One Contract, Indivisible, With Defenses and 'Kiwi' for All
By Rudolph J. Di Massa Jr. and Jarret P. Hitchings
July 3, 2017
The Legal Intelligencer
Under Section 365(a) of the Bankruptcy Code, a debtor in bankruptcy may assume executory contracts or unexpired leases to which the debtor was a party before its bankruptcy filing. Before it is permitted to do so, however, the debtor must cure any and all defaults existing under the agreement (see 11 U.S.C. 365(b)(1)), thereby making the nondebtor counter-party "whole" upon assumption.
Section 547, a separate provision of the Bankruptcy Code, allows the debtor in certain circumstances to avoid and recover pre-petition payments made to a contract counter-party. Because the assumption of contracts and leases usually occurs at an earlier phase of the bankruptcy process, a debtor's later action to avoid pre-petition payments can potentially "re-impair" a contract counter-party that was previously made whole under Section 365(b)(1). To prevent this result, bankruptcy courts have recognized the so-called Kiwi defense, which holds that the assumption of an executory contract or unexpired lease under section 365 bars a subsequent avoidance action under Section 547, see In re Kiwi International Airlines, 344 F.3d 311, 316 (3d Cir. 2003).
As a result of the application of this broad defense, defendants in avoidance actions will commonly attempt to tie allegedly avoidable transfers to previously assumed contracts. This tactic is often employed where the general relationship between the debtor and the defendant counter-party is conducted pursuant to a "master agreement" but a particular transaction is governed by a discrete purchase order or invoice. Frequently, the master agreement will be assumed by a debtor, but the individual purchase orders or invoices will not. To decide whether the Kiwi defense applies in such cases, a court will have to determine whether the allegedly avoidable transfers were made on account of the unified master agreement, which has been assumed, or the discrete purchase order or invoice, which has not.
The bankruptcy court in Pirinate Consulting Group v. C.R. Meyer & Sons (In re NewPage), Adv. Pro No. 13-52429 (Bankr. D. Del. Feb 13, 2017), considered this issue and concluded that a series of "purchase orders" made in connection with a master agreement between parties constituted separate, divisible contracts for purposes of the Kiwi defense. In C.R. Meyer, the debtor, NewPage Corp., operated paper mills throughout the country. Before filing for bankruptcy protection, NewPage entered into a master construction agreement (master agreement) with C.R. Meyer & Sons Co. (CRM), pursuant to which CRM would handle maintenance and construction needs at NewPage's mills in several states. The master agreement provided that CRM would complete certain work described in purchase orders issued by NewPage from time to time. In effect, the purchase orders served to document work to be performed by CRM and to facilitate the payment of invoices by NewPage. Importantly, the master agreement also provided that the purchase orders issued by NewPage to CRM would "constitute separate contracts between" NewPage and CRM.
The parties performed under the master agreement for almost two years. CRM employees worked at the direction of NewPage employees, and their work was later coded against the corresponding purchase orders and invoiced to NewPage on a weekly basis. CRM continued to perform in accordance with the Master Agreement and the outstanding purchase orders even after NewPage filed for bankruptcy in September 2011.
In December 2012, the bankruptcy court confirmed NewPage's Plan of Reorganization (the plan). The plan included a "catch-all" provision concerning the automatic post-confirmation assumption of executory contracts. Specifically, the plan provided that upon confirmation, NewPage automatically assumed any executory contract that had not expired by its own terms prior to confirmation and was not otherwise addressed during the pendency of the bankruptcy case or included on the Plan's schedule of excluded contracts.
In October 2013, the litigation trustee of NewPage's creditor litigation trust (trustee) brought an adversary action against CRM seeking to avoid and recover as preferential over $2 million that NewPage had paid to CRM before NewPage filed its Chapter 11 petition. CRM responded to the action, asserting that under Kiwi it had a complete defense to the avoidance and recovery of the pre-petition transfers. Specifically, CRM argued that the master agreement was assumed by NewPage pursuant to the catch-all assumption provision. As a result, CRM claimed that the allegedly avoidable transfers paid pursuant to the master agreement could not be avoided. The trustee disagreed, arguing instead that the transfers were made on account of the individual purchase orders, each of which constituted a divisible contract that had not been assumed by NewPage. The parties filed cross-motions for summary judgment on a stipulated record, and asked the court to determine whether NewPage had assumed the master agreement and the purchase orders, thus entitling CRM to a complete Kiwi defense.
The court first considered whether the master agreement and the purchase orders constituted a single, unified contract. In order to make this determination, the court looked to applicable state law. Here, the purchase orders concerned the performance of work in Michigan and Wisconsin. Under the law of both states, "the intention of the parties is the first and foremost consideration in analyzing the divisibility of contracts." In addition, in both states, "the apportioning of different prices to different phases of work evidences an intent to form separate agreements." Applying this framework, the court concluded that the Master Agreement and the purchase orders were separate, divisible contracts. In particular, the court relied on the fact that the "master agreement provides that the price for the work discussed in each purchase order is the 'contract sum' stated in each individual purchase order." Consequently, the court determined that the parties' dealings involved different sums payable at different periods "which indicates an intent by the parties to form separate agreements."
The court also concluded that its finding was consistent with other bankruptcy decisions on similar issues. For example, in In re Hawker Beechcraft, (Bankr. S.D.N.Y. June 13, 2013), a master agreement between parties set forth terms and conditions that were to be incorporated into separate purchase orders. The bankruptcy court relied on this fact, in part, in concluding that the master agreement and purchase orders were divisible contracts. Likewise, in Carlise v. Uresco Const. Materials, 823 F. Supp. 271 (M.D. Pa. 1993), the district court found that because each purchase order stemming from a broader distributorship agreement created a separate right to payment, each order constituted a complete contract.
Finally, the bankruptcy court looked to the plan language of the master agreement for indication of an intent by the parties that the purchase orders constitute separate contracts. As noted above, the master agreement stated that each new purchase order "shall constitute separate contracts." In light of this express intention, the court concluded that the master agreement and the purchase order were separate agreements.
The court then considered whether NewPage had automatically assumed the master agreement and the purchase orders. Neither the master agreement nor any purchase order had been assumed during the course of the bankruptcy case. Likewise, none of the agreements was listed on the plan's schedule of excluded contracts. The court thus concluded that if any of the agreements was "executory" and unexpired as of plan confirmation, it had been automatically assumed pursuant to the Plan's catch-all assumption ?provision.
Assessing the master agreement, the court concluded that the master agreement remained an executory contract at the time the plan was confirmed because the master agreement imposed obligations on CRM and NewPage that were materially unperformed as of the date of NewPage's bankruptcy filing. Assessing the purchase orders, however, the court determined that the record on the cross-motions for summary judgment was incomplete because CRM had made no attempt to argue that the separate purchase orders were executory. Accordingly, the court held that it could not rule on whether the purchase orders were automatically assumed under the plan, and, as a result, could not determine whether the transfers made on account of the purchase orders could be shielded from avoidance under Kiwi. On this point, the court denied the cross-motions for summary judgment and set for trial the issue of whether the purchase orders were assumed.
In light of C.R. Meyer, contract counter-parties facing assumption of agreements with bankruptcy debtors should understand—and make clear—which of their agreements are to be assumed. If the parties' business relationship involves serial purchase orders or invoicing within the framework of a master agreement, parties hoping to take advantage of the Kiwi defense should make clear their intent that the master agreement, together with all purchase orders, be treated for Section 547 purposes as one integrated agreement. Even better, the separate purchase orders should make clear that they are orders being placed under, subject to, and as part of the master agreement.
Rudolph J. Di Massa, Jr., a partner at Duane Morris, is a member of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditors' rights.
Reprinted with permission from The Legal Intelligencer, © ALM Media Properties LLC. All rights reserved.