United States: Timing Is Everything: A Creditor's Errant Conclusion As To An Executory Contract Leads To Claim Denial

Although the Bankruptcy Code does not define "executory contract," the widely adopted definition explains it as a "contract under which the obligation of both the bankrupt and the other party to the contract are so far underperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other." Bankruptcy Judge Martin Isgur of the Southern District of Texas, In re Cornerstone Valve, LLC, et al., Case No. 19-30869, recently held that a creditor's failure to properly analyze its contract with the debtor resulted in its otherwise valid unsecured claim being untimely filed.

Debtor Cornerstone Valve LLC ("Cornerstone") designed and manufactured high integrity valves. Pursuant to a contract, Valve Venture LLC ("Valve Venture") supplied parts and inspected Cornerstone's designs. In the course of their relationship, Cornerstone received damaged parts from Valve Venture which Cornerstone blamed on improper packaging by Valve Venture. Cornerstone then lost a major client, and again blamed Valve Venture. As a result, Cornerstone cancelled its remaining orders with Valve Venture. Six months later, on February 19, 2019, Cornerstone filed a Chapter 11 petition in bankruptcy court in the Southern District of Texas. The Court confirmed Cornerstone's plan of reorganization on November 7, 2019.

Prior to confirmation, the Court had set the general bar date for claim holders as July 8, 2019. The confirmed plan also provided that damages arising from the rejection of an executory contract or lease could be filed up to 30 days after the effective date of the plan. After the general bar date, but before the bar date for rejection damages, Valve Venture filed a proof of claim in the amount of $81,492.87 based on unpaid invoices from its pre-petition contract with Cornerstone which Value Venture believed was executory in nature.

The plan paid a 20% dividend to unsecured creditors, but not to Valve Venture. The bankruptcy court explained that the timing of the contract issues and the parties' course of performance made the contract non-executory. Relevant to this conclusion was Valve Venture's August 28, 2018 acknowledged performance of its obligation, in which it insisted it was not at fault, and that Cornerstone was obligated to perform on five open sale orders. The next day, Cornerstone communicated to Valve Venture that it would consider the five open sale orders canceled unless Valve Venture changed the current payment terms. On September 3, 2018, Valve Venture again insisted that Cornerstone must pay because Valve Venture had already accomplished the terms of the contract.

Quoting In re C&S Grain Co., 47 F.3d 233, 237 (7th Cir. 1995), Judge Isgur stated that "in the face of clear evidence of an intent to repudiate, the non-repudiating party is no longer under an obligation to perform. Because one party is not obligated to perform, the contract is no longer executory as defined in bankruptcy." Whether or not Cornerstone was justified in canceling the remaining orders, the bankruptcy court stated that the "effect was a repudiation of the contract by Cornerstone ... [as] the parties' course of performance shows that there were not remaining material obligations on both sides." The bankruptcy court further noted that wrong or not, Cornerstone's conduct left Valve Venture knowing that it had no reasonable basis to believe Cornerstone still sought performance of the contract, or that Cornerstone would pay the remaining invoices in full. Likewise, Cornerstone did not expect Valve Venture to inspect or ship canceled orders. "Because the contract was not executory, Valve Venture was not justified in waiting until the executory contract bar date to file its Proof of Claim." Id. at 6. Thus, there existed nothing for the debtor to assume or reject.¹

Though Valve Venture did not retain its present counsel until after the general bar date, Judge Isgur noted that its initial counsel encouraged the creditor to find an actual bankruptcy attorney to advise on the executory nature of the contract, the filing of a proof of claim, and the bankruptcy in general. Sage advice, indeed.

Footnote

1. Though some courts disagree as to whether a repudiated contract is no longer executory, they reached their decisions out of concern that pre-petition repudiations should not limit a debtor's ability to assume an executory contract. See In re Kemeta, LLC, 470 B.R. 304 (Bankr. D. Del. 2012). Such was not the case for Cornerstone.

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