United States: Bankruptcy Court Reiterates Tempnology - Rejected Contracts Do Not Terminate Or Rescind Pre-Petition Contract Rights Granted To Non-Breaching Party

On September 4, 2020, Bankruptcy Judge Martin Glenn approved in In re Avianca Holdings S.A., et al., 2020 WL 5260572, at *1 (Bankr. S.D.N.Y. 2020), the rejection of two executory contracts entered into by Avianca Holdings S.A. ("Avianca"). In doing so, the Court, among other things, reiterated the Supreme Court's holding in Mission Prod. Holdings v. Tempnology, LLC, 139 S. Ct. 1652 (2019), that rejected contracts constitute a breach and do not automatically terminate or rescind rights granted under the rejected contract.

Executory Contracts

Section 365 of the Bankruptcy Code allows a debtor to assume or reject an executory contract. An executory contract is a contract where unperformed obligations remain by two contracting parties, and the failure of either party to perform constitutes a material breach. Consideration of an executory contract depends upon whether an obligation is material and remains unperformed by each party to a contract at the time a bankruptcy case is filed. If an executory contract exists, a debtor may either assume or reject it. Recently, the Supreme Court in Tempnology held that rejection of an executory contract constitutes a breach, rather than termination or rescission of the rejected contract.² The Court explained that a non-breaching party retains contract rights granted under a pre-petition contract even though a debtor elects to reject such contract post-petition.³ Tempnology's holding applies to all contracts.⁴

Background

Avianca executed a Master Servicing Agreement ("Master Agreement") with USAV to sell its current and future rights to credit card receivables under credit card processing agreements with American Express ("AMEX) and Credomatic (the "Card Processing Agreements"). Seven other agreements were executed to effectuate the Master Agreement. Of relevance here is the "Undertaking Agreement" (together with the Master Agreement and the other six agreements, the "USAV Agreements").

Under the Master Agreement, USAV agreed to pay Avianca $150 million plus an Additional Purchase Price in exchange for rights to specified sales processed by AMEX and Credomatic. To make the $150 million payment, USAV entered into a loan agreement with USAV Lender Group. Citibank served as administrative agent. Upon termination of the Card Processing Agreements, Avianca was obligated to purchase new card processing agreements on substantially similar terms as the Card Processing Agreements. If new card processing agreements were executed, Avianca would be obligated to sell its payment rights to USAV for no additional consideration.

The Master Agreement contained eighteen events that constituted "Trigger Events." A Trigger Event occurred, among other events, if Avianca's ability to operate commercial flights was materially impaired for any reason. A Trigger Event also occurred if Avianca could not carry out the terms or obligations under the Undertaking Agreement and if Avianca could not generate enough receivables to pay to USAV on a monthly basis and maintain a "Collections Coverage Ratio." USAV could terminate the Master Agreement and demand liquidated damages if a Trigger Event occurred. Upon occurrence of a Trigger Event, USAV could also withhold Additional Purchase Price payments from Avianca until the Trigger Event had been resolved.

In March 2020, Citibank sent a notice to Avianca, declaring that a Trigger Event had occurred due to Avianca's inability to fly (flight impairment). Citibank sent another notice later, stating that a "Retention Event" had occurred due to a dip in the Collections Coverage Ratio. After the bankruptcy filing, Avianca sought to reject the Master and Undertaking Agreements under section 365 of the Bankruptcy Code. Avianca conceded that the other six agreements were not executory, but argued that all of the USAV Agreements are inseparable and should be treated as an integrated contract for purposes of rejection.

Bankruptcy Court's Decision

Beginning with the Master and Undertaking Agreements, the Bankruptcy Court determined that both contracts were executory and could be rejected. It found that Avianca had material unperformed obligations pursuant to the Trigger Event obligations under the Master Agreement, which included an ongoing obligation to: (i) sell its rights to payment to USAV for no additional consideration under new card processing agreements, (ii) adhere to all obligations under the Card Processing Agreements, and (iii) maintain its ability to operate domestic and/or international flights.

Still, USAV argued against rejection because the Trigger Event obligations were nonexecutory, as they were mere conditions, and that failure to perform a "condition precedent" is not a breach. The Court rejected this assertion because USAV could "prematurely terminate" the Master Agreement upon the occurrence of a Trigger Event. In its view, "[w]hen parties to a contract define a breach of one party's obligations as a terminable breach, such obligations are material obligations."⁵

The Court also found the Master and Undertaking Agreements executory because USAV had material unperformed obligations, which were to distribute funds and make the Additional Purchase Price payments to Avianca. USAV still argued it had no ongoing obligation because Avianca's flight impairment, a Trigger Event, severed its right to the Additional Purchase Price. Avianca countered that this Trigger Event temporarily, not permanently, relieved USAV from paying the Additional Purchase Price. The Court agreed with Avianca, finding that the Master Agreement allowed USAV to cease Additional Purchase Price payments until a Trigger Event had been resolved. Also, USAV's conduct confirmed the fleeting nature of the cessation of payments because Citibank resumed Additional Purchase Price payments shortly after it sent the March Notice.

Separately, USAV argued that it had no unperformed obligation to pay the Additional Purchase Price because the flight impairment Trigger Event remained ongoing and neither USAV nor Citibank had revoked the Trigger Event. The Court disagreed with this assertion. It wrote, "[t]he fact that an obligation is contingent is irrelevant for purposes of determining whether the underlying contract is executory."⁶ So, even if USAV's obligation to pay the Additional Purchase Price remained contingent on the petition date because the flight impairment Trigger Event had not been resolved, such contingency did not undo the executory nature of the Master Agreement.

As to the Undertaking Agreement, Avianca's ongoing material obligations included: (i) response to inquiries, correct errors, and settle claims and disputes, (ii) provide monthly statements about collections to USAV and Citibank, (iii) use best efforts to collect all payments required under the Card Processing Agreements, and (iv) renew the Card Processing Agreements and ensure that they were still legally binding. USAV also had ongoing material obligations to furnish records and documents to Avianca for Avianca to carry out its duties under the Undertaking Agreement. USAV viewed this as a de minimis obligation, but the Court disagreed. The Court concluded that "an ongoing obligation to furnish all necessary account records to [Avianca] is a material obligation, especially where . . . [Avianca] require[d] those documents to perform [its] obligations under the Undertaking Agreement."⁷

The Court briefly turned to whether the USAV Agreements could be construed as an integrated contract for purposes of rejection under Colombia law. ⁸ It determined that the USAV Agreements could not be construed as such due to the doctrine of "colligated contracts" under Colombia law.⁹ That doctrine states that multiple agreements cannot be treated as an integrated contract under Colombia law. Accordingly, Avianca could not treat all of the USAV Agreements as an integrated contract for purposes of rejection.

Next was whether rejection of the USAV Agreements violated Tempnology. That is, did the Avianca seek to unwind contract rights conferred on USAV in the Master Agreement. ¹⁰ As discussed, the Supreme Court ruled that rejection of an executory contract in bankruptcy operates as a breach, rather than "termination or rescission of the rejected contract." ¹¹ It explained that rejection of an executory contract in bankruptcy is akin to a breach outside of bankruptcy. Rejection does not wipe out contract rights conferred on the non-breaching party. Instead, it gives the non-breaching party a claim for damages, while leaving unharmed the rights granted to the non-breaching party under the rejected contract.

USAV argued that Avianca sought to retain the contract rights conferred on USAV by seeking to reject the Master Agreement, and that USAV was entitled to proceeds arising from new card processing agreements for no additional consideration. The Court rejected these assertions and concluded that rejection of the Master Agreement constituted a breach, not a termination or rescission of rights conferred on USAV under the Master Agreement. As noted earlier, Avianca sold to USAV for consideration its payment rights to receivables or specified sales processed by AMEX and Credomatic under the Card Processing Agreements. The Master Agreement provided that, upon termination of the Card Processing Agreements, Avianca would be obligated to execute new card processing agreements and sell to USAV for no additional consideration its payment rights under the new agreements.

On these facts, the Court ruled that rejection did not deprive USAV of its contract rights under the Master Agreement. Rejection merely allowed Avianca to avoid executing new card processing agreements and selling its right to payments to USAV for no additional consideration under the new agreements. Furthermore, rejection left intact USAV's right to receive payments arising from receivables or specified sales processed by AMEX and Credomatic pursuant to the Card Processing Agreements. Based on this ruling, the Court found that Avianca exercised sound business judgment to reject the Master and Undertaking Agreements, thereby allowing it to preserve cash from receivables under new card processing agreements to operate the company.

Conclusion

Avianca reiterates Tempnology's holding that post-petition rejected contracts constitute a breach, rather than a termination or rescission of the rejected contract. A post-petition rejected contract merely allows a debtor to stop performance of obligations under the rejected contract. It does not eliminate contract rights conferred on a non-breaching party. Tempnology's ruling applies to all contracts. It is also worth noting that consideration of an executory contract depends upon whether an obligation is material and remains unperformed, rather than the contingent nature of the contract. Further, an obligation to assist a debtor in carrying out its duties under an executory contract constitutes a "material unperformed obligation" of the nonbreaching party to such contract. And material obligations include provisions in a contract that define breach of one party's obligations as a terminable breach.

Footnotes

1 Mr. Akuffo is a member of the Bankruptcy and Financial Restructuring practice group at Porzio.

2 Avianca, 2020 WL 5260572, at *8 (citing Tempnology, 139 S. Ct. at 1657-58).

3 Id. (citing Tempnology, 139 S. Ct. at 1659).

4 Id. at *9 (citing Tempnology, 139 S. Ct. at 1661).

5 Id. at *11 (emphasis added).

6 Id.

7 Id. at *13.

8 Colombia law governed the USAV Agreements.

9 Id. at *14.

10 As discussed, Avianca conceded that the other six agreements were non-executory, yet it sought to have them construed as an integrated contract for purposes of rejection. This, perhaps, was the basis for USAV's assertion that Avianca sought to unwind its contract rights under the Master Agreement in violation of Tempnology.

11 Id. at *15 (citing Tempnology, 139 S. Ct. at 1657-58).

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