Rejecting Related Contracts: When Can You Pick and Choose?

In re Trinity Coal Corp., 514 B.R. 526 (Bankr. E.D. Ky. 2014)

The debtors sought to reject easement and disposal agreements with the owners of adjacent coal mines. The adjacent owners objected on the basis that the agreements were an integral part of a larger transaction, and could not be separately rejected.

The debtors and the other party (ICG Entities) had coal mining operations on adjacent properties that had been acquired in 2004 through separate sales from a prior bankruptcy case. The parties decided that the way the property had been divided was “cumbersome and illogical.” Consequently they negotiated a comprehensive property exchange agreement that would allow each to consolidate their interests in a way that would facilitate mining and make their operations more workable.

The transaction involved ~5,500 acres of mineral properties and was documented in a series of agreements including (1) an exchange agreement, (2) an easement agreement, and (3) a disposal agreement. The exchange agreement provided for an exchange of property interests. The easement agreement granted one of the ICG Entities access across the debtors’ property for ingress and egress. The disposal agreement gave the parties reciprocal rights to dispose of spoil from its mining activities on property controlled by the other.

All of the documents, including the easement and disposal agreements, were to be executed at closing. The exchange agreement specifically provided:

Each of the actions required … shall be deemed to have occurred simultaneously at the Closing and unless all of such actions are taken, none of the actions provided for in this [exchange agreement] shall be taken or be deemed to have been taken, and any acts which may have been performed in respect thereof shall be cancelled and treated as if void and of no force and effect.

The exchange agreement also included an integration clause that referenced the exhibits, including the easement and disposal agreements. The easement and disposal agreements each recited that the “sole consideration” for the agreement was the exchange of property rights under the exchange agreement, and referenced the exchange agreement in the integration clause.

The debtors had ceased mining operations by the time they filed bankruptcy, so determined that the easement and disposal agreements were burdensome. However, the ICG Entities continued to operate their mines and asserted that continuation of their rights under the agreements was essential to their business operations.

In determining whether a debtor is permitted to reject an executory contract, the court must first determine what constitutes the contract. The court noted (and the parties agreed) that multiple contracts intended to constitute one transaction may not be severed for purposes of assumption or rejection in bankruptcy. Thus, the question was whether the exchange agreement, easement agreement and disposal agreements were independent or part of one indivisible contract – which was a question of state contract law.

Under applicable law, the key question was the intent of the parties. In this case the court concluded that the agreements made it clear that the intent of the parties was to form one indivisible contract.

In addition to the language of the agreements, it was appropriate to consider the objectives of entering into the agreements and the “common sense of the situation.” The debtors argued that the easement and disposal agreements served a different purpose and were not required to continue mining operations on the properties obtained through the exchange since the ICG Entities could build roads and dispose of spoil on other properties. However, the court rejected this argument since the purpose was to remedy the cumbersome and illogical division of properties so that both sides could operate more efficiently. Thus, the court concluded that the easement and disposal agreements were an essential part of the objectives of the exchange agreement.

The debtor also argued that the severability provisions supported divisibility. The exchange agreement included a standard provision that if one provision was determined to be contrary to law and unenforceable, the remaining provisions were severable and would continue to be enforceable. The court rejected this as a circular argument.

Consequently the court held that the agreements were intended to be indivisible, and thus the debtors could not independently reject the easement and disposal agreements.

Integration and severability clauses are often included as part of the boilerplate language in a contract without much thought. As illustrated by this case, it is worth carefully considering the extent to which a party would be willing to proceed with only part of a transaction, and crafting the boilerplate accordingly.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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