On a topic where there is surprisingly little law, Bankruptcy Judge Douglas D. Dodd of Baton Rouge, La., wrote an opinion that contains everything you need to know about the status of surety bonds in chapter 11.
He held that (1) a surety bond is not an executory contract; (2) even if it were an executory contract, it is a financial accommodation that cannot be assumed; (3) the bonding company may not consent to assumption; and (4) if no claim has been made on the bond, the unsecured claim is disallowed for being contingent and unliquidated.
Judge Dodd’s September 22 opinion is a teaching moment for counsel representing bonding companies. It tells them to nail down the treatment of bonds in a chapter 11 plan and never assume a bond will ride through bankruptcy unaffected.
The E&P Bonds
The debtor was engaged in oil and gas exploration and production. Before bankruptcy, the debtor had acquired four performance bonds covering the debtor’s obligations to the state for environmental liabilities and for plugging and abandoning wells.
The insurer was liable for a maximum of about $10.6 million on the bonds. At filing, the insurer held some $3.2 million in cash to secure the bonding company’s obligations were claims to be made on the bonds.
The bonding company filed a secured claim for $3.2 million and an unsecured claim for the difference, $7.4 million. In the claim, the insurer said that the bonds were financial accommodations that the debtor could not assume or assign.
The Confirmed Plan
The bonding company may have been lulled into complacency throughout the chapter 11 case.
On motion of the debtor near the outset of reorganization, the bankruptcy court authorized the debtor to “continue and maintain” the surety bonds and to pay obligations under the bonds as they came due. Later, the disclosure statement said the debtor would “maintain” the bonds after confirmation, and the plan said that executory contracts were deemed to be assumed unless they were listed for rejection. The bonds were not on the list of rejected executory contracts.
Apart from filing a claim, the bonding company did not appear in the bankruptcy case until six months after confirmation, when the insurer demanded extra collateral for the bonds. The debtor responded by alleging that the demand for collateral was in violation of the discharge injunction, because the bonds were not and could not be assumed.
The Bonding Company Loses (Almost) Every Argument
Right down the line, Judge Dodd sided with the debtor. First, he held that the bonds were not executory contracts.
Applying the so-called Countryman test, Judge Dodd said that the insurer had performed its only obligation to the debtor before bankruptcy by posting the bonds with the state. The insurer’s only continuing obligation was to the state, to make good on the bonds if claims were made. The bonds were not executory contracts because the insurer had no continuing obligations to the debtor.
Even if the bonds were executory contracts, they could not be assumed under Section 365(c)(2). The section bars assumption of a “contract to make a loan, or extend other debt financing or financial accommodations.”
Although the Fifth Circuit has not ruled, Judge Dodd said that a “majority of courts” have held that surety bonds are financial accommodations. Even if the bonds were executory contracts, he held, a bond “is a financial accommodation that cannot be assumed under Section 565(c)(2).”
The insurer argued that a nonassumable contract could still be assumed with the bonding company’s consent.
Judge Dodd disagreed. Even if there were evidence of consent, he held, the bonds still could not be assumed because consent is not an exception to Section 365(c)(2) like it is to Section 365(c)(1)(B).
Not finished drubbing the bonding company, the debtor argued that the unsecured claim was disallowed under Section 502(e)(1)(B). Judge Dodd agreed.
The section provides that “the court shall disallow any claim for reimbursement or contribution of an entity that is liable with the debtor on . . . the claim of a creditor, to the extent that . . . such claim for reimbursement or contribution is contingent as of the time of allowance or disallowance of such claim for reimbursement or contribution.”
Judge Dodd quoted the Collier treatise for saying that the section applies “to a debt owed by the debtor to a creditor which has been guaranteed by a third party.” 4 Collier on Bankruptcy ¶ 502.06[d] (16th ed. 2020). He ruled that the unsecured claim met all the criteria.
The unsecured claim was entirely contingent because no claims had been made against the bonds; the insurer’s claim was for contribution or reimbursement, and the insurer and the debtor would be liable for the same claim if one were made by the state.
Judge Dodd therefore ruled that the unsecured claim “was disallowed upon plan confirmation.”
The bonding company was off the hook for violating the discharge injunction, in light of Taggart v. Lorenzen, 139 S. Ct. 1795, 1799 (June 3, 2019), where the Supreme Court held that a court “may impose civil contempt sanctions [for violating the discharge injunction] when there is no objectively reasonable basis for concluding that the creditor’s conduct might be lawful under the discharge order.”
Judge Dodd decided that the insurer could not be held in contempt because its “uncertainty about its treatment was reasonable.”
On a topic where there is surprisingly little law, Bankruptcy Judge Douglas D. Dodd of Baton Rouge, La., wrote an opinion that contains everything you need to know about the status of surety bonds in chapter 11.
He held that (1) a surety bond is not an executory contract; (2) even if it were an executory contract, it is a financial accommodation that cannot be assumed; (3) the bonding company may not consent to assumption; and (4) if no claim has been made on the bond, the unsecured claim is disallowed for being contingent and unliquidated.
Judge Dodd’s September 22 opinion is a teaching moment for counsel representing bonding companies. It tells them to nail down the treatment of bonds in a chapter 11 plan and never assume a bond will ride through bankruptcy unaffected.