Daily Development for Wednesday, June 20, 2007
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

BANKRUPTCY; AVOIDANCE; EXECUTORY AGREEMENTS;  REDEVELOPMENT AGREEMENTS:  A property owner cannot reject a redevelopment settlement agreement by filing a bankruptcy petition where the municipality has already substantially performed all of its obligations under the agreement, because such an agreement is not executory and therefore not subject to rejection. 

In Re S.A. Holding Co., LLC, 2006 WL 3804558 (U.S. Bkrtcy. D. N.J.  December 22, 2006)

A dispute between an adult nightclub and a municipality was settled when it was agreed that the nightclub would continue to operate as a go-go club for two years in exchange for then allowing the municipality to designate the property for redevelopment and establish[ment] [of] a redevelopment plan.  This agreement was memorialized in a settlement agreement accepted by a court.  The agreement was modified two years later. 

Three years after the modification, the municipality adopted the redevelopment plan by enactment of an ordinance.  The club did not oppose the municipalitys action.  Then, the municipality returned to a New Jersey court to enforce the settlement agreement.  Specifically, the [municipality] sought to close the business as was agreed and for payment of its counsel fees and costs.  The [club] for the first time sought to challenge the redevelopment plan.  A judgment was entered in favor of the municipality.  It directed the business the close immediately. 

The matter dragged on until the day before an evidentiary hearing was to take place, the club filed a bankruptcy petition for relief under Chapter 11 of the Bankruptcy Code.  This automatically stayed the state court action.  In its bankruptcy proceeding, the club sought to reject the settlement agreement as an executory contract. The Bankruptcy Code does not define the term executory contract, nor does [section 365(a)] indicate the phrases intended scope. ... The legislative history of [section 365] indicates that though there is no precise definition of what contracts are executory, it generally includes contracts on which performance remains due to some extent on both sides.  Here, the Court noted that a Court of Appeals decision in the Seventh Circuit commented, taken literally, this definition would render almost all agreements executory since it is the rare agreement that does not involve unperformed obligations on either side. 

Recognizing that a relaxed definition of executory would render nearly every contract executory, the Court, following the Third Circuit, looked to the Countryman= definition of an executory contract. 

Professor Countryman defined an executory contract as a contract under which the obligation of both the bankrupt and the other party to the contract are so far underperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other.  Further, the materiality of any remaining unperformed obligation is evaluated according to the relevant non-bankruptcy law. 

There was no argument that closure of the club remained unperformed.  Therefore, the dispute centered upon whether [the municipality] had substantially performed its obligations under the [Settlement] Agreement at the time of the bankruptcy filing.  That agreement provided that the club would close in exchange for the municipalitys designation of the Property as an area in need of redevelopment and adoption of an enhanced development plan for the Property so that the [club] could develop the property for high density residential uses. 

The Court found the agreement to be simple, straightforward and unambiguous on its face.  Further, the Court found it undisputed that by the end of 2003, [the municipality] had afforded [the go-go club] the extended two year period to operate its sexually oriented business.  It was also clear that the municipality had designated the property for redevelopment and adopted a redevelopment plan.  Consequently, the Court was convinced that the municipality had substantially performed its obligations under the Agreement. 

To complete its analysis, the Court looked at Farnsworth on Contracts 2nd edition Vol. 2, Part 3, Section 8.16.  There it extracted the following:The doctrine of material breach is simply the converse of the doctrine of substantial performance. ... Substantial performance is performance without a material breach, and a material breach results in performance that is not substantial.  Because the Court found that the municipality did not have any substantial unperformed obligations under the Agreement at the time of the bankruptcy, it held that settlement agreement was not executory and therefore not subject to rejection.  Accordingly, the Court denied the go-go clubs bankruptcy motion to reject the agreement.  It had no need to address or make findings with respect to whether the go-go club was acting in bad faith when seeking such a rejection or whether rejection of the Agreement as an executory contract would somehow interfere with [the municipalitys] enforcement of its

 police powers.

Comment: At one time, the dispute over what really was an executory contract consumed courts and commentators.  The dust seems to have settled now.  But there are still uncertainties.  Is it really clear that the municipality had no obligations under the settlement agreement?  Were there express or implied understandings about the nature of the redevelopment plan?  Perhaps that was for the landowner to argue here.  Since it didnt make such arguments, perhaps the courts conclusion was right.  Landowner got what it bargained for, and now its time to pay the piper. 

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