United States: Kiwi Defense Doesn't Get Off The Ground In Preference Litigation Involving Related, But Severable, Contracts

Among the required elements of a claim to avoid a preferential transfer under section 547(b) of the Bankruptcy Code is that, if the creditor-transferee were permitted to retain a pre-bankruptcy payment, it would end up being paid more than it would receive in a hypothetical liquidation of the debtor under chapter 7, assuming the transfer did not occur. This requirement and a defense to preference liability predicated on it—the "Kiwi defense"—were the subject of a ruling handed down by a Delaware bankruptcy court. In Pirinate Consulting Grp., LLC v. C. R. Meyer & Sons Co. (In re NewPage Corp.), 2017 BL 44198 (Bankr. D. Del. Feb. 13, 2017), the court ruled that, although the Kiwi defense can preclude avoidance of prepetition payments under a series of integrated agreements assumed under a chapter 11 plan, the agreements before it were severable, rather than a single, integrated contract. Because there was no evidence that each individual agreement was executory and thus eligible for assumption, the court denied a motion for summary judgment that the Kiwi defense insulated the transfers from avoidance.

Assumption and Rejection of Executory Contracts and Unexpired Leases

With certain exceptions and subject to various conditions, section 365(a) of the Bankruptcy Code authorizes a bankruptcy trustee or chapter 11 debtor-in-possession ("DIP") to assume, assume and assign, or reject most "executory" contracts or unexpired leases. A contract is generally deemed to be "executory" if material obligations remain to be performed by both parties as of the bankruptcy petition date.

A contract can be assumed only if the DIP or trustee "cures" existing defaults and provides adequate assurance of its future performance or, in the case of assumption and assignment, that of the proposed assignee. If the bankruptcy court authorizes the assumption of a contract or lease, both the cure obligations and any subsequent claims for breach of the assumed agreement are entitled to priority as administrative expenses. By contrast, if the DIP or trustee debtor rejects a contract, claims arising from the rejection will generally be treated as prepetition unsecured claims.

Avoidance of Preferential Transfers: The Kiwi Defense

Section 547 of the Bankruptcy Code permits a trustee or DIP to avoid preferential transfers. A transfer made by a debtor to or for the benefit of a creditor on account of an antecedent debt within 90 days of a bankruptcy filing (or one year, if the transferee is an "insider") can be avoided if the debtor was insolvent at the time of the transfer and if the transfer allows the creditor to receive more than it would have received in a hypothetical liquidation under chapter 7 of the Bankruptcy Code had the transfer not occurred.

If a DIP or trustee assumes an executory contract or unexpired lease, assumption may preclude avoidance of otherwise preferential transfers received under the contract by the nondebtor party. This is sometimes referred to as the "Kiwi defense" because it is derived from a ruling by the U.S. Court of Appeals for the Third Circuit in Kimmelman v. Port Auth. of N.Y. & N.J. (In re Kiwi Int'l Airlines, Inc.), 344 F.3d 311 (3d Cir. 2003). In Kiwi, a chapter 7 trustee sued certain creditors to avoid and recover $3.9 million in payments made within 90 days of the debtor's chapter 11 filing. Before the case was converted to a chapter 7 liquidation, the debtor assumed contracts with each of the creditors and, as required by section 365(b) and by section 1110 (which applies to executory aircraft leases), cured all outstanding defaults and provided adequate assurance of its future performance.

The bankruptcy court ruled that because payment defaults under the contracts had to be cured as a condition to assumption, the prepetition payments to the defendants did not improve their position and were therefore not preferential. In other words, the payments would not allow the defendants to receive more than they would have received in a hypothetical chapter 7 liquidation had the payments not been made.

The district court and the Third Circuit affirmed on appeal. Assumption of the defendants' contracts, the Third Circuit explained, transformed their prepetition claims into priority administrative expenses. As such, none of the defendants received more than they would have received in a chapter 7 liquidation. See also generally Collier on Bankruptcy ¶ 547.03[7] (16th ed. 2017) ("[P]referential payments made pursuant to a contract that was assumed during the subsequent bankruptcy case are immune from preference attack. If the payments had not been made, the amount necessary to assume the contract would have been commensurately increased. The transferee received no more than it would have received under chapter 7.").

In Pirinate Consulting, the court considered whether the Kiwi defense insulated from avoidance under section 547(b) pre-bankruptcy payments under a series of related purchase orders governed by a master construction agreement.

Pirinate Consulting

NewPage Corporation ("NewPage"), a producer of printing and specialty papers in North America, filed for chapter 11 protection in September 2011 in the District of Delaware. NewPage's confirmed chapter 11 plan provided that any executory contract which had not been assumed or rejected during the case, or which had expired prior to plan confirmation, would be assumed. The plan also created a litigation trust for estate avoidance claims.

Prior to filing for bankruptcy, NewPage entered into a master construction agreement (the "MCA") with C. R. Meyer & Sons Co. ("CRM"), pursuant to which CRM provided general contracting services for large construction projects. The MCA provided that work projects would be assigned to CRM under separate purchase orders, each of which constituted a separate contract.

In October 2013, the litigation trustee sued CRM to avoid as preferential transfers approximately $3.2 million paid by NewPage to CRM under the purchase orders prior to filing for bankruptcy. On cross motions for summary judgment, CRM argued that the transfers were insulated from avoidance under the Kiwi defense because the MCA and each of the purchase orders constituted a single, integrated contract which had been assumed under NewPage's confirmed chapter 11 plan. The trustee countered that the MCA and the purchase orders constituted separate, severable, and distinct agreements and that the Kiwi defense could not apply to all prepetition payments absent a showing that each individual purchase order was executory and had been assumed under the plan.

The Bankruptcy Court's Ruling

The bankruptcy court looked to state law—here, that of Michigan and Wisconsin—to determine whether the MCA and the purchase orders constituted a single agreement. It noted that, under the laws of both states, the intent of the parties is the "first and foremost consideration in analyzing the divisibility of contracts." The court further explained that, under state law, the parties' assignment of separate prices for separate phases of work generally evinces an intent to create separate contracts.

The court found that, because the right to payment arose under each separate purchase order, which itself related to a separate work order, the intent of the parties was to create separate, severable contracts. Moreover, the MCA expressly provided that each new purchase order would constitute a separate contract. Thus, the court concluded that the parties' intent in entering into each purchase order was to form an agreement separate from the MCA and the other outstanding purchase orders.

Next, the court ruled that CRM had not met its burden of demonstrating that all of the purchase orders were executory contracts, such that the Kiwi defense would shield the transfers from avoidance as preferences. In the Third Circuit, the court explained, whether a contract is executory turns on whether there remain " 'obligations of both the bankrupt and the other party to the contract so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other' " (quoting In re LG Philips Displays USA, Inc., 2006 BL 71563, at *3 (Bankr. D. Del. June 21, 2006)).

CRM's entire argument, the court stated, rested on the erroneous premise that the MCA and the purchase orders constituted an integrated agreement. As a consequence, neither CRM nor the trustee presented any evidence regarding the executoriness of each individual purchase order. Accordingly, the court concluded that it could not rule on whether the purchase orders were immune from avoidance under the Kiwi defense because the parties had yet to establish whether the individual purchase orders were executory and could therefore be assumed.

However, the court held that the MCA was an executory contract which had been assumed under the plan. In this regard, the court found mutual unperformed obligations of both parties, including: (i) CRM's obligation to provide all necessary engineering and servicing items in order to complete the purchase orders, as well as to complete the work on schedule; (ii) CRM's obligation to comply with certain insurance provisions during the pendency of its work for NewPage; (iii) NewPage's obligation to reimburse CRM for certain expenses and comply with the payment terms in each purchase order; and (iv) the obligation of both parties to maintain confidentiality.

Outlook

Pirinate adds a wrinkle to the Kiwi defense in cases involving a master agreement with ancillary, stand-alone agreements. If such a group of agreements is not deemed a single contract under applicable nonbankruptcy law, the assumption of one or more of the agreements, but not the others, may mean that transfers under agreements which are not assumed will not be insulated from avoidance as preferential transfers. Thus, a thorough understanding of applicable state law is paramount in assessing potential avoidance exposure. Given the importance of discerning the parties' intent in such an inquiry, master and ancillary agreements should be drafted to provide clearly that they are intended to be a single, integrated agreement, or the parties will face the risk that the agreements will be deemed severable under state law.

Pirinate also highlights the importance of carefully coordinating each component of a chapter 11 debtor's reorganization strategy. Because section 365(b) of the Bankruptcy Code effectively transforms a pre-bankruptcy default claim into an administrative expense claim, the consequences of assuming a contract can be significant. Given the consequences, any DIP or trustee should assess whether any assumed agreement is required for reorganization. In addition, the effect of assumption on any causes of action against the counterparty to an executory contract should be thoroughly evaluated.

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
Mark G. Douglas
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
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
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions