Assumption of Liabilities

In analyzing the Taylor-Wharton/Harsco purchase agreement, the Bankruptcy Court found that the assumption of liability provision was not executory at the time of the bankruptcy petition: Taylor-Wharton assumed the “assumed liabilities” at closing and owed no ongoing obligation to Harsco based on the provision. While this ruling may not seem surprising, there was no prior case law on point. Thus, the Bankruptcy Court's ruling is helpful in clarifying that, under an asset purchase agreement, the assumption of liability occurs at the closing (if that's what the contract so provides) and is no longer executory, which seems appropriate given that the buyer acquired ownership of the assets sold at closing as well.

The Bankruptcy Court went on to state that the assumption of liability provision may provide a plaintiff seeking recovery based on the accidents covered by such provision with a direct cause of action against Taylor-Wharton under applicable state law. The Bankruptcy Court stated that under Alabama law, when there is an express assumption provision in a purchase agreement, a transferee of all assets of a seller is deemed liable for the transferor's torts. The Bankruptcy Court stated that Delaware corporate law mirrors Alabama law in this respect. Thus, under the Bankruptcy Court's ruling, if a third party makes a claim against the seller with respect to a liability that constitutes an assumed liability, the seller can direct such claimant to the buyer and notify the claimant that the buyer is responsible for the assumed liability.

This part of the ruling is important because one result of the rejection of a purchase agreement is to discharge or effectively eliminate its indemnity provisions because the debtor is excused from performing its indemnity obligation going forward. In fact, in its ruling, the Bankruptcy Court distinguished the assumption of liability provision from Taylor-Wharton's independent obligation under the purchase agreement to indemnify Harsco, noting that the former was not executory while the latter was executory. Ordinarily, any losses arising from an assumed liability would give rise to an indemnity claim against the buyer subject to any time, monetary or other limitations contained in the purchase agreement. But if the purchase agreement is rejected, the seller's indemnity claim will be discharged in the bankruptcy, so the seller's likely recourse will be to: 1) direct the claimant to the buyer or its insurance carrier (if coverage is available) on the basis that the buyer is responsible under the assumption of liability provision and/or 2) seek to have the seller dismissed from the third-party action on the basis that the buyer is the responsible party. Whether the seller also remains jointly liable for such assumed liability will be dependent on applicable state law.

Conclusion

In summary, if, after closing, a buyer files for bankruptcy under Chapter 11 of the Bankruptcy Code and rejects the parties' asset purchase agreement, a key post-closing protection for the seller ' the indemnification of losses related to assumed liabilities ' disappears. However, it is some consolation for the seller that the Bankruptcy Court will respect the form of the asset purchase and will not let the buyer acquire the assets in the deal but use its bankruptcy to completely walk away from the liabilities it assumed.

Patrick J. Leddy is a partner in Jones Day's Mergers and Acquisitions practice, resident in Cleveland, OH. Charles M. Oellermann and Joseph M. Witalec are of counsel and counsel, respectively, in Jones Day's Business Restructuring and Reorganization practice, both resident in Columbus, OH. The views expressed herein are those of the authors alone and do not reflect the views, positions or policies of Jones Day or its clients.

The transaction is straightforward: A buyer purchases certain assets and assumes certain liabilities of a seller under an asset purchase agreement. However, after the transaction closes, the buyer files for bankruptcy under Chapter 11 of the Bankruptcy Code and eventually rejects the asset purchase agreement. From a deal lawyer's perspective, the issue is: What impact does the bankruptcy filing and the contract rejection have on the carefully drafted, thoroughly negotiated asset purchase agreement?

Some guidance on this issue was recently provided by the U.S. Bankruptcy Court for the District of Delaware in In re Taylor-Wharton International LLC v. Blasingame, 2010 Bankr. LEXIS 3994 (Bankr D. Del. Nov. 23, 2010). The key facts in the case are as follows:

• On Dec. 7, 2007, Taylor-Wharton acquired certain assets and assumed certain liabilities from Harsco Corporation pursuant to an asset and stock purchase agreement.
• Under the purchase agreement, Taylor-Wharton assumed, among other things, all liabilities relating to accidents occurring after the closing date caused by products manufactured by Harsco prior to closing (the “assumption of liability provision”).
• On March 2, 2009, a lawsuit was filed in Alabama District Court by certain plaintiffs (the “Blasingame plaintiffs”) against a Taylor-Wharton subsidiary alleging product liability for injuries suffered in a 2008 explosion for a product manufactured by Harsco prior to December 2007.
• On Nov. 19, 2009, Taylor-Wharton filed for bankruptcy under Chapter 11 of the Bankruptcy Code in Delaware. The Blasingame lawsuit was dismissed as a result of the bankruptcy filing.
• On May 26, 2010, Taylor-Wharton's plan of reorganization was approved. The order confirming the plan contained a provision allowing the Blasingame plaintiffs to seek to reinstate their lawsuit in Alabama District Court.
• On June 7, 2010, the Delaware Bankruptcy Court entered an order approving Taylor-Wharton's rejection of the purchase agreement with Harsco as an executory contract.
• On July 14, 2010, the Blasingame plaintiffs filed a petition for reinstatement of their lawsuit with the Alabama District Court. Taylor-Wharton opposed the petition on the ground that the sole basis for Taylor-Wharton's legal responsibility to the Blasingame plaintiffs was the purchase agreement that had been rejected.
• Shortly thereafter, Taylor-Wharton filed a complaint with the Bankruptcy Court arguing that the rejection of the purchase agreement excused Taylor-Wharton from any potential liability under the assumption of liability provision.
• The Blasingame plaintiffs and Harsco filed motions to dismiss Taylor-Wharton's claims, which the Bankruptcy Court granted.

The Bankruptcy Court's Analysis

In dismissing Taylor-Wharton's claims, the Bankruptcy Court focused on how the rejection of executory contracts operates under the Bankruptcy Code. Under ' 365 of the Bankruptcy Code, debtors and debtors-in-possession have the right to assume or reject contracts that are “executory” as of the date of the bankruptcy petition. As defined in the case law, an executory contract is a contract under which the obligations of both parties are so far unperformed that the failure of either party to complete performance would constitute a material breach excusing the performance of the other party. The Bankruptcy Court stated that rejection of an executory contract constitutes a breach of contract, not a rescission of the contract, and has the effect of relieving the debtor from future performance of the contract but does not undo past performance. The Bankruptcy Court also added that an executory contract must be assumed or rejected in its entirety; a debtor cannot pick and choose provisions to assume or reject.

In analyzing the Taylor-Wharton/Harsco purchase agreement, the Bankruptcy Court found that the assumption of liability provision was not executory at the time of the bankruptcy petition: Taylor-Wharton assumed the “assumed liabilities” at closing and owed no ongoing obligation to Harsco based on the provision. While this ruling may not seem surprising, there was no prior case law on point. Thus, the Bankruptcy Court's ruling is helpful in clarifying that, under an asset purchase agreement, the assumption of liability occurs at the closing (if that's what the contract so provides) and is no longer executory, which seems appropriate given that the buyer acquired ownership of the assets sold at closing as well.

The Bankruptcy Court went on to state that the assumption of liability provision may provide a plaintiff seeking recovery based on the accidents covered by such provision with a direct cause of action against Taylor-Wharton under applicable state law. The Bankruptcy Court stated that under Alabama law, when there is an express assumption provision in a purchase agreement, a transferee of all assets of a seller is deemed liable for the transferor's torts. The Bankruptcy Court stated that Delaware corporate law mirrors Alabama law in this respect. Thus, under the Bankruptcy Court's ruling, if a third party makes a claim against the seller with respect to a liability that constitutes an assumed liability, the seller can direct such claimant to the buyer and notify the claimant that the buyer is responsible for the assumed liability.

This part of the ruling is important because one result of the rejection of a purchase agreement is to discharge or effectively eliminate its indemnity provisions because the debtor is excused from performing its indemnity obligation going forward. In fact, in its ruling, the Bankruptcy Court distinguished the assumption of liability provision from Taylor-Wharton's independent obligation under the purchase agreement to indemnify Harsco, noting that the former was not executory while the latter was executory. Ordinarily, any losses arising from an assumed liability would give rise to an indemnity claim against the buyer subject to any time, monetary or other limitations contained in the purchase agreement. But if the purchase agreement is rejected, the seller's indemnity claim will be discharged in the bankruptcy, so the seller's likely recourse will be to: 1) direct the claimant to the buyer or its insurance carrier (if coverage is available) on the basis that the buyer is responsible under the assumption of liability provision and/or 2) seek to have the seller dismissed from the third-party action on the basis that the buyer is the responsible party. Whether the seller also remains jointly liable for such assumed liability will be dependent on applicable state law.

Conclusion

In summary, if, after closing, a buyer files for bankruptcy under Chapter 11 of the Bankruptcy Code and rejects the parties' asset purchase agreement, a key post-closing protection for the seller ' the indemnification of losses related to assumed liabilities ' disappears. However, it is some consolation for the seller that the Bankruptcy Court will respect the form of the asset purchase and will not let the buyer acquire the assets in the deal but use its bankruptcy to completely walk away from the liabilities it assumed.

Patrick J. Leddy is a partner in Jones Day's Mergers and Acquisitions practice, resident in Cleveland, OH. Charles M. Oellermann and Joseph M. Witalec are of counsel and counsel, respectively, in Jones Day's Business Restructuring and Reorganization practice, both resident in Columbus, OH. The views expressed herein are those of the authors alone and do not reflect the views, positions or policies of Jones Day or its clients.