Affirming Bankruptcy Judge Douglas D. Dodd of Baton Rouge, La., the district court held that a surety bond is not an executory contract that a debtor can assume.
The surety may have been lulled into complacency during the chapter 11 case by the debtor’s having said it would continue paying the bonds. Just like Judge Dodd, District Judge Brian A. Jackson held that a surety bond is not an executory contract capable of assumption under the so-called Countryman definition of executory contracts.
The E&P Bonds
The debtor was engaged in oil and gas exploration and production. Before bankruptcy, the debtor had acquired four irrevocable performance bonds securing the debtor’s obligations to the state for environmental liabilities and for plugging and abandoning wells. The bonds were accompanied by an indemnity agreement where the debtor agreed to indemnify the bonding company if it were called on the bonds.
The insurer was liable for a maximum of about $10.6 million on the bonds, Bankruptcy Judge Dodd said in his opinion on Sept. 22, 2020. 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. See In re Falcon V LLC, 620 B.R. 256 (Bankr. M.D. La. Sept. 22, 2020). To read ABI’s report, click here.
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
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. The plan said that executory contracts were deemed assumed unless they were listed for rejection, but the bonds were not on the list of rejected executory contracts.
After confirmation, the debtor failed to pay a premium on the bonds. The bonding company responded by demanding more collateral. The debtor refused, accusing the bonding company of violating the discharge injunction.
To resolve the dispute, the bonding company filed a motion for a declaration that the bonds were among executory contracts assumed automatically on confirmation.
Bankruptcy Judge Dodd agreed with the debtor. He held that the bonds were not executory contracts capable of assumption. And if they were executory, he said they were financial accommodations incapable of assumption.
The bonding company appealed, to no avail.
Countryman Ends the Discussion
The outcome turned on Section 365(a), which permits the assumption of an executory contract with the court’s permission. “Curiously,” Judge Jackson said, the statute does not define “executory contract.”
Judge Jackson prefaced his analysis of the law by recognizing that the Fifth Circuit has adopted the definition of executory contracts proposed by Prof. Vern Countryman of Harvard Law School. The professor called a contract executory if it is “a contract under which the obligation of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other.” Executory Contracts in Bankruptcy: Part I, 57 Minn. L. Rev. 439, 460 (1973).
The key to the outcome was contained on the second page of Judge Jackson’s opinion. He said that the indemnity imposed continuing obligations on the debtor but none on the bonding company.
“Under any stretch” in applying the Countryman definition, Judge Jackson said that the bonding company “owes no additional performance to the Reorganized Debtors after posting the surety bonds.” The bonding company’s “only remaining duty is a contingent obligation” to the beneficiaries of the bonds.
Even “more problematic,” Judge Jackson said, the bonds are “irrevocable.”
“Thus,” he said, “the Reorganized Debtors failure to perform does not create a material breach that excuses [the bond company’s] performance, as required by the second prong of the Countryman test.”
Governed by the Fifth Circuit’s adoption of the Countryman test, Judge Jackson said he would rule, as he “must,” that the bonds were not executory contracts and thus were incapable of assumption.
Judge Jackson upheld the ruling by Judge Dodd and, in the process, said that surety bonds cannot pass unaffected through bankruptcy because the ride-through doctrine applies only to executory contracts that were neither assumed nor rejected.
Affirming Bankruptcy Judge Douglas D. Dodd of Baton Rouge, La., the district court held that a surety bond is not an executory contract that a debtor can assume.
The surety may have been lulled into complacency during the chapter 11 case by the debtor’s having said it would continue paying the bonds. Just like Judge Dodd, District Judge Brian A. Jackson held that a surety bond is not an executory contract capable of assumption under the so-called Countryman definition of executory contracts.
The E&P Bonds
The debtor was engaged in oil and gas exploration and production. Before bankruptcy, the debtor had acquired four irrevocable performance bonds securing the debtor’s obligations to the state for environmental liabilities and for plugging and abandoning wells. The bonds were accompanied by an indemnity agreement where the debtor agreed to indemnify the bonding company if it were called on the bonds.
The insurer was liable for a maximum of about $10.6 million on the bonds, Bankruptcy Judge Dodd said in his opinion on Sept. 22, 2020. 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. See In re Falcon V LLC, 620 B.R. 256 (Bankr. M.D. La. Sept. 22, 2020). To read ABI’s report, click here.
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.