Delaware Bankruptcy Court Rejects “Implied Assumption” of Executory Contracts As Part of Asset Sale

by Kramer Levin Naftalis & Frankel LLP

Kramer Levin Naftalis & Frankel LLP

The Bottom Line

The Delaware Bankruptcy Court recently held, in Stanley Jacobs Prod., Ltd. v. 9472541 Can. Inc. (In re Thane Int'l, Inc.), No. 17-50476 (KG), 2018 Bankr. LEXIS 464 (Bankr. D. Del. Feb. 21, 2018), that a debtor must file a formal motion to assume and assign an executory contract and, in so holding, rejected the doctrine of “implied assumption” based on the conduct of the debtor.  The decision declined to follow cases allowing assumption by conduct and underscores the need for affirmative motion practice to assume an agreement as part of a sale transaction.

What Happened?

The dispute in this case turned on whether the debtor had assumed and assigned an executory contract as part of a sale of all its assets without having filed a formal motion to do so.  The debtor (“Old Thane”) was a seller of consumer goods that ran into financial difficulties.  Its senior lenders commenced an insolvency proceeding in Canada that resulted in the appointment of a receiver.  At the same time, the defendant (“New Thane”) made an offer to purchase substantially all of Old Thane’s assets.  The receiver filed a chapter 15 proceeding in the Delaware bankruptcy court seeking to recognize the foreign proceeding and approve the sale.  The court recognized the proceeding and entered an order approving the sale.

Old Thane had been party to a contract with the plaintiff (“SJPL”) under which SJPL produced infomercials for Old Thane.  Old Thane never provided notice of its bankruptcy filing to SJPL.  As part of the sale motion, the receiver sought to assume and reject certain executory contracts specified in the motion.  The contract with SJPL was not specified as a contract to be assumed or rejected, though the purchase agreement did include a catch-all “Other Assets” category that included unspecified contracts.

Several months after the sale closed, New Thane used one of the SJPL-produced infomercials, but did not pay royalties to SJPL as required under the contract.  SJPL sued New Thane in California district court, which transferred the case to Delaware.  SJPL argued that the catch-all provision in the purchase agreement combined with the conduct of New Thane resulted in an implied assumption and assignment of the contract to New Thane, making New Thane liable for all obligations under the contract.  New Thane argued that the contract was not assumed and assigned to it as part of the sale because a contract cannot be assumed and assigned under the Bankruptcy Code without a formal motion.

The court agreed with New Thane.  Section 365 of the Bankruptcy Code allows a debtor “to do three things with an executory contract: (i) reject it, (ii) assume it or (iii) assume and assign it.”  Id. at *10.  To do any of these three things, the Bankruptcy Code and Federal Rules of Bankruptcy Procedure require the debtor or trustee to file a formal motion.  As Old Thane had not filed a formal motion to assume the SJPL contract (or otherwise included it as an assigned contract in its sale approval motion), the court found that no assumption of the specific contract at issue had occurred.

Some courts have found that a contract may be assumed through the doctrine of “implied assumption.”  To find implied assumption, courts will examine the parties’ conduct for “a series of acts over a period of time evidencing a continuity of purpose.”  Id. at *12.  The court analyzed the evidence SJPL asserted as showing New Thane’s intent to assume the contract and found it unpersuasive.  In particular, allowing courts to find that continued performance under a contract constituted assumption would inject unneeded uncertainty into the assumption analysis.  The court stated that “[c]ondoning such informal means of assumption will force courts to meddle in the fact-laden intricacies of transactions—sometimes well after the departure of a necessary party, such as the case here—to determine the debtor’s, purchaser’s or some third party’s ‘true intention.’”  Id. at *15-16.  The court held that despite the unique facts of this case, “absent a motion, there is no assumption.”  Id. at *16.

The court also found that the catch-all provision in the purchase agreement was not sufficient to assume the contract because the Federal Rules of Bankruptcy Procedure place specific requirements for motions that seek to assume or reject multiple contracts, and those procedures had not been followed.

The court did note that New Thane may have gotten a benefit from the use of the infomercial without having a contractual right to do so.  However, the court declined to speculate whether SJPL would be entitled to any damages from that use because such matters were beyond the jurisdiction of the bankruptcy court.

Why This Case Is Interesting

The court adopted a strict, formulaic approach to determining whether a debtor has assumed an executory contract.  Unless the debtor has filed a formal motion that has been granted by the court, the decision supports an argument that the contract has not been assumed even if the debtor or an alleged third-party assignee makes use of the contract and derives a benefit therefrom.  (The decision does not address whether there is another basis to seek damages from the use of the services covered by the unassumed contract.)  In the instant case, the contract could have been included in an underlying sale of assets and the case underscores the need to make sure that, as part of any sale of assets including executory contracts or unexpired leases, the purchaser or the non-debtor contract party will want to verify whether the contract or lease is expressly included as an assumed contract as part of the sale motion.  Conduct or accepting the benefits of a contract or lease alone does not constitute assumption under this decision.

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Kramer Levin Naftalis & Frankel LLP

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