Business Law

In re Svenhard’s Swedish Bakery, No. 19-15277-C-11, 647 B.R. 554, 2022 Bankr. LEXIS 3583, 2022 WL 17824403 (Bankr. E.D. Cal. Dec. 19, 2022)

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The following is a case update written by Thomas Rupp of             Keller Benvenutti Kim LLP analyzing a recent decision of interest, In re Svenhard’s Swedish Bakery, No. 19-15277-C-11, 647 B.R. 554, 2022 Bankr. LEXIS 3583, 2022 WL 17824403 (Bankr. E.D. Cal. Dec. 19, 2022).

To read the full published decision, click here.

SUMMARY

A California bankruptcy court denied a motion to assume and assign a “garden-variety” discounted payment agreement that the debtor had entered into with the pension fund of its former union employees. The court held that such an agreement was not “executory” and also could not be assumed and assigned because it was a contract to extend financial accommodations under Section 365(c)(2).

FACTS

United States Bakery (“USB”) acquired Svenhard’s Swedish Bakery through a multi-year “creeping acquisition” involving lease-backs and license-backs beginning in 2014.  Sometime in 2015, USB directed Svenhard’s to move its bakery operations from Oakland, which triggered the termination of a collective bargaining agreement with its employees’ union, according to which Svenhard’s incurred a withdrawal liability and was required to contribute to its pension fund (“Pension Fund”). The Pension Fund notified Svenhard’s that the termination of its Oakland operations created approximately $50 million in withdrawal and contribution liabilities.

Svenhard’s reached an agreement with the Pension Fund to resolve this liability which would provide for an extended period of monthly payments totaling approximately $3.5 million (“Discount Agreement”). The Discount Agreement provided that only after the completion of timely payments would the remaining balance be discharged by the Pension Fund.

Six months later, in November 2019, USB terminated a leaseback agreement with Svenhard’s and took direct control over Svenhard’s bakery operations. Svenhard’s was unable to make the next monthly payment under the Discount Agreement. The Pension Fund declared a default, and Svenhard’s filed for chapter 11 on the last day of the grace period to cure before the undiscounted amount became due.

The Pension Fund filed a proof of claim for an undiscounted amount of approximately $46 million in the chapter 11 case. Additionally, the Pension Fund and Svenhard’s sued USB in separate actions, both removed to the Oregon district court. The Pension Fund sought to collect Svenhard’s unpaid liabilities from USB under a theory of successor liability.

In resolving a separate appeal before the Ninth Circuit, Svenhard’s and USB reached an agreement through mediation (without the Pension Fund’s participation), that included Svenhard’s assumption and assignment of the Discount Agreement to USB. Svenhard’s then brought separate motions to approve this compromise and assume and assign the Discount Agreement, to both of which the Pension Fund objected.

RULING

Motion to Assume and Assign

The court held that the Discount Agreement could not be assumed and assigned because it was not executory, both under the widely-cited “Countryman” definition and under controlling Ninth Circuit case law, and also because the Discount Agreement was a contract to extend financial accommodations excluded from assumption under Section 365(c)(2).

The court began its analysis by considering the definition of “executory” proposed by Professor Vern Countryman, that “the obligations of both parties must be so far unperformed that failure of either party to complete performance would constitute a material breach and thus excuse the performance of the other party.” The Ninth Circuit follows the Countryman test, and whether a contract is executory is a question of fact for the bankruptcy court to decide. The court observed that, while Svenhard’s had an ongoing obligation to make monthly payments, the Pension Fund’s obligations with respect to the Discount Agreement (such as delivering releases once all payments had been made) remained contingent, and therefore there was nothing that the Pension Fund needed to do as of the petition date to avoid a material breach.

The bankruptcy court then cited the Ninth Circuit’s controlling opinion in Unsecured Creditors’ Committee v. Southmark Corp. (In re Robert L. Helms Construction & Dev. Co.), 139 F.3d 702 (9th Cir. 1998) (en banc). “Under Helms, the question is whether at the time of filing, ‘does each party have something it must do to avoid materially breaching the contract?’” (quoting Helms, 176 F.3d at 706). Again, the answer is no—there was nothing for the Pension Fund to do at the time of filing to avoid materially breaching the Discount Agreement.

Finally, the court held that the Discount Agreement could not be assumed and assigned because it was a contract to extend financial accommodations that is excluded from assumption or assignment under Section 365(c)(2). “Financial accommodations are extensions of money or credit for the benefit of the debtor [which] may include prepetition workout agreements.” The Discount Agreement was a financial accommodation because it benefited Svenhard’s by allowing it to pay a fraction of its total liability to the Pension Fund over time.

Compromise Motion

The court therefore held that the motion to approve the compromise could not be approved, as it failed the Ninth Circuit’s “fair and equitable” test for approval of compromises in Martin v. Kane (In re A&C Properties), 784 F.2d 1377, 1380 (9th Cir. 1986). The court determined that the probability of success, i.e., success of the motion to assume and assign the Discount Agreement, was zero. As the court put it, “the compromise standards provide the framework for analysis, but the central issue is whether the transaction is permitted by the Bankruptcy Code.” The court added that the compromise could not be approved because it was also not in the best interest of creditors, i.e., the Pension Fund, which held 82.5% of unsecured debt.

PENDING APPEAL

Svenhard’s appealed the orders denying both motions to the Bankruptcy Appellate Panel. The BAP has since dismissed the appeal of the order denying the compromise motion for lack of jurisdiction as it was not a final order. The appeal of the order denying the motion to assume and assign the Discount Agreement remains pending before the BAP as case no. 23-1001.

AUTHOR’S COMMENTARY

Section 365 is a powerful tool in the Bankruptcy Code that can allow a distressed business to realize meaningful value for the estate through its business agreements with its various counterparties, whether they be suppliers, vendors, landlords, or customers. When reviewing contracts to reject, assign, or assume and assign under Section 365, counsel’s first question is usually “is it executory?” followed by analysis under the Countryman test.  Likewise, in a compromise motion to assume and assign an executory contract—even one with the goal of concluding protracted litigation—a movant should also be prepared to address why the probability of success in litigation (i.e., whether the contract could ever be assumed and assigned under legal and equitable principles) weighs in favor of approval. 

Here, the assumption and assignment of the Discount Agreement would likely not have been of any value to a conventional purchaser of the debtor’s bakery business. As the bankruptcy court observed, UBS’s apparent strategy in being assigned the Discount Agreement was to make an end-run around the $46 million successor liability claim that the Pension Fund was simultaneously asserting against UBS in district court.

These materials were written by Thomas Rupp of Keller Benvenutti Kim LLP (trupp@kbkllp.com) in San Francisco, California.  Editorial contributions were provided by Brandon J. Iskander of Goe Forsythe & Hodges LLP in Irvine, California (biskander@goeforlaw.com). 


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