Michael Lastowski

Christopher Winter

Section 365 of 11 U.S.C. provides a debtor with a valuable tool for reorganizing its business by permitting a debtor to assume or reject executory contracts or leases. However, Section 365 has its limits. A debtor must assume or reject a contract or lease in its entirety and may not cherry-pick among its various provisions, as in In re Fleming, 499 F.3d 300, 308 (3d Cir. 2007). An exception arises if the provisions are "severable," as in In re Buffets Holdings, 387 B.R. 115, 120 (Bankr. D. Del. 2008). In In re Contract Research Solutions, (Del. Bankr. May 1, 2013), a debtor argued that a lease amendment that added a new leasehold to the underlying lease was severable. U.S. Bankruptcy Judge Kevin J. Carey of the District of Delaware disagreed.

In Contract Research, the debtor had entered into a lease and two subsequent amendments, all of which related to a single leasehold. The debtor then entered into a third amendment relating to a new leasehold, which was in the same building complex as the original leasehold. The debtor filed a motion to sever and reject the third amendment. The issue before Carey was whether the third amendment represented an agreement separate and independent from the original lease and the two prior amendments or whether the third amendment was a single, integrated contract.

Severability is determined under state law. In this case, Florida law applied. Under Florida law, a court must determine the parties' intent and consider whether: (1) the agreements have a different nature and purpose; (2) the consideration is separate and distinct; and (3) whether the parties' obligations under each of the agreements is interrelated, as in In re Gardinier, 831 F.2d 974, 976 (11th Cir. 1987).

Carey noted that, in the third amendment, the parties ratified the original lease and prior amendments and that this ratification evidenced the integrated nature of the agreements. Further, the third amendment modified provisions of some of the earlier agreements (e.g., extension of lease term, abatement of rent if the new leasehold was not timely delivered, a recalculation of CAM charges, etc.). These factors demonstrated the interrelatedness of the parties' obligations. Further, the court noted that the parties had entered into a standalone lease for another leasehold in the same building complex and that this demonstrated that "when the parties intended their lease arrangements to be separate, they were perfectly capable of making - and did make - a truly separate agreement."

Finally, the debtor argued that a severability provision in the third amendment demonstrated that the agreements were all severable. Carey noted that this boilerplate provision merely provided that, in the event that a portion of the agreement was stricken because of noncompliance with applicable law, the other provisions would remain intact.

Although debtors seek the maximum flexibility in identifying contracts to assume or reject, the decision in Contract Research demonstrates the restrictions that applicable state law imposes on attempts to sever portions of executory contracts or leases.

Michael R. Lastowski is a member of Duane Morris and the head of its Wilmington office. Licensed to practice in Delaware, Pennsylvania and New York, he primarily represents Chapter 11 debtors. Christopher M. Winter, a partner with the firm, is a Delaware business lawyer who focuses his practice on Chapter 11 bankruptcy law and proceedings, commercial and corporate finance and transactions, and Delaware corporate and alternative entity law.

Reprinted with permission from Delaware Business Court Insider, © ALM Media Properties LLC. All rights reserved.