Articles Posted in Executory Contracts

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Making a quiet entrance into the public realm during the final week of last year, a new opinion from the United States Bankruptcy Appellate Panel of the Ninth Circuit (the “BAP”) suggests that it is time to revisit the definition of an “executory contract” as has been applied for years by the United States Court of Appeals for the Ninth Circuit. The opinion, Carruth v. Eutsler (In re Eutsler), B.A.P. 9th Cir. December 27, 2017, is careful to follow the Ninth Circuit’s holding in Unsecured Creditors’ Comm. v. Southmark Corp. (In re Robert L. Helms Constr. & Dev. Co.), in deciding an appeal which turned on whether or not a shareholders’ agreement that contained a buy-out mechanism was executory or not. But the new BAP opinion lingers on a discussion of how and why that long-relied-on authority should be revisited.

iStock-508815976-BK-300x200It is tempting to dismiss the BAP’s provocative musings on executory contracts as nothing more than intellectual day-dreaming. But practitioners have for many years been reading, analyzing, debating, drafting around, and counseling clients about Helms and the “Countryman” definition of executory contracts adopted by Helms. A change to the rule in Helms would be a seismic event—a contract provision that most thought would be interpreted in one manner would suddenly be thrown into question and potential challenge. Millions of dollars riding not only on options but also on franchise agreements, licensing arrangements, film development and distribution deals, and countless other transactions would have to be re-analyzed. Thus, although the BAP did not actually change the rule—it has no power to do so and to its credit the panel acknowledged as much—even the potential for such a change is a significant event. Continue reading

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As a creditor, the news of a debtor who owes you a substantial sum of money filing bankruptcy is often the most alarming news you can learn—that is, until you seek advice of counsel and learn that payments the debtor made to you within 90-days prior to the bankruptcy will be the subject of a lawsuit and likely recoverable by the bankruptcy estate as a “preference.”  This is usually the point I offer soothing chamomile tea to the client.

Recovery of “preference” transfers in bankruptcy cases, though seemingly unfair to the individual creditor, serve an important role and offer a degree of protection to the creditors as a whole.  The primary elements of a preference transfer are relatively straightforward: a debtor who is insolvent, makes a payment or payments to a creditor, within 90 days[1] prior to the bankruptcy filing, to satisfy at least a portion of a pre-existing debt[2], and the creditor receives more than it would have had the debtor filed a chapter 7 (liquidation) bankruptcy case.  Though the “don’t rob Peter to pay Paul” concept appears clear enough, the Ninth Circuit has recently illustrated how complicated the matter can become in In re Tenderloin Health[3] where the court addressed the often overlooked final element to a preference—the “greater amount” test.

As the Ninth Circuit noted, the “greater amount test … ‘requires the court to construct a hypothetical chapter 7 case and determine what the creditor would have received if the case had proceeded under chapter 7’ without the alleged preferential transfer.” Id. at *7.  This task of creating a hypothetical chapter 7 liquidation grows ever more daunting as a case grows more complex, leading to uncertainty for a creditor client, especially when unresolved legal issues come up within the hypothetical bankruptcy.

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We asked some of our financial advisor colleagues to give us brief read outs on what they felt 2017 has in store for us now that we have gotten beyond the inauguration and into the first weeks of the Trump administration.  Their thoughts follow: have been seeing a lot of highly leveraged deals that impact the performance of the business. These deals are leading to reduced spending on capital expenditure, marketing and even experienced management.  Once new ownership is in place, these strictures prevent the company from operating with the same efficiency as in the past, let alone growing.  Another scenario we have been encountering is companies getting beyond the management ability of the founder as the company increases revenues from $25M to $50M and then to $100M or more. In either case, increasing interest rates will cause dislocation, because it does not take much to push these companies into a zone where they are showing significant financial stress.

That being said, we are also seeing that lenders are still being lenient because it’s really hard to get a full recovery in a liquidation, and appraisal firms always seem to be the first to hedge on their ability liquidate inventory en masse.  Also, my sense is that lenders don’t really want to sell their loans to exit a credit as it hurts their reputation.  Still, we are finding that lenders keep getting surprised with over-advances for many reasons.  When we are called in to assist in such situations, we focus our efforts on trying to fix the operating issues of the businesses and make a reasoned re-allocation of limited resources.

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What is IP in the Bankruptcy World?

In bankruptcy, intellectual property (IP) licenses are considered property of the bankruptcy estate, and a bankrupt party can do a variety of things with these licenses.  It is important for holders of IP licenses to know what the possibilities are.  But first, what exactly constitutes IP under the Bankruptcy Code?

The Bankruptcy Code defines IP to include: trade secrets; patents; patent applications; and copyrights.  Curiously, the Bankruptcy Code’s definition of IP does not include trademarks, and courts are divided regarding whether trademarks should be included in IP, as the term is defined under the Code.  Most courts have interpreted the omission of “trademarks” from the definition to mean that trademarks are treated differently than the other forms of IP in bankruptcy.

IP Licenses Are Generally Considered to Be Executory Contracts in Bankruptcy

Although the term “executory contract” is not defined in the Bankruptcy Code, it generally includes contracts on which performance remains due to some extent on both sides.  Under the Bankruptcy Code, an IP license is generally considered to be an executory contract because such a license almost always requires some form of continuing performance by both sides.  For example, a licensee must continue to pay royalties in order to be able to use the IP, and a licensor is obligated to continue to refrain from suing the licensee for infringement (so long as the agreed-upon royalty payments are made).  These obligations constitute outstanding “performance” sufficient to make an IP license an executory contract.  Because IP licenses are considered executory contracts, a bankrupt party has certain options, described below, regarding what it can do with these licenses. Continue reading