The Fifth Circuit recently applied long-held law to complex facts. The holding is simple: A debtor cannot assign part of a contract.
In its per curiam opinion on October 27, the appeals court said that it’s “all or nothing.”
A man was injured in a gym when a piece of equipment failed, evidently causing severe injuries. In state court, the customer sued both the gym and the gym’s franchisor. Contending that the particular equipment was not permitted under the franchise agreement, the franchisor won dismissal of the suit. Dismissal was upheld on appeal.
On the eve of trial in state court, the gym filed a petition under Subchapter V of chapter 11. Less than two days after the filing, the gym notified the bankruptcy judge that there was a settlement. In short order, the bankruptcy judge approved the settlement without giving notice to the franchisor.
Without reciting every term of the settlement, here’s what’s important: The gym agreed to entry of a $1 million judgment to be paid by the gym’s insurer. The gym also agreed to a confession of judgment that the customer’s damages were $7 million.
Here’s the rub: As approved by the bankruptcy court, the gym assigned to the customer all of the gym’s rights of indemnity against the franchisor under the franchise agreement.
Back in state court, the customer filed a new suit against the franchisor, asserting the gym’s indemnification rights against the franchisor. Based on the confession of judgment and the indemnification rights, the customer claimed that the franchisor was liable for $7 million. Although the prior suit against the franchisor had been dismissed, the state court declined to dismiss the new complaint. According to the Fifth Circuit, it’s still alive in state court.
The franchisor went to bankruptcy court, complaining that approval of the settlement was defective because it had not been given notice. After a new hearing, the bankruptcy court approved the settlement a second time, and the district court affirmed. The franchisor appealed to the Fifth Circuit.
Among the myriad ways to attack the settlement, the circuit court only analyzed the appeal in terms of the assignment of executory contracts. On the facts of the case, the circuit court said that the franchise agreement was an executory contract.
With regard to assumption of an executory contract, the panel said, “When it comes to assuming an executory contract, we have been clear that it’s all or nothing.” [Emphasis in original.] With regard to assignment of executory contracts, the panel said, “assignments are likewise all-or-nothing.” In other words, “a debtor assuming an executory contract cannot separate the wheat from the chaff.”
Applying settled law to the facts, the panel said that the gym “did not assign the entirety of the franchise agreement to the [customer].” Specifically, the gym assigned only its rights of indemnification but otherwise retained the franchise agreement.
The debtor’s “partial assignment is not authorized by Title 11,” the panel held.
The appeals court reversed approval of the settlement and remanded.
The Fifth Circuit recently applied long-held law to complex facts. The holding is simple: A debtor cannot assign part of a contract.
In its per curiam opinion on October 27, the appeals court said that it’s “all or nothing.”
A man was injured in a gym when a piece of equipment failed, evidently causing severe injuries. In state court, the customer sued both the gym and the gym’s franchisor. Contending that the particular equipment was not permitted under the franchise agreement, the franchisor won dismissal of the suit. Dismissal was upheld on appeal.
On the eve of trial in state court, the gym filed a petition under Subchapter V of chapter 11. Less than two days after the filing, the gym notified the bankruptcy judge that there was a settlement. In short order, the bankruptcy judge approved the settlement without giving notice to the franchisor.