Made before bankruptcy, a discounted settlement agreement is not an executory contract that may be assumed in a subsequent chapter 11 case. It’s either not executory or is a financial accommodation that the debtor can’t assume, according to Bankruptcy Judge Christopher M. Klein of Sacramento, Calif.
Discounted settlement agreements are ubiquitous. They are often employed in workout agreements designed to avoid bankruptcy. Typically, a creditor allows the debtor to pay a discounted amount in satisfaction of a larger debt. If the discount is paid in full, the larger debt is discharged.
If the debtor defaults before bankruptcy and does not cure within the allotted time, the debtor may not reinvigorate the settlement by assuming the agreement as an executory contract, for reasons explained by Judge Klein in his December 19 opinion.
The Discounted Payment Agreement
The facts were more complicated but boil down to this: Before bankruptcy, the debtor closed a bakery, resulting in withdrawal liability to a union pension fund. The pension fund had a withdrawal claim for about $43 million.
In settlement, the pension fund allowed the debtor to pay $3 million over 20 years. If paid in full, the entire $43 million liability would be expunged.
The debtor made the required monthly payments for six months, then defaulted. The fund gave notice of default and five days to cure. Before the time for cure had elapsed, the debtor filed a chapter 11 petition.
The debtor languished in chapter 11 for three years before the debtor scrounged enough to pay the remainder of the $3 million. Aiming to resuscitate the pre-bankruptcy settlement, the debtor filed a motion to assume the agreement as an executory contract under Section 365.
The pension fund successfully opposed contract assumption. The union wasn’t litigating against its own interest, because assumption of the agreement and payment of the $3 million would extinguish the $39 million remainder of the claim. By that time, the pension fund believed it could collect the $39 million from an alleged third-party successor to the debtor’s business.
Not an Executory Contract
To be assumed under Section 365, the agreement must be an executory contract, a term not defined in the Bankruptcy Code. The Ninth Circuit, however, has adopted the so-called Countryman definition, which says that a contract is executory if the obligations of both parties are so far unperformed that a failure by either to complete performance would constitute a material breach excusing performance by the other.
According to Judge Klein, the Ninth Circuit focuses on mutuality.
On the filing date, Judge Klein observed that both parties had “nominally” unperformed obligations. However, the pension fund’s obligations were contingent on full performance by the debtor. The pension fund, he said, “need do nothing to avoid a material breach” as of the filing date.
Cited by Judge Klein, the Restatement (Second) of Contracts says that performance of a duty subject to a condition cannot come due unless the condition occurs or is excused. Ergo, no performance was due from the pension fund because there had been no timely payment.
Furthermore, a contract is not executory if either party has substantially performed, and the pension fund already had performed.
Judge Klein concluded that the agreement was not executory and thus could not be assumed. Even if it were executory, the agreement was a financial accommodation that can’t be assumed under Section 365(c)(2). He noted how courts have held prepetition workout agreements to be financial accommodations.
The agreement, Judge Klein said, was “an accommodation allowing [the debtor] to pay a sum of money over time that is a fraction of the total liability” and “is a financial accommodation for purposes of Section 365(c)(2).”
Judge Klein denied the motion to assume the agreement, saying that the debtor’s “proposed assumption of the deferred payment agreement is dead on arrival.”
Made before bankruptcy, a discounted settlement agreement is not an executory contract that may be assumed in a subsequent chapter 11 case. It’s either not executory or is a financial accommodation that the debtor can’t assume, according to Bankruptcy Judge Christopher M. Klein of Sacramento, Calif.
Discounted settlement agreements are ubiquitous. They are often employed in workout agreements designed to avoid bankruptcy. Typically, a creditor allows the debtor to pay a discounted amount in satisfaction of a larger debt. If the discount is paid in full, the larger debt is discharged.
If the debtor defaults before bankruptcy and does not cure within the allotted time, the debtor may not reinvigorate the settlement by assuming the agreement as an executory contract, for reasons explained by Judge Klein in his December 19 opinion.