Debtor May Assume License as Executory Contract Despite Anti-Assignment Language

The primary issue for lessors presented in the case is which type of “test” should be applied in making the court's decision. In ruling that the respondent may assume the SLA under 11 U.S.C. '365(c) (which literally states that the trustee may not assume or assign any executory contract or unexpired lease of the debtor), the court declined to apply the “hypothetical test” or “literal test” used in this context by the Third, Ninth and Eleventh Circuits, but, instead, applied the “actual test” adopted by the First Circuit and numerous bankruptcy courts. While acknowledging that the “actual test” has the weakness of reading the statutory language “assume or assign” to mean “assume and assign” and that the “literal test” has the obvious virtue of being consistent with the dictate of the Supreme Court that the plain meaning of a statute must be enforced when its terms are unambiguous, the court found the “actual test” to be far more harmonious with the statutory scheme. The court reasoned that the “actual test” had the virtue of being consistent with the general goals of Chapter 11 because it allowed licensees to benefit from the protections of the bankruptcy law while encouraging the maximization of the economic value of the debtor's estate. Furthermore, the Court pointed out that even though the plain meaning of statutes must generally be enforced, there is a competing principle that statutes should not be interpreted to produce results that are unreasonable in light of the drafter's intentions (See, e.g. United States v. Ron Pair Enters, Inc. 489 U.S. 235, 242, 109 S.Ct. 1026, 103 L.Ed.2d 290 (1989)).

Furthermore, the court rejected respondent's ancillary contention that even if it cannot assume the SLA, it may nevertheless use the licensed software, giving RCC only a pre-petition claim for monetary damages, as not persuasive, because the rights of a debtor and creditor following rejection are the same as if the debtor had breached the contract before filing for bankruptcy (In re Alongi, 272 B.R. 148, 154 (Bankr.D.Md. 2001)). In this case, the right of rescission applies because under Maryland law (the applicable state law in this case), if one party to a contract materially breaches the contract, the other party has the right of rescission (Washington Homes, Inc. v. Interstate Land Dev. Co., 281 Md. 712, 728, 382 A.2d 555, 563 (1978)). The court reasoned that otherwise, there would be no reason for a debtor ever to assume a contract if a debtor could reject a contract and still retain its benefits.

The Fourth Circuit has not yet ruled upon which test applies under these circumstances. The courts in the Fourth Circuit may follow the other courts of appeal that have adopted a literal reading and the hypothetical test. The judge in this case opined that in the exercise of his own judgment, the actual test was more harmonious with the statutory scheme. He based his opinion upon the competing principle that statutes should not be interpreted to produce results that are unreasonable in light of the drafter's intentions. Therefore, depending upon the judicial circuit in which the debtor is located, the court will apply the “literal,” “actual” or “hypothetical test,” and the outcome of the case may depend on which test is applied.

In a recent decision of interest to the leasing community, the U.S. District Court of Maryland has held that a Chapter 11 debtor could assume a software license agreement (SLA), as an executory contract, although the agreement contained a clause that the debtor could not “assume or assign” the agreement, and even though the assignability of the SLA was clearly precluded by federal copyright law.

In the case of RCC Technology Corp. v. Sunterra Corp. (287 B.R. 864 (2003)), the creditor, Resort Computer Corporation (RCC), appealed an order of the U.S. Bankruptcy Court denying RCC's motion to “deem rejected” a SLA between it and the bankruptcy debtor, Sunterra Corporation. The District Court affirmed this order, but grounded its decision upon other reasons than those articulated by the U.S. Bankruptcy Court.

The court relied upon a long line of authorities in reaching its decision. (See, e.g. Everex Sys., Inc. v. Cadtrak Corp. (In re CFLC, Inc.), 89 Fed. 673 (9th Cir. 1996); In re Access Beyond Techs., Inc., 237 B.R. 32, 43-44 (Bankr.D.Del. 1999)). The court held that intellectual property licensing agreements such as the SLA are executory contracts. The court found these authorities to be persuasive on the issue.

The primary issue for lessors presented in the case is which type of “test” should be applied in making the court's decision. In ruling that the respondent may assume the SLA under 11 U.S.C. '365(c) (which literally states that the trustee may not assume or assign any executory contract or unexpired lease of the debtor), the court declined to apply the “hypothetical test” or “literal test” used in this context by the Third, Ninth and Eleventh Circuits, but, instead, applied the “actual test” adopted by the First Circuit and numerous bankruptcy courts. While acknowledging that the “actual test” has the weakness of reading the statutory language “assume or assign” to mean “assume and assign” and that the “literal test” has the obvious virtue of being consistent with the dictate of the Supreme Court that the plain meaning of a statute must be enforced when its terms are unambiguous, the court found the “actual test” to be far more harmonious with the statutory scheme. The court reasoned that the “actual test” had the virtue of being consistent with the general goals of Chapter 11 because it allowed licensees to benefit from the protections of the bankruptcy law while encouraging the maximization of the economic value of the debtor's estate. Furthermore, the Court pointed out that even though the plain meaning of statutes must generally be enforced, there is a competing principle that statutes should not be interpreted to produce results that are unreasonable in light of the drafter's intentions (See, e.g. United States v. Ron Pair Enters, Inc. 489 U.S. 235, 242, 109 S.Ct. 1026, 103 L.Ed.2d 290 (1989)).

Furthermore, the court rejected respondent's ancillary contention that even if it cannot assume the SLA, it may nevertheless use the licensed software, giving RCC only a pre-petition claim for monetary damages, as not persuasive, because the rights of a debtor and creditor following rejection are the same as if the debtor had breached the contract before filing for bankruptcy (In re Alongi, 272 B.R. 148, 154 (Bankr.D.Md. 2001)). In this case, the right of rescission applies because under Maryland law (the applicable state law in this case), if one party to a contract materially breaches the contract, the other party has the right of rescission ( Washington Homes, Inc. v. Interstate Land Dev. Co., 281 Md. 712, 728, 382 A.2d 555, 563 (1978)). The court reasoned that otherwise, there would be no reason for a debtor ever to assume a contract if a debtor could reject a contract and still retain its benefits.

The Fourth Circuit has not yet ruled upon which test applies under these circumstances. The courts in the Fourth Circuit may follow the other courts of appeal that have adopted a literal reading and the hypothetical test. The judge in this case opined that in the exercise of his own judgment, the actual test was more harmonious with the statutory scheme. He based his opinion upon the competing principle that statutes should not be interpreted to produce results that are unreasonable in light of the drafter's intentions. Therefore, depending upon the judicial circuit in which the debtor is located, the court will apply the “literal,” “actual” or “hypothetical test,” and the outcome of the case may depend on which test is applied.