On May 21, 2021, the Third Circuit issued an opinion in the high-profile bankruptcy of The Weinstein Company, LLC (TWC) clarifying precisely what ingredients are needed to make a contract “executory” under § 365 of the Bankruptcy Code.
Section 365 is the provision of the Bankruptcy Code which allows a debtor-in-possession to assume or reject executory contracts and unexpired leases. In order for an executory contract to be assumed (meaning, to be retained by the debtor; as opposed to being tossed out by virtue of “rejection”), the debtor must cure or provide adequate assurance that it will cure any defaults under that executory contract. See 1 U.S.C. 365(b)(1). An executory contract that has been assumed subsequently may be assigned by the debtor to another entity; typically, the purchaser of property from Debtors’ bankruptcy estate pursuant to a § 363 sale. The § 365 cure provision does not, however, apply to non-executory contracts. In this enlightening opinion penned by Judge Ambro, the Third Circuit makes clear precisely which contracts are “executory.”
As a matter of background, TWC and its debtor affiliates (collectively, the Debtors) filed for relief under Chapter 11 of the Bankruptcy Code in March 2018 amidst numerous sexual misconduct allegations brought against co-founder Harvey Weinstein. The overriding goal of TWC’s bankruptcy was to get court approval on an asset purchase agreement with Spyglass Media Group, LLC (Spyglass), pursuant to § 363 of the Bankruptcy Code. Among the assets in Debtors’ bankruptcy estate was a contract with Bruce Cohen, who produced the critically acclaimed Silver Linings Playbook, released in November 2012. Among other things, TWC’s contract with Bruce Cohen (the Cohen Agreement) includes a provision that assures that Cohen would receive certain future compensation equal to roughly 5% of the net profits of Silver Linings Playbook. Debtors sold the Cohen Agreement, among myriad other assets, to Spyglass in a § 363 sale (the Sale). At the time of the Sale, TWC owed Cohen approximately $400,000 in unpaid contingent compensation.
At issue before the Third Circuit was whether the Cohen Agreement was “executory” at the time of the Sale. If so, then Cohen would be entitled to the cure amount of approximately $400,000; if not, then Cohen would be owed nothing for the unpaid contingent compensation (but would remain entitled to future contingent compensation). Ultimately, the Third Circuit found the Cohen Agreement to be non-executory, thereby affirming the District Court’s decision, which itself affirmed the Bankruptcy Court’s decision.
As a general matter, the Third Circuit follows the so-called Countryman test for determining whether a contract is executory or non-executory. Under the Countryman test, an executory contract is defined as “a contract under which the obligation of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other.” Spyglass Media Group, LLC v. Cohen (In re Weinstein Company Holdings, LLC), Nos. 20-1750 and 20-1751, slip op., pages 10–11 (3d Cir. May 21, 2021) (quoting Vern Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn. L. Rev. 439, 460 (1973)). The Third Circuit succinctly enunciated the test for executory contracts: “[T]he test for an executory contract is whether, under the relevant state law governing the contract, each side has at least one material unperformed obligation as of the bankruptcy petition date.” Id. (emphasis added).
Applying this test, the Third Circuit concluded that the Cohen Agreement was non-executory because, although failure to pay contingent compensation to Cohen would result in a material breach, Cohen as counterparty did not maintain any outstanding obligations the non-performance of which would result in material breach under New York law (the applicable state law) or by the terms of the Cohen Agreement. See id., at page 25. Such is the case because, as the Third Circuit indicated, Cohen’s remaining obligations (i.e., to refrain from pursuing injunctive relief over intellectual property he does not own) were ancillary and immaterial. Id., at page 22. Importantly, the Court elaborated that parties could contract around a state’s default contract rule regarding substantial performance (which is key in defining what sorts of breaches are material), and that, by crafting provisions that take the contract outside of such state rules, parties can “override the Bankruptcy Code’s intended protections for the debtor.” Id. In this instance, the Third Circuit concluded that “[n]o provision in the contract clearly and unambiguously overrode New York’s default substantial performance rule that obligations are immaterial if they do not go to the root and purpose of the transaction,” and that, therefore, the Cohen Agreement was subject to New York’s substantial performance rule and commensurate definition for material breach. Id., at page 25.
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Zachary J. Schnapp is an associate in the bankruptcy & restructuring department at Klehr Harrison.
Morton Branzburg (LAW ‘76) is a partner in the bankruptcy & restructuring, litigation, and corporate & securities departments at Klehr Harrison.