Page 6 - Corporate Restructuring & Bankruptcy

S6 | MONDAY, JUNE 13, 2016 | Corporate Restructuring & Bankruptcy
| NYLJ.COM
Current Issues ‘Running With’ Contract Rejections in Oil, Gas Cases
BY MELANIE McLAUGHLIN KOTLER AND TIMOTHY S. SPRINGER
T he prolonged downturn of oil prices has begun to take its toll. Over 27 oil and gas bankruptcy cases have filed in 2016, and
over 69 since 2015,1 as companies seek to access powerful protections under the U.S. Bankruptcy Code (the Code).
One such protection at the forefront of the trend is the ability to escape certain burden- some contracts. Rejecting these contracts under §365 of the Code can create substantial bargaining power for a going concern enter- prise or increase the value of assets sold through a bankruptcy.
This article analyzes a hiccup in this strat- egy presented in three recent cases—one that promises to recur. The outcome in these cases will signal a trend that broadly affects similar agreements across the industry.
Rejection Analysis in Chapter 11 Bankruptcy
Some brief background on the Chap- ter 11 bankruptcy process helps illustrate the problem. Immediately upon filing, the “automatic stay” takes effect, which means a blanket injunction protects the debtor and its assets from most forms of attack.2 The automatic stay and other protections give debtors a “breathing spell” to soften the blow of a bankruptcy filing.3
During this breathing spell, a debtor4 is able to analyze its options under §365, which per- mits a debtor to “assume” or “reject” certain “executory” contracts and unexpired leases.5 Rejection is deemed a material breach and generally converts any damages into a prepe- tition, general unsecured claim.6 The decision to reject a contract is reviewed under the rela- tively lenient business judgment standard.7
The Code does not define “executory,” creating fertile ground for debate. The com- monly accepted view defines “executory” to mean when each side continues to owe material, unfulfilled duties of performance under the contract.8 For instance, a contract between a supplier (who is obligated to pro- vide goods) and a buyer (who is obligated to pay) is executory. But a fully funded loan where only the buyer’s payment obligation remains is not executory.
In comparison, a property interest is not an executory contract susceptible to rejec- tion under §365. State law defines property interests, which the Code imports into the federal-law rejection analysis.9 But other Code provisions allow a debtor to sell property of the bankruptcy estate “free and clear” of interests in certain situations.10 So a debtor may be able to escape property interests, even if not accomplished through §365.
Covenants Running With Land
One particular property interest has cre- ated a wrinkle in the typical rejection analy- sis: covenants running with land. Texas law requires five elements for a covenant to run:
MELANIE McLAUGHLIN KOTLER is an attorney in Nor- ton Rose Fulbright’s New York office. TIM SPRINGER is an associate in the firm’s Dallas office.
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