United States: In Head-To-Head Contest Between Separate Debtors In Bankruptcy, Right To Reject Executory Contract Prevails

Last Updated: August 10 2016
Article by Joseph A. Florczak

A recent dispute in the U.S. Bankruptcy Court for the Eastern District of Missouri addressed a somewhat novel question of bankruptcy law: What is the proper standard of review when a debtor in a chapter 11 case wants to reject a contract with a counterparty that is also a chapter 11 debtor in a different bankruptcy court and that wishes to assume the same contract? According to the court in In re Noranda Aluminum, Inc., 549 B.R. 725 (Bankr. E.D. Mo. 2016), the "business judgment" standard applies to determine whether rejection should be authorized, rather than a "balancing of the equities" test.

A Sales Contract Burdensome to One Debtor and Essential to Another

The treatment of a long-term sales contract for bauxite used in the initial phases of aluminum manufacturing was the central issue in this duel of competing bankruptcy cases. Noranda Bauxite Ltd. ("NBL") is a debtor affiliate of Noranda Aluminum, Inc. ("Noranda") in their jointly administered chapter 11 cases in the Eastern District of Missouri.

NBL is a Jamaican company whose principal business is the operation of a bauxite mine in Discovery Bay, Jamaica. Bauxite is the principal raw material used in the refining and manufacture of aluminum primary-metals products. NBL's operations provided substantially all the bauxite used in Noranda's upstream primary-metals business, as well as bauxite for sales to third-party metal producers. Among NBL's principal third-party customers was Sherwin Alumina Company, LLC ("Sherwin").

Sherwin's principal business is the operation of a facility to refine bauxite in Gregory, Texas (the "Gregory Facility"). The Gregory Facility is intentionally located on the Gulf of Mexico to facilitate easy access to bauxite mined in Jamaica. The facility was also designed and engineered for the particular features of Jamaican bauxite, which requires more energy and specific processes than bauxite mined in other locations.

In December 2012, NBL and Sherwin entered into a long-term sale-purchase agreement by which Sherwin would purchase bauxite from NBL through 2018 (the "Bauxite Contract"). Under the terms of the Bauxite Contract, Sherwin would purchase bauxite from NBL at a price indexed to Mineração Rio do Norte ("MRN"), a floating reference point that is pegged to the market price for bauxite set by the largest Brazilian bauxite producer. Reflecting the additional effort required to refine Jamaican bauxite as compared to other sources, NBL agreed to a sales price of 73 percent of MRN.

Sherwin viewed the Bauxite Contract as essential to its business viability. The Bauxite Contract provided 65 percent of the total bauxite used in Sherwin's operations. Moreover, Sherwin viewed obtaining bauxite from different sources as wholly impractical, given the location of its operations on the Gulf Coast and because the Gregory Facility is specially engineered to refine Jamaican bauxite. Sherwin estimated that obtaining bauxite from an alternative source might be 50 percent more expensive, not including an estimated $10 million to retool the Gregory Facility to process non-Jamaican bauxite. In brief, without the Bauxite Contract, Sherwin judged that it would likely have to cease operations, which would likely result in the loss of more than 1,000 jobs on the Texas Gulf Coast.

In contrast, NBL viewed the Bauxite Contract as economically burdensome. NBL's cost per ton to mine, process, and transport the bauxite from its Jamaican mines exceeded the sale price. In other words, NBL lost money on every ton of bauxite that it shipped under the terms of the Bauxite Contract with Sherwin. In addition, the terms of NBL's chapter 11 debtor-in-possession ("DIP") financing agreement required NBL to reject the Bauxite Contract. Although NBL did not view the rejection of the Bauxite Contract as a central component of its restructuring, the company determined that rejection of the contract might allow NBL to enter into a new agreement with Sherwin or another third-party buyer at more favorable rates.

Sherwin filed for chapter 11 protection in January 2016 in the Southern District of Texas. In the first days of its bankruptcy case, given the importance of the Bauxite Contract to its operations, Sherwin moved to assume the Bauxite Contract pursuant to section 365 of the Bankruptcy Code. Less than a month later, in February 2016, NBL filed its own chapter 11 case. Contending that the Bauxite Contract was economically unfavorable, NBL sought court authority to reject the Bauxite Contract. Accordingly, the conflicting motions set up a duel between the two chapter 11 cases.

Assumption and Rejection Under Section 365 of the Bankruptcy Code

Under section 365 of the Bankruptcy Code, a bankruptcy trustee or DIP may, among other things, "assume" or "reject" executory contracts or unexpired leases (agreements with respect to which material obligations remain for each contract party). Generally speaking, the assumption of an executory contract or unexpired lease restores the terms and enforceability of the agreement, provided that any defaults under the agreement are cured, among certain other conditions. In contrast, the rejection of an executory contract operates as a deemed breach of the contract effective immediately before the filing of the bankruptcy petition, with the nonbreaching counterparties receiving prepetition damages claims on account of such rejection in the bankruptcy case.

The underlying policy consideration of this framework is to allow a trustee or DIP to maximize the value of the bankruptcy estate by assuming contracts that are beneficial to the bankruptcy estate and rejecting contracts that pose an economic burden to the estate.

The Business Judgment Standard

In nearly every circumstance, a bankruptcy court will evaluate a decision by a trustee or DIP to assume or reject a contract according to the "business judgment" standard. Under this deferential standard, the court will not substitute its own judgment so long as the decision reflects a rational business purpose and lacks any indicia of fraud, insider dealing, or other forms of abuse.

In the Eighth Circuit, which encompasses the district where Noranda's chapter 11 case is pending, the business judgment standard has two prongs: the assumption or rejection must (i) be in the exercise of sound business judgment, showing benefit to the estate; and (ii) not involve bad faith or gross abuse of business discretion. See In re Crystalin, L.L.C., 293 B.R. 455 (B.A.P. 8th Cir. 2003).

Balancing of the Equities Test

In its objection to NBL's motion to reject the Bauxite Contract, Sherwin argued that a "balancing of the equities" test should be applied in cases where one chapter 11 debtor seeks to assume a contract which another chapter 11 debtor seeks to reject, citing the 1980s-era decisions in In re Midwest Polychem, Ltd., 61 B.R. 559 (Bankr. N.D. Ill. 1986); In re H.M. Bowness, Inc., 89 B.R. 238, 242 (Bankr. M.D. Fla. 1988); and In re Sun City Investments, Inc., 89 B.R. 245, 249 (Bankr. M.D. Fla. 1988). Under this test, Sherwin argued, the court should balance the relative benefits and/or harms to each of the bankruptcy estates that would be caused by assumption or rejection of the contract at issue. Using such a framework, Sherwin maintained, a court could properly deny rejection of a contract if rejection would "mortally wound" the business of one chapter 11 debtor and produce only a marginal benefit for the other chapter 11 debtor.

The Bankruptcy Court's Ruling—The Business Judgment Test Prevails

The Noranda Aluminum bankruptcy court declined to adopt the balancing of the equities test, noting that the cases applying it were neither current nor binding precedent. Moreover, the court observed that the Midwest Polychem court did not choose between the business judgment standard and the balancing of the equities test, as that court's determination was the same under either standard. The Noranda Aluminum court also noted that a careful reading of H.M. Bowness and Sun City indicates that those courts actually applied the business judgment standard.

The Noranda Aluminum court also rejected Sherwin's arguments in the alternative, asserting that application of the business judgment standard in this "extreme case" would require consideration of the potential impact on the contract counterparty in certain exceptional circumstances. The court acknowledged that a higher standard may apply when a debtor's authority to reject a contract would conflict with "policies designed to protect the national interest underlying federal regulatory schemes." However, it found that no such interests were implicated in NBL's proposed rejection of the Bauxite Contract. According to the court, the Bankruptcy Code creates special protections for certain types of executory contracts or unexpired leases, including intellectual property license agreements (section 365(n)), collective bargaining agreements (section 1113), aircraft leases (section 1110), and railroad line leases (sections 1165 and 1169), none of which the Bauxite Contract implicated.

Outlook

Despite the court's professed sympathy for Sherwin's plight, its analysis in Noranda Aluminum adheres closely to the long-established principles and policy rationale of the business judgment rule. The court flatly rejected the argument that a court must consider the impact of the rejection of a contract on the contract counterparty, at least under the circumstances presented. The ruling suggests that, in competing bankruptcy cases, a trustee or DIP's right to reject an executory contract or unexpired lease as an exercise of business judgment trumps the desire of a different trustee or DIP to assume the same contract.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.