Bankruptcy Update Blog

Another Gotcha for the Calendar: Section 365(d)(1)

Although it may be difficult to define precisely what an “executory contract” is (with the Bankruptcy Code providing no definition), I think most bankruptcy lawyers feel how the late Supreme Court Justice Potter Stewart famously felt about obscenity--we know one when we see it.  Determining that a patent license was executory in the first place was an issue in the Fifth Circuit’s recent decision in RPD Holdings, L.L.C. v. Tech Pharmacy Services (In re Provider Meds, L.L.C.),[1] but more interesting to this blogger was the issue, apparently decided by a Court of Appeals for the first time under the Code, of the effect of a timing provision that is unique in Chapter 7 cases.

In cases under the chapters of the Code that contemplate the confirmation of a plan (Chapters 9, 11, 12 and 13), the trustee (or party acting in the trustee role, usually a debtor-in-possession) has until confirmation of the plan to assume or reject all of the debtor’s executory contracts, unless the court shortens the time at the request of the non-debtor party to a contract.[2]  However, in Chapter 7 cases, the debtor’s executory contracts are automatically rejected 60 days after the entry of the order for relief unless the trustee has assumed or rejected them within the 60-day period or “such additional time as the court, within such 60-day period, fixes . . . .”[3]

Does the automatic rejection occur even if the debtor failed at or after the commencement of its Chapter 7 case to disclose the existence of the executory contract?  A trustee obviously cannot assume or reject a contract (or seek additional time to do so) of which she has no knowledge.  That was the decisive question in Provider Meds

Plaintiff RPD Holdings was the assignee of a patent license that was assumed after the expiration of the 60-day period (which had not been extended), and it was defending the validity of the assumption and the continued existence of the license that had been assigned to it after its ostensibly late assumption.  RPD was advocating “an implicit exception [to] section 365(d)(1) for when a bankruptcy debtor fails to schedule the executory contract and the trustee was unaware of the contract within the sixty-day period.”[4]  The three possible responses to the suggestion of an implicit exception are well represented in the decisions of the lower courts: (1) no exceptions ever; (2) always an exception when there has been a failure to schedule; and (3) an exception only “where a debtor intentionally conceals the existence of the contract from a trustee.”[5]

The Fifth Circuit rejected response (2) because “[t]he Bankruptcy Code places an affirmative duty on the trustee to ‘investigate the financial affairs of the debtor,’”[6] relying on the Ninth Circuit’s analysis of the analogous provision of the pre-Code Bankruptcy Act.[7]  As there was no contention that the disputed patent license had been concealed from the trustee, RPD Holdings could not benefit from response (3), and the patent license had therefore been automatically rejected before it had purportedly been assumed and assigned to RPD (and the assumption and assignment was therefore a nullity):

We therefore hold that the License Agreement was deemed rejected by operation of law when [the] trustee failed to assume it within the sixty-day period.  At 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 estate’s trustee.[8]

 

[1]  2018 U.S. App. LEXIS 30600 (5th Cir. Oct. 29, 2018).  The issue whether the license agreement was executory turned on esoteric points of patent law and litigation and is not further discussed in this post.

[2]  Bankruptcy Code § 365(d)(2).

[3]  Id. § 365(d)(1).  An order for relief is entered in a voluntarily commenced case under any chapter immediately upon the filing of the petition.  When, as occurs often, a Chapter 11 case is converted to Chapter 7, the 60-day period begins to run upon conversion.

[4]  2018 U.S. App. LEXIS 30600 at *18.

[5]  Id.

[6]  Id. at *19, quoting Code § 704(a).

[7]  Cheadle v. Appleatchee Riders Ass'n (In re Lovitt), 757 F.2d 1035 (9th Cir. 1985).

[8]  2018 U.S. App. LEXIS 30600 at *20-21.  The Court added in a footnote that “[w]e do not decide here whether this rule might shift if a debtor is shown to have hidden assets from a trustee,” apparently referring to executory contracts as “assets.”