Fifth Circuit Holds Executory Contract Not Listed on Bankruptcy Schedules Is Automatically Rejected Upon Expiration of 60-Day Period in Chapter 7 and Not Capable of Being Sold

by Kramer Levin Naftalis & Frankel LLP
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The Bottom Line

The Fifth Circuit recently held in RPD Holdings, L.L.C. v. Tech Pharmacy Services (In re Provider Meds, L.L.C.), No. 17-1113 (5th Cir. Oct. 29, 2018), that a patent license that was not specifically listed on the debtors’ bankruptcy schedules was automatically deemed rejected where it was not assumed within 60 days of the cases’ conversion from Chapter 11 to Chapter 7.

What Happened?

This decision is based upon a series of bankruptcy cases involving OnSite. The entities involved in operating OnSite, referred to as the “OnSite parties,” placed dispensing machines with long-term care facilities, then used proprietary OnSite software to remotely dispense pharmaceuticals from the machines to nurses in the facilities. The appellee, Tech Pharmacy Services (Tech Pharm), held a patent on certain system, software and related methods of remote pharmaceutical dispensing. In 2010, Tech Pharm sued several OnSite parties for infringing on this patent, and the OnSite parties counterclaimed, challenging the patent. The parties settled and entered into a License Agreement that granted a “non-exclusive perpetual license” to the OnSite parties for so long as the patents are valid and enforceable. The OnSite parties agreed to pay a one-time licensing fee for each machine placed into operation after the agreement was executed, and to provide quarterly reports for all new machines placed in service. 

Beginning in 2012 and continuing into 2013, six of the OnSite parties filed separate Chapter 11 bankruptcy cases in the Northern District of Texas. Each of these cases was later converted to Chapter 7. Five of the six OnSite debtors were parties to the Tech Pharm License Agreement. Despite the bankruptcy requirement that they schedule all assets and creditors, however, none of the debtors listed the License Agreement or Tech Pharm on their schedules.

In three of the OnSite bankruptcy cases, RPD, the appellant, purchased the Onsite debtors’ collateral in which it held a security interest. (RPD agreed to purchase the property instead of litigating the validity of its liens). The terms of each sale were set forth in a separate asset purchase agreement (APA), and the bankruptcy court approved each sale by a separate sale order. The License Agreement was not explicitly mentioned in the APAs, but rather the APAs provided that to the extent property subject to the APA was an executory contract, such property was assumed and assigned to RPD. 

Tech Pharm subsequently sued certain OnSite debtors, alleging they failed to comply with their obligations under the License Agreement to provide quarterly reports and pay licensing fees for new machines. RPD intervened and argued that the debtors had assigned or otherwise transferred the License Agreement to RPD.

By way of background, Section 365(d)(1) of the Bankruptcy Code imposes a 60-day deadline for a trustee in a Chapter 7 case to assume an executory contract. Where a case is converted from Chapter 11 to Chapter 7, the 60-day period commences on the date of conversion. While the 60-day period may be extended for cause, no such request was made to extend the deadline in the Chapter 7 cases.

The bankruptcy court held that RPD did not have rights under the License Agreement because it had not purchased the license under any of the sales, and, in any event, the License Agreement was an executory contract that was deemed rejected by operation of law prior to any alleged transfer. The district court affirmed. RPD appealed. On appeal, RPD argued that its rights under the License Agreement were established by final non-appealable bankruptcy court orders approving the sales and the lower courts erred in finding that RPD had no rights under the License Agreement.

On appeal, the Fifth Circuit determined that the License Agreement was, indeed, an executory contract because each side had ongoing material obligations. Specifically, Tech Pharm was obligated to refrain from suing counterparties for patent infringement for machines placed in service in the future, and the OnSite debtors were required to provide quarterly reports, pay certain licensing fees and refrain from making public disclosures about the settlement. RPD argued that the License Agreement was non-executory because it was entered into in conjunction with a settlement agreement to dismiss Tech Pharm’s suit with prejudice, thereby rendering illusory Tech Pharm’s obligation to refrain from future suits. The Fifth Circuit disagreed, finding that principles of claim preclusion did not apply to preclude a future suit where infringement claims are based on acts that occurred after the initial lawsuit — even where the alleged infringement is “essentially the same” as litigated in the prior action.

Having concluded that the License Agreement was, in fact, an executory contract, the Fifth Circuit held that it was deemed rejected when the estates failed to assume it prior to expiration of the statutory 60-day period. In so holding, the Fifth Circuit rejected RPD’s position that the court should find an exception to Section 365(d)(1) because a debtor fails to list a contract on its schedules and the Chapter 7 trustee is unaware of the contract prior to expiration of the 60 days. The Fifth Circuit was persuaded by a Ninth Circuit decision that had held that “a trustee has an affirmative duty to investigate for unscheduled executory contracts” and that the trustee’s “nonaction” within the 60 days is a “conclusive presumption” of rejection. The Fifth Circuit found that the Chapter 7 trustee has an affirmative duty to investigate the debtor’s financial affairs, and further that Section 365(d)(1) does not impose an actual or constructive notice requirement related to the deadline. The Fifth Circuit held that “[a]t a minimum, the statutory presumption of rejection after sixty days is conclusive where there is no suggestion that the debtor” intentionally concealed a contract from the trustee.

The Fifth Circuit also rejected RPD’s contention that the sale orders and the order effectuating a global agreement entered by the bankruptcy court establish that RPD purchased the License Agreement. The court found that this argument is based on the assumption that the License Agreement remained part of the bankrupt estates at the time of the sales; yet, here, by the time the sale orders were finalized, the 60-day period had already lapsed and the License Agreement had been deemed rejected by operation of the statute, and was thus no longer property of the debtors’ estates to be sold to RPD.

Why This Case Is Interesting

As the Fifth Circuit noted, there is no consensus among courts on whether a contract will be deemed automatically rejected where a debtor fails to list it on the schedules and the trustee is not aware of the contract within the 60-day period. Some courts have held that automatic rejection will not occur where a debtor intentionally conceals the existence of a contract. This was not the case here. Absent intentional concealment, courts have found that failing to schedule a contract will not prevent it from being rejected, though the Fifth Circuit noted that one bankruptcy court has held that failure to schedule the contract should always toll the rejection deadline. With this decision, the Fifth Circuit aligned itself with those courts that have concluded failure to schedule a contract does not prevent it from being rejected, but left unanswered the result where a debtor has hidden assets from trustee. In any event, the decision underscores the importance of purchasers of assets in a bankruptcy sale — whether working with the debtor or the trustee — undertaking a thorough review of contracts that are necessary to operate the acquired business. Broad catch-all language in an APA may not protect the buyer if the specific asset is no longer part of the bankruptcy estate capable of being sold. Even an honest omission may result in a buyer not having purchased assets that it thought were covered under a sale order. Accordingly, diligence on the part of a purchaser (and the Chapter 7 trustee) is imperative.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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