A debtor who was a restaurant franchisor sold substantially all of its assets in a bankruptcy auction. The buyer did not receive all of the equipment that it thought was included in the sale, and discovered a franchise agreement that it wanted to have assigned long after the normal sale related executory contract process had been completed. It sought a court order (1) directing turnover of the missing equipment (or a judgment for the value of the equipment), and (2) confirming that it was successful in assignment and assumption of the franchise agreement.
The first question dealt with equipment that was listed on the debtor’s bankruptcy schedules. Notwithstanding this fact, the debtor, through its president (Toni P), claimed to have sold the company owned stores to two entities (Joli and Forty-One) owned by Toni P’s mother 12 days before the debtor filed bankruptcy. A couple of months later a new entity owned by Toni P’s mother (Life A.B.) opened a fast food restaurant (Just Toni’s) in the former debtor store location.
The debtor claimed that listing the equipment in the schedule was a mistake (although it also did not include the purported transfer to Toni P’s mother in the statement of financial affairs). The court did not find it credible that the debtor simply made a mistake, and ordered that the equipment be turned over to the buyer, or alternatively entered a judgment for ~$25,000 in favor of the buyer against Jolie, Life A.B. and Just Toni’s.
The matter of the missing franchise agreement assumption raised a variety of procedural issues. The franchise agreements were not listed in the bankruptcy schedules initially filed by the debtor. The auction was held in October 2010. There was activity in 2011 to require the debtor to file amended schedules that included franchise agreements. The amended schedules filed by the debtor identified two franchise agreements dated December 17, 2009, but noted that the agreements expired March 30, 2011 pursuant to a six‑month notice of nonrenewal, and also stated that they were rejected pursuant to the confirmed plan of reorganization.
In July 2012 the liquidating trustee discovered previously undisclosed 15-year franchise agreements between the debtor and Joli and Forty-One dated 12 days before the bankruptcy was filed (when the mother’s entities purportedly acquired the company stores). The buyer gave notice that it elected to assume the 15-year franchise agreement with Joli.
It turned out that there were two versions of the Joli franchise agreement floating around – a 15-year agreement and a 15-month agreement (that would have expired). The mother testified that there were varying terms because after she consulted with her attorney she decided to shorten the term from 15 years to 15 months. Her daughter also testified that the 15‑month agreement was a replacement executed a few days before the debtor filed bankruptcy. However, the court didn’t buy the argument that the 15-month agreement replaced the 15-year agreement – noting various discrepancies in the testimony and documentation, and the failure to reduce the $25,000 purchase price was not reduced despite the considerably shorter period of time.
The defendants (which included the debtor and the mother’s entities) next argued that a court order was required to assume, reject or assign an executory contract. However, the court pointed out that the bankruptcy rules allow assumption of executory contracts through a plan of reorganization; and Section 1123(b)(2) of the Bankruptcy Code specifically authorizes a plan to provide for assumption of executory contracts that were not previously rejected. In this case, the plan of reorganization provided as follows:
If the Liquidating Trustee becomes aware of any Executory Contracts or Unexpired Leases that was [sic] not included in the Schedules, the right of the Liquidating Trustee to assume or reject such contract or lease shall be extended until the date that is thirty (30) days after the date on which the Liquidating Trustee becomes aware of the existence of such contract or lease and such assumption or rejection shall not require Court approval.
The court agreed that the assumption was timely under the plan since the buyer sent a notice assuming and accepting the longer franchise agreement in August 2012, which was within 30 days after the agreement was discovered by the liquidating trustee. The court dismissed any due process concerns since the other party to the later-discovered agreement was the mother “whose daughter should have disclosed that franchise agreement when the Debtor sought bankruptcy relief in 2009.”
The defendants next contended that the buyer did not comply with the sale bid procedures order. As is fairly typical, the order established a procedure that allowed the debtor to seek authority to assume and assign contracts and leases at the request of the purchaser, and gave the purchaser 60 days following the closing of the sale to select the contracts and leases it desired. However, the court noted that the debtor could not have selected the 15-year franchise agreement within 60 days after the closing since the agreement had not yet been disclosed. Consequently, this argument failed.
Finally, the defendants contended that the buyer did not comply with the terms of the asset purchase agreement (APA), since the APA required the debtor to obtain court approval to assume and assign executory contracts. Again as is typical, the APA established a procedure that required the debtor to use its best efforts to obtain bankruptcy court approval and that included conditionally assuming and assigning executory contracts to the buyer subject to (1) providing parties to the contracts with notice setting a bar date for any claims for damages or setoff, (2) transferring the contracts free and clear of any cure claims not approved by the court, and (3) giving the buyer an option to accept or reject a contract within 30 days after the bar date for contract claims. However, once again the court noted that obviously the buyer could not elect to assume a contract that was not disclosed until long after the deadline.
Consequently, the court found in favor of the buyer and concluded that the 15-year franchise agreement was properly assumed and assigned under the terms of the plan of reorganization.
The implications of wrongdoing were clearly a key consideration for the court. It is not clear how some of the issues would have been decided if the contract was with an innocent party – particularly since the procedure under the plan of reorganization apparently did not provide an opportunity for the party to raise issues such as required cure payments or adequate assurance of future performance. In any event, this case provides some examples of mechanisms that parties use to give a buyer flexibility and time to make decisions about executory contracts.
Vicki R. Harding, Esq.