The following is a case update written by Zev Shechtman of Danning, Gill, Israel & Krasnoff, LLP, analyzing a recent decision of interest:
In re Weinstein Co. Holdings LLC, 997 F.3d 497 (3d Cir. 2021) involved a work-for-hire contract between The Weinstein Company—a bankrupt movie company—and Bruce Cohen, the producer of the critically acclaimed 2012 film, Silver Linings Playbook. The United States Court of Appeals for the Third Circuit held that the contract was not an executory contract, affirming the decision of the Delaware district court, which affirmed the decision of the Delaware bankruptcy court.
To read the full published decision, click here.
In 2011, Bruce Cohen (“Cohen”) entered into an agreement (the “Cohen Agreement”) with a special purpose entity formed by The Weinstein Company (“TWC”) for the production of Silver Linings Playbook. Under the agreement, Cohen would receive $250,000 of fixed compensation and contingent future compensation of about 5% of the film’s net profits. The film, released in 2012, was successful.
Six years later, in March 2018 TWC filed for chapter 11 bankruptcy protection, following the revelation of allegations of sexual misconduct by one of TWC’s founders and principals Harvey Weinstein. In bankruptcy, TWC sold its assets to Spyglass Media Group, LLC under section 363 of the Bankruptcy Code (title 11 of the United States Code).
After the sale, Spyglass filed a declaratory relief action against Cohen in the bankruptcy court. Spyglass sought a determination that the Cohen Agreement was not an executory contract under section 365 of the Bankruptcy Code. Under section 365, an executory contract cannot be assumed or assigned unless all defaults are cured. If Spyglass prevailed in its argument that the contact was not executory, Spyglass would not be required to pay $400,000 in unpaid contingent compensation owed to Cohen. By purchasing the rights to a non-executory contract under section 363, Spyglass would only be required to pay contingent compensation on a go-forward basis. Various similarly situated parties joined in Cohen’s briefing, thus making the dispute a multi-million dollar concern.
The bankruptcy court granted summary judgment in favor of Spyglass and the district court affirmed.
The Third Circuit started with the definition of executory contracts. Like many other courts, the Third Circuit uses the definition for an executory contract posited by Professor Vern Countryman: “a contract under which the obligation of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other.” Synthesized with other authorities, the court summed up the test for executoriness as: “whether, under the relevant state law governing the contract, each side has at least one material unperformed obligation as of the bankruptcy petition date.”
New York law governed the Cohen Agreement. Thus, the court considered whether there was at least one material obligation owed by both parties the breach of which “would constitute a material breach under New York law.” New York law provides that a “material breach” is a failure to perform an obligation that “defeats the essential purpose of the contract.” Further, New York’s “substantial performance doctrine” provides that “[i]f the party in default has substantially performed, the other party’s performance is not excused.”
The court found that TWC had at least one clearly material obligation—to pay contingent compensation, particularly since most of the compensation to be paid to Cohen under the Cohen Agreement was contingent. Because Cohen had already produced the film, however, his remaining obligations were not material. “[H]e contributed almost all his value when he produced the movie.” The court found that Cohen’s obligations under the contract, such as indemnification, anti-injunction, and anti-assignment clauses were ancillary, boilerplate, redundant or otherwise immaterial.
Cohen further argued that under New York law parties can agree that certain obligations are material, even if the terms might otherwise seem immaterial. The court agreed with Cohen’s description of New York law, but did not find that the Cohen Agreement unambiguously avoided New York’s substantial performance rule. The court reasoned that the term that Cohen argued made any breach a material breach, requiring that Cohen not “otherwise be in breach or default” to receive contingent compensation, was “buried in a long covenant provision.” The subject term was not found in the remedies or termination section, which would make it clear that the terms are material. The court viewed the requirement that Cohen not be in breach as a “condition precedent,” rather than a duty, and thus not subject to section 365.
Finally, the court noted that accepting Cohen’s argument would logically imply that the Cohen agreement “would be an executory contract forever.” The court ruled that a result so contrary to the Bankruptcy Code’s protections for debtors should not be effected absent clear and unambiguous contractual text.
The Third Circuit’s reasoning makes practical sense. Cohen was hired to produce a film. He produced it. Cohen therefore performed his material obligations under the agreement. But New York law says that parties can agree that all terms are material terms, even terms that would otherwise be immaterial. Cohen’s problem was that the agreement at issue was not clear and unambiguous on this point. Imagine, however, a contract that was clear and unambiguous and followed the Third Circuit’s admonishment that such terms belong in a termination section (probably in all caps and bold). This stroke of a pen could have, theoretically, rendered the agreement executory forever. Attorneys drafting contracts for parties receiving contingent, backend payments, such as participation agreements in entertainment transactions, should take heed. Executoriness could be the difference between getting paid or not in a bankruptcy case. Including material provisions that extend beyond the completion of the work-made-for-hire, or language rendering backend provisions material, could make the difference between executoriness and non-executoriness.
Another practical way to look at this decision is that it is consistent with the general purpose of the Bankruptcy Code and the business of bankruptcy. Venue in the Delaware bankruptcy court is often sought because it is viewed as favorable toward corporate restructuring needs. In this case, TWC selected venue in Delaware despite being headquartered in New York and doing business in New York and Los Angeles. Bankruptcy courts, and particularly the Delaware bankruptcy court, are not in the habit of killing large transactions that arrive at their steps. The acquisition of the TWC assets free and clear of the past liabilities allowed a new entity to manage TWC’s valuable assets for the future economic benefit of counterparties. A contrary ruling would have added millions or tens of millions of dollars to a roughly $300 million transaction and would have shifted a greater relative burden to other creditors of TWC. Such a precedent could chill interest in future bankruptcy sales under section 363 of the Bankruptcy Code where the primary assets are contractual rights.
These materials were written by Zev Shechtman of Danning, Gill, Israel & Krasnoff, LLP in Los Angeles, California (ZS@DanningGill.com). Editorial contributions were provided Maggie Schroedter of Robberson Shroedter, LLP (firstname.lastname@example.org) and the publications committee of the ILC. Mr. Shechtman is a member of the Business Law Section and serves as Vice Chair of the Editorial Board of the Business Law News.