Shannon McGarr
St. John’s University School of Law
American Bankruptcy Institute Law Review Staff
Section 365(a) of title 11 of the United States Code (the "Bankruptcy Code") allows a bankruptcy trustee to assume and assign an executory contract of the debtor.[1] In In re Svenhard’s Swedish Bakery, the United States Bankruptcy Appellate Panel for the Ninth Circuit affirmed a holding that a prepetition settlement agreement between a debtor and an unsecured creditor was not an executory contract, because the creditor’s only obligation under the settlement agreement (releasing the debtor’s remaining liabilities) was not due until after the debtor fully performed by paying the amount agreed upon in full.[2]
The debtor, Svenhard’s Swedish Bakery ("Svenhard’s"), was a member of the Confectionery Union and Industrial Pension Fund (the "Pension Fund"), the unsecured creditor at issue in this case.[3] In 2015, after Svenhard’s effectively withdrew from the Pension Fund, the Pension Fund notified Svenhard’s of a large withdrawal liability ("Withdrawal Liability") and its failure to make several pension contributions ("Contribution Liability").[4] Svenhard’s and the Pension Fund negotiated a settlement agreement which provided that Svenhard’s would pay the Pension Fund monthly installments at a reduced amount to satisfy both the Withdrawal Liability and Contribution Liability.[5]Importantly, the settlement agreement provided that upon Svenhard’s full payment under the terms of the agreement, the Pension Fund would execute a release for the Withdrawal Liability and a separate release for the Contribution Liability.[6] The agreement additionally provided that if Svenhard’s failed to make a payment, the Pension Fund could declare a default and, if Svenhard’s then failed to cure, hold Svenhard’s liable for the full Withdrawal and Contribution Liabilities.[7] Svenhard’s ceased operations in November 2019 and missed a payment to the Pension Fund in December 2019.[8] The Pension Fund declared a default under the agreement on December 13, 2019.[9] Five days later, on December 19, 2019, Svenhard’s filed a chapter 11 bankruptcy petition.[10]
In its chapter 11 bankruptcy case, Svenhard’s asserted that the settlement agreement with the Pension Fund was an executory contract under section 365(a) of the Bankruptcy Code and filed a motion to assume and assign the settlement agreement to a buyer who agreed to cure the default.[11] Absent the ability to assume and assign the settlement agreement, Svenhard’s would owe the full liability (not the settlement agreement’s reduced amount).[12]Svenhard’s claimed there were remaining obligations for both parties to the settlement agreement: Svenhard’s was required to make monthly payments; and the Pension Fund was required to release the Withdrawal Liability and Contribution Liability claims.[13] The Pension Fund argued that under Ninth Circuit law the settlement agreement was not an executory contract, and thus could not be assumed and assigned, because the Pension Fund’s release of Svenhard’s claims was not required until Svenhard’s made all required payments under the settlement agreement.[14]The bankruptcy court sided with the Pension Fund, holding that the settlement agreement lacked the requisite mutuality of obligation necessary to be considered executory.[15] Svenhard’s appealed.[16]
The Bankruptcy Code does not provide a definition for what type of agreement constitutes an "executory contract."[17] The Ninth Circuit employs the "Countryman test," which states that "a contract is executory if ‘the obligations of both parties are so underperformed that the failure of either party to complete performance would constitute a material breach and thus excuse the performance of the other.’"[18] To determine whether a contract is executory in the Ninth Circuit, a court must determine: (1) whether both parties have remaining material obligations; and (2) if, as of the petition date, failure to perform those obligations would give rise to a material breach and excuse performance by the other party.[19]
Using the Countryman test, the Appellate Panel held that the settlement agreement between the Pension Fund and Svenhard’s was not an executory contract because the Pension Fund was only obligated to provide the releases upon full payment by Svenhard’s.[20] Therefore, unless Svenhard’s had fully performed by making all required payments, the Pension Fund could not breach the settlement agreement by refusing to execute the releases, causing the settlement agreement to fail the second step of the test.[21] Moreover, the Appellate Panel questioned whether or not the settlement would pass the first “material obligations” step of the test, because the Pension Fund’s obligation to execute the releases may not be considered "material" due to the releases being "likely ministerial" in light of the settlement’s nature.[22]
In Svenhard’s, the court held that a contract in which Party A’s performance is contingent upon the completion of Party B’s performance is not executory under the Countryman test.[23] In such a contract, Party A cannot breach unless they refuse to perform after Party B has completed their performance.[24] Thus, such a contract is not executory, as Party A’s obligations are not “underperformed.”[25]
[1] See In re Svenhard’s Swedish Bakery, No. EC-23-1001-GLB, 2023 Bankr. LEXIS 2125, at *1 (B.A.P. 9th Cir. Aug. 29, 2023).
[2] See id. at *13–14.
[3] See id. at *1–2.
[4] See id. at *2–3.
[5] Id.
[6] Id. at *3.
[7] Id.
[8] Id.
[9] Id.
[10] Id. at *3–4.
[11] Id. at *5.
[12] See id. at *3.
[13] Id. at *5.
[14] Id. at *5–6.
[15] Id. at *6.
[16] Id.
[17] Id. at *7–8.
[18] Id. at *8 (citing Unsecured Creditors’ Comm. V. Southmark Corp. (In re Robert L. Helms Constr. & Dev. Co.), 139 F.3d 702, 705 (9th Cir. 1998) (quoting Griffel v. Murphy (In re Wegner), 839 F.2d 533, 536 (9th Cir. 1988))).
[19] Id.
[20] Id. at *9.
[21] Id. at *10.
[22] Id. at *11.
[23] See id. at *10.
[24] See id.
[25] See id. at *12–13.