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Generally speaking, after a bankruptcy filing, executory contracts are not enforceable against a debtor that has not yet assumed the contract. N.L.R.B. v. Bildisco and Bildisco, 465 U.S. 513, 531 (1984). However, the reverse is not true. During the pre-assumption period, the non-debtor party to the contract is presumed to be obligated to perform in accordance with a contract. Howard C. Buschman III, Benefits and Burdens: Post-Petition Performance of Unassumed Executory Contracts, 5 Bankr. Dev. J., 341, 346, 359 (1988); Univ. Med. Ctr. v. Sullivan (In re Univ. Med. Ctr.), 973 F.2d 1065, 1075 (3d Cir. 1992); McLean Indus., Inc. v. Med. Lab. Automation, Inc. (In re McLean Indus., Inc.), 96 B.R. 440, 449 (Bankr. S.D.N.Y. 1989). Of course, a debtor who elects to receive the benefits of a contract while deciding whether to assume or reject the contract is expected to pay for the value of the goods and services received in accordance with the contract. As the Supreme Court noted in Bildisco, 465 U.S. at 531, 'If the debtor-in-possession elects to continue to receive benefits from the other party to an executory contract pending a decision to reject or assume the contract, the debtor-in-possession is obligated to pay for the reasonable value of those services ' ' See also Schokbeton Indus., Inc. v. Schokbeton Prods. Corp. (In re Schokbeton Indus., Inc.), 466 F.2d 171, 175 (5th Cir. 1972).
There are some limitations, however, on the ability of the debtor in possession to obtain the benefit of a contract after bankruptcy but prior to assumption. Section 365(b)(4) of the Bankruptcy Code, for example, excuses a landlord from providing services and supplies incidental to the lease when there has been a nonmonetary default under the lease, unless the landlord is compensated for the services or supplies. 11 U.S.C. ' 365(b)(4). With respect to nonresidential realty leases, the debtor in possession must pay the full rent as it accrues post-petition, prior to assumption, even if the premises are not used or occupied. 11 U.S.C. ' 365(d)(3); Cukierman v. Uecker (In re Cukierman), 265 F.3d 846, 850 (9th Cir. 2001) ('We have held that claims arising under ' 365(d)(3) are entitled to administrative priority even when they may exceed the reasonable value of the debtor's actual use of the property'); In re Curry Printers, Inc., 135 B.R. 564 (Bankr. N.D. Ind. 1991) (requiring lease payments regardless of actual usage).
Protecting the Seller
With a contract to sell goods, or to provide services, the issue from the perspective of the seller is how to protect itself going forward. Is an administrative expense claim for the provision of post-petition trade credit a sufficient protection? Experience tells us that debtors sometimes do not pay their post-petition administrative obligations. Vendors may prefer cash on delivery or payment in advance of delivery. How, or rather why, would and could such a unilateral change in the contract be effectuated post-petition?
Trade Credit Provisions
A key inquiry is to examine the trade credit provisions of the contract. The reason for this is that as a practical matter, the issue when the case is before the bankruptcy court is whether the bankruptcy judge will make a trade vendor provide post-petition trade credit. There are no reported cases where the debtor was able to require a trade vendor to provide trade credit. There are cases where the vendor has been required to sell to the debtor, but not on credit in a bankruptcy context. See, eg, Blackwelder Furniture Co. v. Seilig Mfg. Co., 550 F.2d 189 (4th Cir. 1977) (injunction to reinstitute franchise agreement and thus duty to sell, but not in a bankruptcy context); cf., In re Coserv, LLC, 273 B.R. 487, 494 (Bankr. N.D. Tex. 2002) (in dicta, stating that a vendor's refusal to supply to a debtor absent payment of a prepetition claim is in violation of the automatic stay of ' 362(a)(6) and equating it to 'economic blackmail'). The presence of trade credit terms can provide a basis on which a vendor can stop selling to a debtor, and thus cease performance under the contract.
Section 365(c)(2) provides that a debtor 'may not assume ' any executory contract ' if ' such contract is a contract to make a loan, or extend other debt financing or financial accommodations, to or for the benefit of the debtor ' ' 11 U.S.C. ' 365(c)(2). Section 365(c)(2) is designed 'to protect a party to a contract from being forced to extend cash or a line of credit to one who is a debtor under the Bankruptcy Code.' Tully Constr. Co. v. Cannonsburg Environmental Assocs., Ltd. (In re Cannonsburg Environmen-tal Assocs., Ltd.), 72 F.3d 1260 (6th Cir. 1996) (in dicta quoting 1 Collier Bankruptcy Manual ' 365.02[2], at 14-15 (3d ed.1995)).
While the terms 'loan,' 'debt financing,' or 'financial accommodations' are not defined in the Bankruptcy Code, courts have reviewed the legislative history and held that the terms are to be 'strictly construed so as not to extend to an ordinary contract to provide goods and services that has incidental financial accommodations or extensions of credit.' Gill v. Easebe Enters., Inc. (In re Easebe Enters., Inc.), 900 F.2d 1417, 1419 (9th Cir. 1990) (rev'd on other grounds); In re Whiteprize, LLC, 275 B.R. 868, 873 (Bankr. D. Ariz. 2002). For example, in In re Emerald Forest Constr., Inc., 226 B.R. 659 (Bankr. D. Mont. 1998), an equipment lease was found not to be a financial accommodation contract since the primary purpose of the lease was the leasing of the equipment and any extension of credit that occurred was incidental to the primary purpose. Of course, with a lease, the goods being leased are already in possession of the debtor and the statute contains an obligation to pay equipment lease payments after the first 60 days (unless the court orders otherwise based on the equities), and the right to seek an administrative expense payment for the use during the first 60 days. 11 U.S.C.
' 365(d)(5) (former ' 365(d)(10)); Guttman v. Xtra Lease, Inc. (In re Furley's Trans., Inc.), 263 B.R. 733, 742 (Bankr. D. Md. 2001) ('Section 365(d)(10) does not preclude Xtra Lease from applying under ' 503(b)(1) for administrative expenses that arose during the first 59 days of the Debtor's Chapter 11 case.'); In re Pan Am. Airways Corp., 245 B.R. 897, 899 (Bankr. S.D. Fla. 2000) (the court can order lease payments under ' 365(d)(1) during the first 60 days of the case 'based on the equities of the case' and can award an administrative expense claim for such period where the standards of ' 503(b)(1)(A) are met); In re Continental Airlines, 146 B.R. 520, 525 (Bankr. D. Del. 1992) (allowing an administrative expense claim for the postpetition, pre-rejection use of an aircraft where aircraft was used in ordinary course of the debtor's business). Similarly, the Eleventh Circuit in Citizens and S. Nat'l Bank v. Thomas B. Hamilton Co. (In re Thomas B. Hamilton Co.), 969 F.2d 1013 (11th Cir. 1992) determined that a credit card merchant processing agreement was not a contract to make a loan or extend debt financing, and cited to the legislative history to ' 365 that 'characterization of contracts to make a loan, or extend other debt financing or financial accommodations, is limited to the extension of cash or a line of credit and is not intended to embrace ordinary leases or contracts to provide goods or services with payments to be made over time.' Accordingly, the court held that merchant credit card processing was not a 'financial accommodation.' 969 F.2d at 1018. Of course, the contract being assumed enabled the merchant processor to require a security deposit to protect itself from chargebacks on credit card slips it purchased. The point is that the law and the cases are usually practical in their analysis.
Debt Financing
In other instances, where the debt financing was an integral part of the contract, courts have found that an extension of debt financing renders the contract unassumable and thus unenforceable. In John Deere Co. v. Cole Bros., Inc. (In re Cole Bros., Inc.), 154 B.R. 689 (W.D. Mich. 1992), for example, the court found that the debt financing was not incidental but rather an integral part of a dealership agreement which included a floor plan financing component. Likewise, in TransAmerica Commercial Finance Corp. v. Citibank, N.A. (In re Sun Runner Marine, Inc.), 945 F.2d 1089 (9th Cir. 1991), the Ninth Circuit affirmed the reversal of the bankruptcy court and held that even with consent, a floor plan financing agreement through which a party would lend money to retail boat dealers so they could buy boats from the debtor and resell them to customers was not assumable under ' 365(c)(2).
In addition to the limitations on being able to require a vendor to provide post-petition trade credit under ' 365(c)(2), the Uniform Commercial Code (UCC) is also an area that merits analysis in considering what a seller should do when its buyer files bankruptcy. The UCC contains provisions authorizing the seller to suspend performance and refuse to deliver goods or stop delivery of goods in transit when there is an insolvent buyer, when there is anticipatory repudiation, or where there are reasonable grounds for insecurity of performance. U.C.C. ” 2-609, 2-702, 2-705; Montello Oil Corp. v. Marin Motor Oil, Inc. (In re Marin Motor Oil, Inc.), 740 F.2d 220, 225 (3d Cir. 1984). Generally, a buyer's filing of bankruptcy has no effect on a seller's ability under the UCC and state law to stop goods in transit. Haywin Textile Prods., Inc. v. Bill's Dollar Stores, Inc., (In re Bill's Dollar Stores, Inc.), 164 B.R. 471, 475 (Bankr. D. Del. 1994); In re Fabric Buys, 34 B.R. 471, 473-75 (Bankr. S.D.N.Y. 1983); B. Berger Co. v. Contract Interiors, Inc. (In re Contract Interiors, Inc.), 14 B.R. 670, 675 (Bankr. E.D. Mich. 1981). Further, stoppage of goods in transit has been held not to violate the automatic stay of ' 362 of the Bankruptcy Code. See Nat'l Sugar Refining Co. v. C. Czarinkow, Inc. (In re Nat'l Sugar Refining Co.), 27 B.R. 565 (S.D.N.Y. 1983). Accordingly, an argument can be made that if the UCC provides that a seller need not sell to an insolvent debtor and can stop goods in transit, and because the Bankruptcy Code does not do anything to limit a seller's rights under the UCC, then a seller cannot be required to ship post-petition to a debtor in bankruptcy if it could not be required to do so under the UCC. See Thomas Moers Mayer, Developments in Executory Contracts-2005, Thirty Second Annual Southeastern Bankruptcy Law Institute, April 2006, pp. 18-21.
Conclusion
The hard question is the scope of the alternatives available to a seller and how it should act to protect its economic interests. The teachings of The Supreme Court in Citizens Bank v. Strumpf, 516 U.S. 16 (1995), is a good example of what a prudent seller should do when faced with the prospect of dealing with a threat of a motion for violating the automatic stay and for sanctions, or for a temporary restraining order, as a response to not doing business with a debtor on credit post-bankruptcy. Under Strumpf, the seller should promptly move for relief from the automatic stay or seek other judicial direction recognizing that the seller is relieved of its duty to sell to the debtor, under credit, post-petition.
The practical result of the preceding discussion is that this fight is usually resolved by a compromise of some sort between the vendor and the debtor. At the end of the day, of course, that is what is supposed to happen in bankruptcy cases.
Grant T. Stein is a senior partner in Alston & Bird's Bankruptcy, Reorganization and Workouts Group, resident in the firm's Atlanta office. He is a Fellow in the American College of Bankruptcy, President-Elect of the Association of Insolvency and Restructuring Advisors (AIRA), and a Director of the Southeast-ern Bankruptcy Law Institute. Jennifer M. Meyerowitz is a senior associate in Alston & Bird's Bankruptcy, Reorganization and Workouts Group resident in the firm's Atlanta office. She is the Co-Chair of the IWIRC Georgia-Network and is on the Board of Directors of the Bankruptcy Section of the Atlanta Bar Association.
Generally speaking, after a bankruptcy filing, executory contracts are not enforceable against a debtor that has not yet assumed the contract.
There are some limitations, however, on the ability of the debtor in possession to obtain the benefit of a contract after bankruptcy but prior to assumption. Section 365(b)(4) of the Bankruptcy Code, for example, excuses a landlord from providing services and supplies incidental to the lease when there has been a nonmonetary default under the lease, unless the landlord is compensated for the services or supplies. 11 U.S.C. ' 365(b)(4). With respect to nonresidential realty leases, the debtor in possession must pay the full rent as it accrues post-petition, prior to assumption, even if the premises are not used or occupied. 11 U.S.C. ' 365(d)(3); Cukierman v. Uecker (In re Cukierman), 265 F.3d 846, 850 (9th Cir. 2001) ('We have held that claims arising under ' 365(d)(3) are entitled to administrative priority even when they may exceed the reasonable value of the debtor's actual use of the property'); In re Curry Printers, Inc., 135 B.R. 564 (Bankr. N.D. Ind. 1991) (requiring lease payments regardless of actual usage).
Protecting the Seller
With a contract to sell goods, or to provide services, the issue from the perspective of the seller is how to protect itself going forward. Is an administrative expense claim for the provision of post-petition trade credit a sufficient protection? Experience tells us that debtors sometimes do not pay their post-petition administrative obligations. Vendors may prefer cash on delivery or payment in advance of delivery. How, or rather why, would and could such a unilateral change in the contract be effectuated post-petition?
Trade Credit Provisions
A key inquiry is to examine the trade credit provisions of the contract. The reason for this is that as a practical matter, the issue when the case is before the bankruptcy court is whether the bankruptcy judge will make a trade vendor provide post-petition trade credit. There are no reported cases where the debtor was able to require a trade vendor to provide trade credit. There are cases where the vendor has been required to sell to the debtor, but not on credit in a bankruptcy context. See, eg,
Section 365(c)(2) provides that a debtor 'may not assume ' any executory contract ' if ' such contract is a contract to make a loan, or extend other debt financing or financial accommodations, to or for the benefit of the debtor ' ' 11 U.S.C. ' 365(c)(2). Section 365(c)(2) is designed 'to protect a party to a contract from being forced to extend cash or a line of credit to one who is a debtor under the Bankruptcy Code.' Tully Constr. Co. v. Cannonsburg Environmental Assocs., Ltd. (In re Cannonsburg Environmen-tal Assocs., Ltd.), 72 F.3d 1260 (6th Cir. 1996) (in dicta quoting 1 Collier Bankruptcy Manual ' 365.02[2], at 14-15 (3d ed.1995)).
While the terms 'loan,' 'debt financing,' or 'financial accommodations' are not defined in the Bankruptcy Code, courts have reviewed the legislative history and held that the terms are to be 'strictly construed so as not to extend to an ordinary contract to provide goods and services that has incidental financial accommodations or extensions of credit.' Gill v. Easebe Enters., Inc. (In re Easebe Enters., Inc.), 900 F.2d 1417, 1419 (9th Cir. 1990) (rev'd on other grounds); In re Whiteprize, LLC, 275 B.R. 868, 873 (Bankr. D. Ariz. 2002). For example, in In re Emerald Forest Constr., Inc., 226 B.R. 659 (Bankr. D. Mont. 1998), an equipment lease was found not to be a financial accommodation contract since the primary purpose of the lease was the leasing of the equipment and any extension of credit that occurred was incidental to the primary purpose. Of course, with a lease, the goods being leased are already in possession of the debtor and the statute contains an obligation to pay equipment lease payments after the first 60 days (unless the court orders otherwise based on the equities), and the right to seek an administrative expense payment for the use during the first 60 days. 11 U.S.C.
' 365(d)(5) (former ' 365(d)(10)); Guttman v. Xtra Lease, Inc. (In re Furley's Trans., Inc.), 263 B.R. 733, 742 (Bankr. D. Md. 2001) ('Section 365(d)(10) does not preclude Xtra Lease from applying under ' 503(b)(1) for administrative expenses that arose during the first 59 days of the Debtor's Chapter 11 case.'); In re Pan Am. Airways Corp., 245 B.R. 897, 899 (Bankr. S.D. Fla. 2000) (the court can order lease payments under ' 365(d)(1) during the first 60 days of the case 'based on the equities of the case' and can award an administrative expense claim for such period where the standards of ' 503(b)(1)(A) are met); In re Continental Airlines, 146 B.R. 520, 525 (Bankr. D. Del. 1992) (allowing an administrative expense claim for the postpetition, pre-rejection use of an aircraft where aircraft was used in ordinary course of the debtor's business). Similarly, the Eleventh Circuit in Citizens and S. Nat'l Bank v. Thomas B. Hamilton Co. (In re Thomas B. Hamilton Co.), 969 F.2d 1013 (11th Cir. 1992) determined that a credit card merchant processing agreement was not a contract to make a loan or extend debt financing, and cited to the legislative history to ' 365 that 'characterization of contracts to make a loan, or extend other debt financing or financial accommodations, is limited to the extension of cash or a line of credit and is not intended to embrace ordinary leases or contracts to provide goods or services with payments to be made over time.' Accordingly, the court held that merchant credit card processing was not a 'financial accommodation.' 969 F.2d at 1018. Of course, the contract being assumed enabled the merchant processor to require a security deposit to protect itself from chargebacks on credit card slips it purchased. The point is that the law and the cases are usually practical in their analysis.
Debt Financing
In other instances, where the debt financing was an integral part of the contract, courts have found that an extension of debt financing renders the contract unassumable and thus unenforceable. In
In addition to the limitations on being able to require a vendor to provide post-petition trade credit under ' 365(c)(2), the Uniform Commercial Code (UCC) is also an area that merits analysis in considering what a seller should do when its buyer files bankruptcy. The UCC contains provisions authorizing the seller to suspend performance and refuse to deliver goods or stop delivery of goods in transit when there is an insolvent buyer, when there is anticipatory repudiation, or where there are reasonable grounds for insecurity of performance. U.C.C. ” 2-609, 2-702, 2-705; Montello Oil Corp. v. Marin Motor Oil, Inc. (In re Marin Motor Oil, Inc.), 740 F.2d 220, 225 (3d Cir. 1984). Generally, a buyer's filing of bankruptcy has no effect on a seller's ability under the UCC and state law to stop goods in transit. Haywin Textile Prods., Inc. v. Bill's Dollar Stores, Inc., (In re Bill's Dollar Stores, Inc.), 164 B.R. 471, 475 (Bankr. D. Del. 1994); In re Fabric Buys, 34 B.R. 471, 473-75 (Bankr. S.D.N.Y. 1983); B. Berger Co. v. Contract Interiors, Inc. (In re Contract Interiors, Inc.), 14 B.R. 670, 675 (Bankr. E.D. Mich. 1981). Further, stoppage of goods in transit has been held not to violate the automatic stay of ' 362 of the Bankruptcy Code. See Nat'l Sugar Refining Co. v. C. Czarinkow, Inc. (In re Nat'l Sugar Refining Co.), 27 B.R. 565 (S.D.N.Y. 1983). Accordingly, an argument can be made that if the UCC provides that a seller need not sell to an insolvent debtor and can stop goods in transit, and because the Bankruptcy Code does not do anything to limit a seller's rights under the UCC, then a seller cannot be required to ship post-petition to a debtor in bankruptcy if it could not be required to do so under the UCC. See Thomas Moers Mayer, Developments in Executory Contracts-2005, Thirty Second Annual Southeastern Bankruptcy Law Institute, April 2006, pp. 18-21.
Conclusion
The hard question is the scope of the alternatives available to a seller and how it should act to protect its economic interests.
The practical result of the preceding discussion is that this fight is usually resolved by a compromise of some sort between the vendor and the debtor. At the end of the day, of course, that is what is supposed to happen in bankruptcy cases.
Grant T. Stein is a senior partner in
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