

There was no preference on a second ground, according to Judge Myers, because a preference requires a transfer of “an interest in property.” The judicial decision, he said, did “not effect a transfer of the realty.” The decision and order in state court did not amount to a transfer, “but, rather, an order compelling transfer.”

The absence of a transfer also meant that the decision in state court did not amount to a transfer, giving the debtors nothing to avoid as a preference.

Judge Myers closed the circle by granting motions by the buyers and the chapter 13 trustee to dismiss the case. He saw “cause” for dismissal because he found that the debtors filed their chapter 13 plan “with the ‘primary motive’ and purpose to defeat this state court litigation.”

Question: Does everyone agree that a creditor’s election to pursue specific performance means there is no claim and no executory contract? And what will happen next in state court?

If the debtors can’t make up the $50,000 shortfall to convey the land free of liens, will the buyers then have claims for damages in the absence of specific performance, despite what the contract may say? In a second chapter 13 filing, will the debtors be able to accomplish something they couldn’t in the first? 

All things considered, the facts would make for a magnificent final exam question, with an emphasis on issue-spotting.