A case decided by a federal bankruptcy court in Massachusetts reinforces the principle that executory contracts must be explicitly assumed by the debtor—and approved by the court.

Even in instances in which the debtor continues to receive and benefit from services provided, the provider may not claim that acceptance of and payment for such services constitutes an implied assumption of the contract, the court held in Gray v. Western Envtl. Servs. & Testing, Inc., et al., 352 B.R. 546 (Bankr. D.Mass. 2006).

Further, because the contracts at issue were not assumed, the estate also could bring a preference action to recover payments made by the debtor.

The five defendants in the case were subcontractors of the debtor. The debtor filed a petition for relief under chapter 11, as did several of the debtor’s subsidiaries. The cases were consolidated, and the debtor filed a motion for authority to sell substantially all of its assets, consisting of several lines of business. The sale motion was approved, an auction was held, and two winning bidders purchased the debtor’s business.

Both sale agreements were drawn up as "As Is" transactions. At the sale hearing, the court instructed the debtor to file a motion to assume and assign the executory contracts and/or leases that the winning bidders wished to purchase as part of the sale. The only contracts so designated were real property leases. No additional executory contracts were identified in the sale order.

However, the winning bidders continued to do business with the defendants. The defendants provided services to the purchaser businesses, which continued to compensate the defendants.

The chapter 11 plan administrator brought adversary actions against the five defendants, seeking to have payments made within 90 days of the bankruptcy filing avoided as preferential payments on the grounds that the contracts never had been assumed, either as part of the sale or through a court order.

The defendants argued that the sale motion and sale order "effectively" worked an assumption of their contracts. Because the Bankruptcy Code requires an assumption of executory contracts before they may be assigned to third parties, the defendants argued that the sale of their contracts necessarily required a prior assumption. They further argued that the failure to formally assume the contracts was an oversight, and that the debtor intended to assume the contracts but neglected to file the appropriate motion.

The defendants also argued that the value the estate received from the sale reflected the value of the defendant’s contracts as if they had been assumed and assigned.

In the alternative, the defendants argued that they did not receive appropriate notice of the sale, and as a remedy for the lack of notice, the court should order a retroactive assumption of the contracts.

The plan administrator argued that the lack of notice did not warrant the retroactive assumption of the contracts. Instead, the defendants could receive an extension for filing claims arising from the rejection of their contracts, he argued.

The bankruptcy court noted, "It is well-established that the doctrine of ‘implied assumption’ has little, if any merit." Thus, even in instances in which a nondebtor continues to provide services under the contract, and the debtor continues to accept the benefits of such services, the contract is not considered to have been assumed absent court approval.

"Under First Circuit case law and the view of the overwhelming majority of courts from other jurisdictions, the Defendants’ contracts were not assumed, as there has been no request for, and no court approval of, an assumption of their contracts," concluded the court.

Hence, the payments received by the defendants "like so many other parties who received pre-petition payments from the Debtor," were subject to preference avoidance, concluded the court.

The ruling is a reminder to creditors that continued performance on a contract does not constitute assumption, and that creditors may be exposed to preference actions. Thus, in the event a contract is to be assumed, it can only be done through motion and entry of a court order.

This article is presented for informational purposes only and is not intended to constitute legal advice.