The ability of a bankruptcy trustee or chapter 11 debtor-in-possession (“DIP”) to assume, assume and assign, or reject executory contracts and unexpired leases is an important tool designed to promote a “fresh start” for debtors and to maximize the value of the bankruptcy estate for the benefit of all stakeholders. However, the Bankruptcy Code and the Federal Rules of Bankruptcy Procedure (“Bankruptcy Rules”) establish strict requirements for the assumption, assignment, and rejection of contracts and leases. The U.S. Bankruptcy Court for the District of Delaware addressed the consequences of failing to comply with those requirements in In re Dura Auto. Sys., LLC, 628 B.R. 750 (Bankr. D. Del. 2021). The court confirmed that the U.S. Court of Appeals for the Third Circuit-like the majority of other courts that have decided the issue-has rejected the doctrine of “implied assumption” of executory contracts in bankruptcy cases.
Assumption, Assumption and Assignment, and Rejection of Executory Contracts and Unexpired Leases in Bankruptcy
Section 365(a) of the Bankruptcy Code provides that, with certain exceptions delineated elsewhere in the statute, “the trustee, subject to the court’s approval, may assume or reject any executory contract or unexpired lease of the debtor.” The trustee’s power to assume or reject is conferred upon a DIP under section 1107(a) of the Bankruptcy Code. Rejection results in a court-authorized breach of the contract, with any claim for damages treated as a prepetition claim against the estate on a par with the claims of other general unsecured creditors (unless the debtor has posted security). 11 U.S.C. § 365(g). Assumption of a contract requires, among other things, that the trustee or DIP cure all existing monetary defaults and provide adequate assurance of its future performance. 11 U.S.C. § 365(b).
One purpose of section 365(a) is to provide the debtor with “a reasonable time within which to determine whether adoption or rejection of the executory contract would be beneficial to an effective reorganization.” Univ. Med. Ctr. v. Sullivan (In re Univ. Med. Ctr.), 973 F.2d 1065, 1075 (3d Cir. 1992).
Bankruptcy courts will generally approve assumption or rejection of a contract or lease if presented with evidence that either course of action is a good business decision. See Mission Prod. Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652, 1658 (2019) (“The bankruptcy court will generally approve [the] choice [to assume or reject], under the deferential ‘business judgment’ rule.”). Upon assumption, most kinds of executory contracts may also be assigned by the trustee or DIP to third parties under the circumstances specified in sections 365(c) and 365(f). In chapter 11 cases, except with respect to certain kinds of contracts (such as nonresidential real property leases, aircraft lease agreements, and commitments to a federal depository institutions regulatory agency), the trustee or DIP may decide to assume or reject at any time up to confirmation of a chapter 11 plan. However, any nondebtor party to a contract may seek to compel the trustee or DIP to assume or reject the contract prior to confirmation, in which case the bankruptcy court must decide what period of time is reasonable to make the decision. 11 U.S.C. §§ 365(d)(2), (d)(4), and (o). Pending the decision to assume or reject, the trustee or DIP is generally obligated to keep current on most obligations that become due under the contract postpetition. 11 U.S.C. §§ 365(d)(3) and (d)(5).
Bankruptcy Rule 6006 sets forth procedures governing the assumption, assumption and assignment, or rejection of executory contracts and unexpired leases. Rule 6006(a) provides that “[a] proceeding to assume, reject or assign an executory contract or unexpired lease, other than as part of a plan, is governed by [Bankruptcy] Rule 9014.” Under Bankruptcy Rule 9014(a), the trustee or DIP must request the relief by motion filed with the bankruptcy court, with reasonable notice and an opportunity for a hearing provided to the contract counterparty.
In October 2019, automotive supply company Dura Automotive Systems, LLC and certain affiliates (collectively, “Dura”) filed for chapter 11 protection in the Middle District of Tennessee. Venue of the cases was transferred shortly thereafter to the District of Delaware.
Prior to filing for bankruptcy, Dura contracted with Plasti-Paint, Inc. (“PLP”) for the painting of auto roof rails under contracts (“PLP contracts”) and related purchase orders. The PLP contracts allowed Dura to place weekly orders without having to issue new purchase orders. As a critical supplier, PLP continued to provide services to Dura under the contracts after the bankruptcy petition date.
In January 2020, Hain Capital Investor Master Fund, Ltd. (“Hain”) purchased PLP’s claims against Dura under the PLP contracts and all associated rights. Under the claims purchase agreement, if Dura assumed any of the PLP contracts, Hain was entitled to all cure amounts payable upon assumption.
In June 2020, the court approved the sale of substantially all of Dura’s North American assets to Dura Buyer DNA, LLC (together with its assignees, including DUS Operating, Inc. (“DUS”), the “Purchaser”). As part of the transaction, which was closed in June 202, Dura assumed and assigned certain executory contracts to the Purchaser in accordance with section 365 and court-approved procedures. Under the sale agreement, the Purchaser was obligated to pay all of Dura’s monetary defaults under the assigned executory contracts before the sale closed. Dura, however, never sought to assume and assign or to reject the PLP contracts.
After the sale, PLP rendered performance to the Purchaser under the PLP contracts but announced that it would soon modify its paint process. PLP and the Purchaser accordingly entered into a new contract in June 2020. The new contract substituted DUS as the contract counterparty but otherwise made no significant changes. However, the parties operated under the PLP contracts until September 2020, when PLP implemented its new paint process. The parties then used both the old and new contracts until December 2020, after which they began operating solely under the new contract.
In October 2020, Hain sought an order from the bankruptcy court compelling the Purchaser to pay it approximately $1.8 million to cure alleged defaults under the PLP contracts. Hain argued that, despite Dura’s failure to formally assume and assign the PLP contracts as part of the sale transaction, the cure amounts were due under the doctrine of “implied assumption,” based on Dura’s conduct. According to Hain, Dura impliedly assumed the PLP contracts because: (i) the new contract between PLP and the Purchaser’s designee DUS was substantially similar in purpose to the PLP contracts; (ii) the new contract was a continuation of the PLP contracts and the parties intentionally structured their dealings so that they could avoid paying Hain the cure amount; and (iii) DUS benefited from the PLP contracts without taking responsibility for paying the cure amount.
DUS countered that the bankruptcy court never approved Dura’s assumption and assignment of the PLP contracts, and the Third Circuit, like many other courts, has rejected the concept of implied assumption.
The Bankruptcy Court’s Ruling
The bankruptcy court denied Hain’s motion.
Bankruptcy Judge Karen B. Owens explained that, because Dura neither sought nor obtained court approval to assume and assign the PLP contracts to the Purchaser, the contracts were not assumed and the Purchaser (or its assignee DUS) did not have to pay the cure amount required as a condition to assumption under section 365(b). Citing University Medical (Third Circuit precedent by which the bankruptcy court was bound), Judge Owens noted that the Third Circuit has rejected the implied assumption doctrine. Dura, 328 B.R. at 754. Although courts outside of the Third Circuit have permitted implied assumption, she wrote, they are “a small minority.” Id.
In accordance with University Medical, Judge Owens emphasized, “‘assumption must be approved. It cannot be presumed.'” Id. (quoting University Medical, 973 F.2d at 1077). In University Medical, she explained, the Secretary of the U.S. Department of Health and Human Services asserted that the unique circumstances of the Medicare Act should allow a contract to be assumed if performance continues after the petition date even without formal court approval. However, the Third Circuit refused to depart from the plain language of the Bankruptcy Code that mandates court approval for assumption of an executory contract. In so ruling, Judge Owens noted, the court of appeals stressed the importance of motion practice and court approval so that all of the pros and cons to the estate and stakeholders can be considered and an executory contract’s status with respect to the estate can be finalized. Id. at 755 (citing University Medical, 973 F.3d at 1078-79).
According to Judge Owens, PLP voluntarily provided services after the sale until the new contract became effective, and there was “no motivation” to seek court approval to assume the PLP contracts and pay the cure amount after PLP sold its claims under the contracts to Hain. Instead, the parties focused on continuing PLP’s critical services and finalizing the painting process and the new contract. In addition, Hain never requested court approval of assumption of the PLP contracts (as was its right under section 365(d)(2) and the claims purchase agreement) or attempted to stop the parties from continuing their dealings or from entering into a new contract, despite being aware that PLP was continuing to provide services.
Judge Owens rejected Hain’s contention that section 105(a) of the Bankruptcy Code (providing that the court can “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions” of the Bankruptcy Code) authorized a finding of implied assumption. This argument, she wrote, was rejected by the Third Circuit in University Medical and defies the plain language of the Bankruptcy Code and the Bankruptcy Rules. Id. at 756 (citing Law v. Siegel, 571 U.S. 415, 421 (2014) (holding that a bankruptcy court cannot use section 105(a) to override explicit mandates of the Bankruptcy Code)).
Finally, Judge Owens noted that Hain could pursue any claim it might have for breach of the claims purchase agreement outside of bankruptcy. Hain’s claims under the PLP contracts, by contrast, would be resolved in due course in Dura’s bankruptcy.
Dura Automotive demonstrates the importance of strict compliance with the rules and procedures established in the Bankruptcy Code and the Bankruptcy Rules for the assumption, rejection, and assignment of executory contracts and unexpired leases. Although a minority of courts have concluded that a contract or lease can be assumed under the doctrine of implied assumption, debtor and nondebtor contract parties (as well as other stakeholders in the bankruptcy case) are better served by adhering to the rules rather than leaving the fate of their interests under a contract or lease to the court’s equitable discretion.
The decision also serves as a reminder that claims purchasers must be vigilant and proactive to ensure that their rights under a purchase or assignment agreement are preserved (e.g., by actively participating in the bankruptcy case or including an indemnity in the agreement.)