Among the many tools the Bankruptcy Code provides a debtor in
bankruptcy is the ability to assume and reject executory contracts
and unexpired leases. This powerful tool is not without
limits, however. Among other things, it is an "all or
nothing" proposition—a debtor must assume or reject the
entire agreement. It cannot assume or reject only portions of the
agreement. This rule ensures that a debtor must assume or reject
the benefits of the contract with the burdens, "cum
onere."
Though simple in theory, application of this principle can become
complicated where the relationship between a customer and vendor is
actually governed by a number of related agreements. It is not
uncommon for commercial parties to have a relationship governed by
a "master agreement" and related license, leasing,
maintenance, operating, and other similar agreements. The
recent case of In re Physiotherapy Holdings, Inc., No.
13-12965 (Bankr. D. Del.), highlights the risks to intellectual
property rights when a debtor requests that a bankruptcy court
treat each of the related agreements separately for purposes of
assumption and rejection.
In In re Physiotherapy Holdings, Inc., Judge Gross of the
United States Bankruptcy Court for the District of Delaware allowed
the debtor to assume a license agreement while simultaneously
rejecting other agreements with the licensor. The licensor
objected on the grounds that the contracts were all a single,
integrated agreement—but the court effectively permitted the
debtor to keep the one contract that was valuable to it, and to
disavow the rest of the agreements.
The Context: A License Related to a Master
Agreement
In January 2011, Physiotherapy Holdings, Inc. and its affiliates
(the "Debtors")—providers of outpatient physical
therapy services—hired Huron Consulting Services LLC
("Huron"), a healthcare consulting company, to assess
opportunities for improving their revenue cycle. In connection
with that engagement, in 2011 and 2012, the Debtors and Huron
entered into various agreements (the "Huron Agreements"),
including a "Master Agreement" and a "License
Agreement." Pursuant to the License Agreement, Huron
granted the Debtors the right to use certain computer software
necessary to the Debtors' billing and collection
activities. Also of note, although the License and Master
Agreements each contained provisions requiring the Debtors to
indemnify Huron, the indemnity under the Master Agreement was much
broader than under the License Agreement.
The Debtors filed a chapter 11 petition in November 2013 and, in
December 2013, the Debtors' chapter 11 plan was
confirmed. Pursuant to the plan, the Debtors and Huron agreed
to defer disputes over the treatment of the Huron Agreements in the
bankruptcy case—including the Debtors' rights to assume
or reject the Agreements—until after plan
confirmation. Among other things, the plan also transferred
potential claims that the Debtors had against Huron to a litigation
trust. Huron was planning to seek indemnity from the Debtors
for those claims pursuant to the broad indemnity provisions in the
Master Agreement.
Shortly after confirmation of the chapter 11 plan, the Debtors
filed a motion to assume the License Agreement and reject all of
the other Huron Agreements, including the Master
Agreement. Huron objected, arguing that the Debtors could not
assume the License Agreement without also assuming the other Huron
Agreements.
The Bankruptcy Court's Decision: Separate Contracts,
Separate Assumption and Rejection
Last month, Judge Gross issued an opinion granting the Debtors'
motion.
The court first addressed two threshold matters. The court
determined that the Debtors' assumption of the License
Agreement and rejection of the other agreements was a sound
exercise of their business judgment—the standard for
assumption or rejection of a contract under section 365 of the
Bankruptcy Code. With respect to assumption of the License
Agreement, the court pointed to the Debtors' assertion that the
software licensed under the License Agreement was necessary for the
continued operation of their business, at least in the short
term,1 and to the fact that because the Debtors had
already paid their obligations under the License Agreement in full,
assumption would not require cure or result in an administrative
claim against the estate. With respect to the Debtors'
decision to reject the other Huron Agreements, the court noted that
"[i]ndemnifying Huron," as might be required under one or
more of the agreements, "would be prohibitively expensive for
Debtors." Slip. Op. at 5. In short, one contract had
to be assumed for the Debtors to be successful, and the other
contract had to be rejected to prevent the Debtors from
failing—assumption or rejection of both contracts was not
practicable if the Debtors were to reorganize.
Second, the court determined that the License Agreement was
generally of a type that was assumable by the Debtors. Huron
had argued that, pursuant to intellectual property law and section
365(c) of the Bankruptcy Code, the Debtors could not assume the
License Agreement without Huron's consent—which Huron had
not given. The court rejected Huron's argument and relied
on a provision in the License Agreement, which it interpreted to
expressly permit assignment of the Agreement in the event of
bankruptcy by the Debtors. The court explained that
"[t]he law is well settled in this Circuit that the right to
assign by necessity creates the right to assume." Slip. Op. at
7 (citing In re Midway Airlines, Inc., 6 F.3d 492, 497
(7th Cir. 1993)). Because the License Agreement reflected
Huron's prior consent to assignment, it could
necessarily be assumed by the Debtors.
The court then turned to the central issue: whether the
Debtors could assume the License Agreement while simultaneously
rejecting the other Huron Agreements. The court noted that, in
light of the potential indemnity obligations, the issue was
"of great financial importance to Debtors and
Huron." Slip. Op. at 7.
Huron relied on the well-established bankruptcy principle of
"assumption cum onere," meaning that if a debtor
assumes a contract, it must do so in its entirety—it cannot
chose to assume the benefits without also assuming the
burdens. It argued that the License Agreement and the Master
Agreement were a single, integrated contract and that the terms of
the Master Agreement were integrated into the License
Agreement. As a result, the Debtors could not simultaneously
assume the License Agreement and reject the Master Agreement and
other Huron Agreements. In support, Huron relied on provisions in
the Master and License Agreements containing typical contract
integration language in multi-agreement deals.
The court rejected Huron's position, distinguishing the Huron
Agreements from the agreements found to be integrated in In re
Holland Enterprises, Inc., 25 B.R. 301 (Bankr. E.D.N.C. 1982)
and In re Buffets Holdings, Inc., 387 B.R. 115 (Bankr. D.
Del. 2008). The court first pointed to the indemnity
provisions in the two contracts, noting that the indemnity under
the Master Agreement was broader than under the License Agreement.
It reasoned that "if the Master Agreement and License
Agreement are to be read as a single agreement, there would be no
need for indemnity language in the License Agreement" because
"the broader provisions of the Master Agreement would be
sufficient." Slip. Op. at 11. Second, the court
noted that the agreements were not executed at the same
time.2 Third, the court pointed to language in the
Agreements providing that in the event of a contradiction between
the terms of the Master Agreement and the License Agreement (or one
of the other agreements), "the Master Agreement takes the back
seat." Id. at 13. Finally, the court
explained that the standard integration language in the Master
Agreement did not mean that the License Agreement was a "mere
component" of the Master Agreement; to the contrary, "the
integration clause simply means all of the Agreements between the
parties are reflected in the Agreements as written, thereby
eliminating parol evidence." Id. As a result,
the court concluded the Agreements "do not constitute an
integrated arrangement which the Court should consider
singular." Id.
The Bottom Line
Defining which agreements constitute the executory contract that is
subject to assumption or rejection in bankruptcy is a key step in
determining whether assumption or rejection is
permissible. The decision in Physiotherapy Holdings
demonstrates the importance of that analysis when crucial
intellectual property licenses are at issue in a bankruptcy
reorganization. Indeed, in Physiotherapy Holdings, it is
impossible to ignore the fact that the feasibility of the
Debtors' reorganization plan apparently hinged on their ability
to retain the License Agreement software and reject the
indemnification obligation. According to the Debtors, they
could not operate without the License Agreement software and could
not replace it for six to nine months, and they could not afford to
indemnify Huron. A decision finding that the Debtors could not
separately assume the License Agreement would have apparently
doomed the Debtors' reorganization plan. So, this is a
case where the specific facts put a great deal of pressure on the
issue of contract "integration." But more generally,
the case also serves as a potent reminder that clearly reflecting
the intent of the parties in drafting integration, merger, and
other clauses can be extremely important to the ultimate protection
of intellectual property rights, especially where such rights are
part of client relationships evidenced by multiple agreements.
1 The Debtors were in the process of investigating
alternative software, but it would take a number of months before
any alternative could be implemented to replace the Huron
software.
2 Although the court was correct that not all of the
Huron Agreements were executed at the same time, the License
Agreement and Master Agreement had been executed on the same
date.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.