Opinion
Case No. 19-15277-C-11 Docket Control Nos. DT-61 & DT-62
2022-12-19
IN RE: SVENHARD'S SWEDISH BAKERY, Debtor.
Jason M. Blumberg, Sacramento, CA, for U.S. Trustee. Solomon B. Cera, San Francisco, CA, for Special Counsel Solomon B. Cera. Gary Garrigues, Larkspur, CA, for Special Counsel Gary Garrigues. Paul S. Jasper, One Embarcadero Center, San Francisco, CA, for Creditor Committee. Derrick Talerico, Los Angeles, CA, for Debtor.
Jason M. Blumberg, Sacramento, CA, for U.S. Trustee.
Solomon B. Cera, San Francisco, CA, for Special Counsel Solomon B. Cera.
Gary Garrigues, Larkspur, CA, for Special Counsel Gary Garrigues.
Paul S. Jasper, One Embarcadero Center, San Francisco, CA, for Creditor Committee.
Derrick Talerico, Los Angeles, CA, for Debtor.
OPINION ON MOTION TO APPROVE COMPROMISE
CHRISTOPHER M. KLEIN, Bankruptcy Judge:
It was a great settlement: extinguish a $46 million liability for $3 million on the condition of adherence to a precise payment schedule. The entity that acquired the debtor's business thwarted payments, caused default, and let three years pass. Now defending lawsuits seeking $46+ million, the acquirer wants to use Bankruptcy Code § 365 to revive the discounted payment agreement.
The salient question is: whether a garden-variety discounted payment agreement to release a large debt contingent on prior full payment of an agreed smaller sum under specific terms is an "executory contract" that may be assumed and assigned per Bankruptcy Code § 365 over the creditor's objection.
The answer is: this contract is not a § 365 executory contract. First, the agreement lacks the mutuality of obligation required to constitute a § 365 executory contract. Second, en banc law of the circuit confirms it is not executory. Third, it is a contract to extend financial accommodations to the debtor that § 365(c)(2) excludes from assumption and assignment.
The fact the proposed assumption comes by way of the Ninth Circuit Appellate Mediation Program does not alter the equation.
The motions to assume the contract and to approve the compromise are both DENIED. The contract is not an executory contract that can be assumed and assigned. The compromise flunks the governing "fair and equitable" test because probability of success in litigation of the § 365 assumption/assignment question is zero and because the creditor holding more than 82.5% of the unsecured debt in the chapter 11 case objects.
Parties
The contestants are chapter 11 debtor Svenhard's Swedish Bakery, United States Bakery (USB), which acquired the Svenhard's business, and the Bakery & Confectionery Union & Industry International Pension Fund (Pension Fund).
The Pension Fund filed a proof of claim for $45,967,500.92 based on withdrawal liability occasioned by Svenhard's termination, allegedly at USB's direction and supervision, of its bakery operations in Oakland, California.
For convenience, the claim is described herein as $46+ million and uses the term "withdrawal liability" to conflate the withdrawal and contribution liabilities. The $45,967,500.92 proof of claim as of the December 19, 2019, case filing reflects a "withdrawal liability" and a "contribution liability" plus accrued interest. The "withdrawal liability" is $39,629,322.96, plus interest at a rate prescribed by PBGC regulations from May 1, 2016. The "contribution liability" is $563,106.39, plus accrued interest. Complaint, ¶¶ 48 & 56, Board of Trustees of the Bakery and Confectionery Union and International Union Pension Fund v. United States Bakery, Mountain States Bakeries LLC, Central California Baking Company, (filed 11/10/20), No. 1:20-cv-01587-DAD-BAM, U.S. Dist. Ct. E.D. Cal.; transferred to D. Or., note 3 infra. Dkt. 493.
Svenhard's is suing USB on eight counts based on USB's acquisition of Svenhard's and its termination of Svenhard's business: (1) Successor Liability; (2) Breach of Fiduciary Duty; (3) Aiding and Abetting Breach of Fiduciary Duty; (4) Fraud; (5) Conversion; (6) Rescission; (7) Violation of California Business & Professions Code § 17200 ; and (8) Equitable Subordination.
Svenhard's Swedish Bakery v. United States Bakery; Mountain States Bakeries LLC; Central California Baking Company; Murrey R. Albers; Michael Petitt; and Kenneth Hall, U.S. Dist. Ct. D. Or. No. 20-cv-01454-SI. It was filed in this court as Adv. No. 2020-1029. The reference was withdrawn and the civil action transferred to the District of Oregon.
The Pension Fund is suing USB and two USB subsidiaries on a theory of successor liability to collect Svenhard's unpaid pension obligations under ERISA and 29 U.S.C. § 1392.
Note 1, supra. Now pending in the U.S. District Court for the District of Oregon as No. 3:21-CV-00617-SI.
Also pending is Ninth Circuit appeal No. 21-16991 from the District Court's dismissal of USB's appeal from this court's denial of USB's motion to convert the chapter 11 to chapter 7. The District Court ruled it lacked jurisdiction because USB did not obtain leave to appeal the interlocutory order.
Through appellate mediation, from which the Pension Fund was excluded, USB and Svenhard's agreed to make peace by way of Svenhard's assuming the defaulted discounted payment agreement with the Pension Fund for which USB would make the payments.
The full terms of the settlement included: (1) Entry of a final, non appealable order assuming and assigning the discounted payment agreement to USB as a valid and subsisting contract; (2) USB funds the amount to cure the default on the agreement; (3) USB pays the debtor $3,000,000; (4) USB forfeits all rights and claims to assets of the debtor's estate; (5) Debtor and USB will dismiss with prejudice Adv. No. 20-01030, 9th Circuit Case No. 21-16991, and Oregon District Court Case No. 20-cv-01454-SI; (6) USB withdraws Proof of Claim No. 54; and (7) Mutual releases.
These motions ask this court to ratify that treaty.
Debtor's Motion to Approve Settlement Agreement With United States Bakery Pursuant to Federal Rule of Bankruptcy Procedure 9019, DC No. DT-061, Dkt 459; Debtor's Motion to Assume and Assign Settlement Agreement With Confectionery Union and Industrial Pension Fund, DC No. DT-062, Dkt 461.
Facts
USB acquired the Svenhard's bakery business in a multi-year creeping acquisition beginning in 2014, featuring multiple transactions with lease-backs and license-backs that permitted operations to continue in the Svenhard's name.
In 2015, allegedly at USB's direction, Svenhard's operations were moved from Oakland, California, to Exeter, California, where Svenhard's continued to operate under a lease-back from USB.
The relocation to Exeter occasioned termination, effective December 4, 2015, of a collective bargaining agreement with Local 125 of the Bakery, Confectionery, Tobacco Workers & Grain Millers International Union according to which Svenhard's was required to contribute to the ERISA-qualified Pension Fund.
Svenhard's Partnership, L.P., was a signatory but has disappeared from the dispute for unexplained reasons.
The Pension Fund notified Svenhard's, pursuant to 29 U.S.C. § 1399, there was an accrued Withdrawal Liability said to be $50,150,043, payable in monthly installments of $162,941. In addition, there was a Delinquent Contribution Liability of $514,847.67 on account of severance and accrued vacation.
Svenhard's did not timely request review of the assessment of Withdrawal Liability pursuant to 29 U.S.C. § 1399. Hence, the full amount became due and owing.
Svenhard's pled poverty and eventually persuaded the Pension Fund to agree to a discount on the uncontested liabilities based on Svenhard's supposed financial condition.
A discounted payment agreement encompassing both Withdrawal Liability and Contribution Liability was executed April 15, 2019, between the Pension Fund and Svenhard's requiring monthly payments totaling $21,080.80.
The terms for the Withdrawal Liability, stated in the agreement as $39,105,840, provided for Svenhard's to make 240 monthly payments of $ 12,500/month (i.e. a total of $3,000,000), upon completion of which the entire $39,105,840 (plus interest from May 1, 2016) would be discharged.
The $3,000,000 discounted Withdrawal Liability could be prepaid at any time by paying all remaining monthly installments, discounted to present value at a rate of 5.1%.
The Delinquent Contribution Liability payment agreement capitalized interest accrued as of the date of the agreement and provided for Svenhard's to pay $598,482.96 at a rate of $8,580.80 per month, amortizing the debt at a rate of 5.25% until paid in full, which could be by prepayment of the unamortized amount. If all required discounted payments of the Withdrawal Liability were not made, then the full non-discounted amount (stated as $39,105,840) would be due with interest at rates prescribed by Pension Benefit Guaranty Corporation regulations calculated from May 1, 2016, with credit only for amounts actually paid.
If all required payments on the Delinquent Contribution Liability were not timely paid, then the entire unamortized amount of that liability would be due with interest at 5.25%.
Paragraphs 12 and 14 of the discounted payment agreement provided for separate releases to be provided to Svenhard's "upon full payment of the amounts" required for the Withdrawal Liability and the Delinquent Contributions Liability.
Svenhard's made the first six $21,080.80 payments (June-November 2019) under the discounted payment agreement.
In November 2019, USB terminated its lease-back to Svenhard's and took control of Svenhard's commercial bakery operations, as well as possession of Svenhard's facilities.
USB's termination of the Svenhard's leaseback had the effect of starving Svenhard's of the ability to make the $21,080.80 payment due December 1, 2019.
The Pension Fund declared a default on December 13, 2019, on the $3,000,000 discounted payment agreement and gave five business days in which to cure the default.
Svenhard's filed its chapter 11 case on December 19, 2019, one day before the cure period expired. The filed proofs of claim total $69,247,970.68 ($10,612,005.58 secured; $2,965,396.05 priority; $55,670,569.05 unsecured).
No payment has been made on the discounted payment agreement since November 2019.
As noted, Svenhard's and the Pension Fund have separate civil actions pending against USB in the District of Oregon.
Jurisdiction
Jurisdiction is founded on 28 U.S.C. § 1334(a). A motion to approve a compromise is a core proceeding for a Bankruptcy Judge to hear and determine. 28 U.S.C. § 157(b)(2).
Analysis
These are motions to assume the defaulted discounted payment agreement and to approve as "fair and equitable" a compromise premised on the proposed assumption. The compromise standards provide the framework for analysis, but the central issue is whether the transaction is permitted by the Bankruptcy Code.
I. Compromise Must Be "Fair and Equitable"
A compromise must be "fair and equitable" taking into account four factors: (1) probability of success in litigation; (2) difficulties, if any, in matter of collection; (3) complexity of litigation involved and expense, inconvenience, and delay necessarily attending it; and (4) the paramount interest of the creditors and a proper deference to their reasonable views in the premises. E.g., Martin v. Kane (In re A&C Properties), 784 F.2d 1377, 1380 (9th Cir. 1986).
Here, the questions of collectability and of obviating complexity, expense, inconvenience and delay are overshadowed by the questions of the legal merits of what is proposed and of the expressed interest of creditors.
II. Probability of Success in Litigation
The first crucial "fair and equitable" factor is probability of success in litigation. The answer turns on whether the discounted payment agreement is an "executory" contract that may be assigned and assumed pursuant to § 365.
Despite the number of zeroes involved, the terms of the discounted payment agreement are commonplace. Courts routinely encounter compromises according to which a large sum, either claimed or already adjudged, will be deemed fully paid on the condition that a smaller sum is paid by a time or times certain.
From 10,000 feet, Bankruptcy Code § 365 (Executory Contracts and Unexpired Leases) is deceptively simple.
The trustee, subject to the court's approval, may assume or reject an executory contract. 11 U.S.C. § 365(a).
The trustee, with stated exceptions, may assign an executory contract that has been assumed. 11 U.S.C. § 365(f)(1).
A. Is the Agreement Proposed For Assumption Executory?
The Bankruptcy Code does not define "executory contract." The absence of a precise definition has bedeviled courts since enactment of the Bankruptcy Code of 1978.
The Supreme Court has noted that the term executory contract was intended to mean a contract on which performance remains due to some extent on both sides, but it has not provided more helpful guidance. NLRB v. Bildisco & Bildisco, 465 U.S. 513, 522 n.6, 104 S.Ct. 1188, 79 L.Ed.2d 482 (1984) (dictum).
A leading approach to the meaning of executory contract is that of Professor Vern Countryman, which holds that the obligations of both parties must be so far unperformed that failure of either party to complete performance would constitute a material breach and thus excuse the performance of the other party. Vern Countryman, Executory Contracts in Bankruptcy: Part 1, 57 MINN. L. REV. 439, 460 (1973).
There are approaches other than the Countryman analysis. There is a functional test and an exclusionary approach. Jay L. Westbrook & Kelsi Stayard White, The Demystification of Contracts in Bankruptcy, 91 Am. Bankr. L.J. 481, 491-95 (2015) ; Jay L. Westbrook, A Functional Analysis of Executory Contracts, 74 Minn. L. Rev. 227, 282-85 (1989) ; Michael T. Andrew, Executory Contracts Revisited: A Reply to Professor Westbrook, 62 Colo. L. Rev. 1 (1991); Am. Bankr. Inst. Comm'n to Study Reform of Chapter II, 23 AM. BANKR. INST. L. REV. 1, 121-25 (2015).
Whether a contract is "executory" is a question of fact to be determined by the bankruptcy court. Unsecured Creditors' Committee v. Southmark Corp. (In re Robert L. Helms Construction & Dev. Co.), 139 F.3d 702, 706 n.13 (9th Cir. 1998) (en banc).
After the Supreme Court's 2018 decision in Village at Lakeridge, it may be more accurate to describe the question whether a contract is executory for purposes of § 365 as a mixed question of law and fact as to which facts predominate for which the standard of review is clear error. U.S. Bank Nat'l Ass'n v. Village at Lakeridge, LLC, 583 U.S. ––––, 138 S.Ct. 960, 966-67, 200 L.Ed.2d 218 (2018).
1. Mutuality of Obligation
The Ninth Circuit follows the Countryman test that focuses on mutuality of obligation. Griffel v. Murphy (In re Wegner), 839 F.2d 533, 536 (9th Cir. 1988).
Correlatively, mutuality connotes simultaneity. When a party has substantially performed its side of a bargain, such that the party's failure to perform further would not be a material breach excusing performance by the other party, the contract is no longer executory. Marcus & Millichap Inc. v. Munple, Ltd. (In re Munple, Ltd.), 868 F.2d 1129, 1130 (9th Cir. 1989).
As of the date of the filing of the Svenhard's chapter 11 petition, the discounted payment agreement nominally had obligations remaining on both sides. Svenhard's obligation was immediate and precise, with timely payment being of the essence. The Pension Fund's obligation was contingent on prior full performance by Svenhard's of its side of the bargain.
The narrow question is whether the mutual obligations were so far unperformed that the failure by either party to perform would constitute a material breach excusing performance by the other party. Commercial Union Ins. Co. v. Texscan Corp. (In re Texscan Corp.). 976 F.2d 1269, 1273 (9th Cir. 1992).
a. Materiality
Materiality of the remaining obligation is a question of state law. Texscan, 976 F.2d at 1272 ; Wegner, 839 F.2d at 536.
The choice of law provision in the discounted payment agreement selects the law of the state of Maryland.
Under Maryland law, a breach is material if it affects the purpose of the contract in some important or vital way. In re Cho, 581 B.R. 452, 462-63 (Bankr. D. Md. 2018) (citing cases).
Under the terms of the agreement in question, the Pension Fund has no present duty that is unperformed. Rather, its obligation to execute a release is contingent on prior full performance by Svenhard's of a contractual obligation as to which time was of the essence. The Pension Fund need do nothing to avoid a material breach.
Accordingly, at the time of the chapter 11 filing, the Pension Fund had no obligation to perform and needed to do nothing to avoid being in breach. As the time that was of the essence to the contract has now long since lapsed, under Maryland law the Pension Fund is not capable of a material breach.
b. Excuse Performance
A contract is not executory when either party has substantially performed an obligation such that failure to perform further would not constitute a material breach by the other party. Munple, 868 F.2d at 1130.
The structure of the requirement that Svenhard's have substantially performed by paying in full before a release was required is significant.
If the Pension Fund were to refuse to honor its obligation to execute a release after receiving full payment, there would be no performance remaining due from Svenhard's to be excused. The Pension Fund's obligation matures only after Svenhard's has already fully performed.
The parties do not mention Munple. They argue that the fact that separate releases required for the contribution and withdrawal liabilities mean that one could precede the other makes the contract executory. This court is not persuaded that the Ninth Circuit's Munple analysis is so easily circumvented.
Under Munple, such a contract is not executory.
2. Ninth Circuit En Banc Decision in Helms
The Ninth Circuit's en banc decision in Helms confirms this court's analysis that the discounted payment agreement, which is contingent on prior full performance by the debtor, is not a § 365 "executory contract."
As noted, the question whether a contract is "executory" is a question of fact for the bankruptcy court to determine. Helms, 139 F.3d at 706 n.13. Under Helms, the question is whether at the time of filing, "does each party have something it must do to avoid materially breaching the contract?" Helms, 139 F.3d at 706.
The answer in this instance, as a question of fact, is "no." On the day of filing, the Pension Plan did not have to do anything to avoid materially breaching the contract. Its obligation was a condition contingent on future completion of full performance by Svenhard's according to the agreed schedule.
Performance of a duty subject to a condition cannot become due unless the condition occurs or its non-occurrence is excused. Restatement (Second) of Contracts § 225(1) (1981).
This court determines as a matter of fact, that the deferred payment agreement is not a § 365 executory contract. Hence, the agreement cannot be assumed and assigned pursuant to § 365.
3. Financial Accommodation Contracts under § 365(c)(2)
Even if it were to be concluded that the discounted payment agreement does qualify as a § 365 executory contract, there nevertheless remains a fatal flaw.
The essence of the discounted payment agreement to accept $3 million on account of the $46+ million withdrawal liability is the provision to Svenhard's of a financial accommodation premised on its alleged inability to pay the full liability.
Executory contracts to provide financial accommodations to or for the benefit of the debtor are excluded by § 365(c)(2) from eligibility for assumption and assignment.
Financial accommodations are extensions of money or credit for the benefit of the debtor. Transamerica Comm'l Fin. Corp. v. Citibank, N.A. (In re Sun Runner Marine. Inc.). 945 F.2d 1089, 1092 (9th Cir. 1991).
Financial accommodations may include prepetition workout agreements. In re Prosser, 388 F. Appx. 100 (3d Cir. 2010), aff'g 2008 WL 2275397 (D.V.I. 2008) ; Steele v. Boutiette (In re Boutiette), 168 B.R. 474, 481 (Bankr. D. Mass. 1994) ;
The deferred payment agreement is an accommodation allowing Svenhard's to pay a sum of money over time that is a fraction of the total liability. It benefits Svenhard's by enabling the discharge of a much larger liability. Hence, it is a financial accommodation for purposes of § 365(c)(2).
In short, as a matter of law, § 365(c) (2) dictates that the movant's proposed assumption of the deferred payment agreement is dead on arrival.
4. No Executory Contract Capable of Assumption
In sum, the discounted payment agreement in question is, as a matter of fact, not an "executory contract" within the meaning of § 365. Even if it were to be deemed executory, the nature of the agreement as a financial accommodation, as a matter of law dictated by § 365(c)(2), prevents Svenhard's from assuming and assigning it.
It follows that the probability of success in litigation seeking to assume and assign the discounted payment agreement is doomed to failure. On this count alone, the mediated result is not a "fair and equitable" compromise.
III. Views of Creditors
The views of creditors and a proper deference to their reasonable views in the premises also loom large in considering whether the proposed settlement is "fair and equitable."
The Pension Fund, which holds more than 82.5% of the unsecured debt in the case, objects to the assumption and assignment of its discounted payment agreement.
The reasonableness of the Pension Fund objection may be measured, first, by the obvious merit of the objector's argument that the subject contract is not an "executory contract" for purposes of § 365.
Second, in the related civil actions aimed at establishing successor liability the exposure of the role of USB suggests that the Pension Fund has a meritorious basis for questioning the validity of the discounted payment agreement in the first place.
Since approving the compromise might affect issues in those civil actions before they are decided on the merits, the Pension Fund is taking a reasonable position that the compromise coming from a mediation that excluded the Pension Fund is a subterfuge designed to frustrate meritorious litigation.
The Committee of Unsecured Creditors supports the settlement. It reasons that it is caught in the middle of the Pension Fund-USB dispute, that Svenhard's may not prevail in its lawsuit against USB, that it will not be possible to fund a chapter 11 plan if the two civil actions in the District of Oregon drag on, and that the litigation could last for a long time. There is considerable practical common sense in this view from the holders of a small fraction of the unsecured debt, nevertheless it is a distinctly minority view.
Joinder and Separate Statement of Committee of Unsecured Creditors Regarding Continued Hearing on Debtor's Motion to Assume and Assign Settlement Agreement and Motion to Approve Compromise, at 2-4. Dkt. 518.
Balancing the competing positions of the respective creditor blocs, this court is persuaded that a reasonable deference to the views of the holder of more than 82.5% of the unsecured debt counsels that the mediated result is not a "fair and equitable" compromise.
This conclusion deferring to the reasonable views of creditors means that the compromise flunks the "fair and equitable" test regardless of whether the discounted payment agreement may be assumed and assigned.
IV. No Decision whether Contract "Valid and Subsisting"
The court is also asked to determine that the discounted payment agreement is a "valid and subsisting" contract.
USB says that the determination of a "valid and subsisting" contract is an essential term of the compromise and that without a binding determination on that account there is no deal. It is apparent USB's strategy is to wipe out the Pension Fund's $46+ million claim that is being asserted in the District Court litigation in Oregon.
Specifically: "USB cannot agree to pay the Debtor $3,000,000 unless it receives the assignment of a valid and subsisting contract that is binding and enforceable on the parties and which is no longer subject to attack in this or any other proceeding." Creditor United States Bakery's Response to Bakery & Confectionery Union & Industry International Pension Fund's Opposition to Debtor's Motion to Approve Settlement Agreement and Motion to Assume and Assign Settlement Agreement, at 2. (emphasis supplied) Dkt. 495. That "any other proceeding" is, of course, the Pension Fund's civil action in Oregon. Sly.
E.g., USB: "upon assumption and assignment there will no longer be a Pension Fund claim to adjudicate in the bankruptcy proceeding because USB will have assumed all those obligations." Id. Dkt. 495.
The Pension Fund objects that judicial resolution of the question of the "validity" of the contract would be premature. The Pension Fund notes that information has surfaced during the course of the litigation regarding the undisclosed role of USB in negotiations with the Pension Fund that, if true, suggests the agreement may have been infected by misrepresentations about Svenhard's finances that may provide a meritorious basis to renounce the 93% discount to which it agreed in the discounted payment agreement.
It is not essential to the § 365 contract assumption question that there be a determination regarding enforceability of the subject contract.
The judicial determination that a contract may be assumed or rejected under § 365 does not necessarily launder the contract of all defenses and excuses to performance that are otherwise available to the parties. Durkin v. Benedor Corp. (In re G.I. Indus., Inc.), 204 F.3d 1276, 1280-82 (9th Cir. 2000).
Furthermore, it is procedurally incorrect to embed a "valid and subsisting" determination in a motion to assume or reject a contract. Diatom, LLC v. Committee (In re Gentile Family Indus.), 2014 WL 4091001, *5 (9th Cir. BAP 2014) ("validity of a contract, if disputed, cannot be determined in the context of a motion to assume or reject. An adversary proceeding is required.").
If this court is to decide the question whether the contract is "valid and subsisting," it must do so in an adversary proceeding governed by ordinary adversary proceeding civil litigation rules, rather than summary claims procedure. The debtor, for example, could file a complaint for a declaratory judgment that the contract is "valid and subsisting" against which the Pension Fund could defend or counterclaim. Or, the Pension Fund could file its own complaint.
This court is ready, willing, and able to entertain such an adversary proceeding but must leave such a filing to the genius of counsel.
* * *
Conclusion
It is no small irony that USB now wants a determination that the contract agreeing to a 93% discount of the withdrawal liability remains enforceable.
USB's actions in November 2019 terminating Svenhard's business operations stripped Svenhard's of the source of funds to continue to comply with the discounted payment agreement. If USB had done then what it now proposes three years later, there likely would be no issue because the discounted payment agreement would have continued to be performed as agreed and on schedule.
USB could have provided funds to maintain the Pension Fund payments so Svenhard's could continue to perform its side of the bargain. Instead, it was USB's reflexive hardball strategy of resistence to the chapter 11 case that triggered the Pension Fund default and provoked Svenhard's adversarial attack on USB, which had the incidental consequence of belling the proverbial cat as to facts that have exposed USB to successor liability claims.
Although settlement of the various disputes regarding USB's acquisition of Svenhard's without burdensome trials may be desired as a matter of judicial policy, the mediated compromise presented to this court is not adequate to the task.
The motions to approve the compromise and to assume and assign discounted payment agreement are DENIED.
Separate orders will issue.