In re Bergt, Bankruptcy No. A95-00334-HAR

• Decision Date: 22 October 1999
• Docket Number: A96-00345-HAR,A96-00346-HAR.,A96-00344-HAR,Bankruptcy No. A95-00334-HAR,A95-00820-HAR
• Citation: 241 BR 17
• Parties: In re Neil G. BERGT; Alaska International Properties, Inc., an Alaska corporation; Viewpoint Ventures Partnership; Alaska International Industries, Inc.; and Alaska Diversified Properties, Inc., Debtors.
• Court: U.S. Bankruptcy Court — District of Alaska

241 B.R. 17 (1999)

In re Neil G. BERGT; Alaska International Properties, Inc., an Alaska corporation; Viewpoint Ventures Partnership; Alaska International Industries, Inc.; and Alaska Diversified Properties, Inc., Debtors.

Bankruptcy Nos. A95-00334-HAR, A95-00820-HAR, A96-00344-HAR, A96-00345-HAR, A96-00346-HAR.

United States Bankruptcy Court, D. Alaska.

October 22, 1999.

Ronald W. Goss, Shulkin Hutton, Seattle, WA, for Debtors.

Jeffrey P. Stark, Delaney, Wiles, Hayes, Gerety, Ellis & Young, Anchorage, AK, for Wood River Ltd.

Patrick J. McCabe, Owens & Turner, Anchorage, AK, for GCI.

Diane F. Vallentine, Jermain, Dunnagan & Owens, Anchorage, AK, for All Acquisitions.

MEMORANDUM DECISION DENYING REJECTION OF WOOD RIVER, LTD.'S RIGHT OF FIRST REFUSAL BECAUSE IT IS NOT EXECUTORY AND § 365(a) IS NOT AN AVOIDING POWER

HERBERT A. ROSS, Bankruptcy Judge.

                Contents Page
                1.   INTRODUCTION ................................................................. 18-19
                2.   FACTUAL AND PROCEDURAL BACKGROUND ............................................ 18-19
                3.   ISSUES .......................................................................... 19
                4.   ANALYSIS ........................................................................ 19
                4.1. Ninth Circuit Case Law Establishes That the Right of First Refusal is Not an
                       Executory Contract When There Was No Sale Pending at the Time of
                       Bankruptcy .................................................................... 19
                4.2. Rejection of a Right of First Refusal on Property of the Estate Does Not
                       Result in "Avoiding" the Property Interest of the Nondebtor Holder of the
                       Right ...................................................................... 20-21
                     4.2.1. Law Review Articles by Michael Andrew and Jay Westbrook .................. 21
                     4.2.2. The Basics and Some Case Law Regarding Rejection of Executory
                              Contracts Applying the Andrew-Westbrook Analysis .................... 24-25
                     4.2.3. Ninth Circuit Case Law Does Not Foreclose the Andrew-Westbrook
                              Approach and Some Supports It ....................................... 27-28
                     4.2.4. Secondary Authority Generally Adopts the Andrew-Westbrook Approach ....... 33
                5.   CONCLUSION ...................................................................... 36
                

1. INTRODUCTION — Debtors want to sell several lots, acquired prepetition subject to a right of first refusal (RFR) in favor of adjoining lot owners. They moved to reject the RFR as an executory contract,¹ and impliedly avoid the RFR.

An adjoining lot owner opposed on the grounds that the RFR is not an executory contract subject to rejection. Should the court approve the rejection of the RFR?

Under the controlling case law, the RFR is not an executory contract subject to rejection. More importantly, rejection is not an avoiding power.

2. FACTUAL AND PROCEDURAL BACKGROUND — These are jointly administered chapter 11 cases. The debtors have an approved disclosure statement and are seeking confirmation. They propose a liquidating plan involving the sale of a number of physical assets, mostly real property scattered around Alaska, to a local telecommunication company, GCI.

Included as part of the package are lots which were acquired before bankruptcy by debtor Alaska International Industries, Inc. (AIII), subject to an RFR in favor of other lot owners in the subdivision. Under the RFR, AIII must offer the lots it wants to sell to the other lot holders in the subdivision on the same terms offered to a third party purchaser so the other lot owners can preempt the sale for their own benefit.

Wood River, Ltd. is owner of lots in the subdivision, and claims the right to exercise an RFR to match the offer AIII has to sell the lots to GCI. AIII disputes that the RFR still exists on various grounds (including abandonment, unclean hands, waiver, or the fact that it is part of a package deal), but this Memorandum only concerns the pure bankruptcy issue of whether the RFR is an executory contract which can be rejected under 11 U.S.C. § 365(a).

The debtors argue that rejection of the contract will benefit the estate by facilitating the package sale to GCI, which may be in jeopardy if the lots are not included. Implicit in debtors' motion is the assumption that, upon approval of the rejection, Wood River, Ltd.'s RFR will evaporate and it will become an unsecured creditor of the bankruptcy estate. Parenthetically, the unsecured creditors of AIII will receive only a very small percentage of their claims under the proposed plan.

Wood River, Ltd. defends on the ground that the RFR is not an executory contract.

At oral argument, the court questioned whether rejection was, in fact, an avoiding power, and if the question of whether the RFR was an executory contract was of any consequence.

3. ISSUES — The issues are: (a) is the RFR an executory contract subject to rejection, and if so, (b) does rejection of the RFR result in avoiding its enforcement by the nondebtor holder of the RFR?

4. ANALYSIS —

4.1. Ninth Circuit Case Law Establishes That the Right of First Refusal is Not an Executory Contract When There Was No Sale Pending at the Time of Bankruptcy — The 9th Circuit has recently held that an option agreement, at least one that is not in the process of being exercised at the time the bankruptcy is filed, is not an executory contract.² This was in the en banc decision in the Robert L. Helms Construction case, which overturned a prior 9th Circuit decision holding that an option agreement was per se an executory contract.³

The court adhered to the "Countryman" test in defining an executory contract. It set out the Countryman test of whether a contract was executory as follows:

. . . a contract is executory if "the obligations of both parties are so unperformed that the failure of either party to complete performance would constitute a material breach and thus excuse the performance of the other." citation omitted⁴

The en banc panel concluded that if an option was not in the process of being exercised at the time of the bankruptcy, it was not an executory contract. On the other hand, one of the situations in which an option might be executory is if it had been exercised, but closing had not taken place when the bankruptcy was filed.⁵

The question is whether the RFR in the present proceeding has attributes sufficiently similar to the option in the Robert L. Helms Construction case so that the Helms decision controls the treatment of the RFR. Although AIII argues that there are distinctions, I conclude that an option to sell real property and an RFR with respect to real property are so close in concept that, notwithstanding their differences, an RFR would be determined to be or not to be an executory contract under the same test as enunciated in the Helms case. That is, if there was not a sale pending when the bankruptcies were filed, the RFR is not an "executory contract."

An RFR is defined in Black's Law Dictionary as:

Right to meet terms of proposed contract before it is executed; e.g. right to have first opportunity to purchase real estate when such becomes available, or right to meet any other offer. The holder of such a right has the option to purchase the grantor\'s real estate on the terms and conditions of sale contained in a bona fide offer by a third party to purchase such real estate, provided it is an offer that the grantor is otherwise willing to accept. See also Option. italics added

The holder of an RFR cannot compel a sale, but has a preemptive right to buy when the owner decides to sell.⁶ It is sometime characterized as a "conditional option"⁷ or as a "preemptive option."⁸

Helms, without discussing the difference between an option and an RFR, cited a BAP opinion, Coordinated Financial Planning Corporation,⁹ a case involving an RFR as if it were authority on the option issue. In Coordinated Financial, the BAP held that an RFR was an executory contract, apparently assuming that a rejection by the trustee would avoid the estate's need to comply with the RFR. Coordinated Financial has been impliedly overruled on that point by Helms.

So, the easy answer to the debtors' motion to reject is that the RFR on AIII's lots is not an executory contract and not subject to rejection since it was not being "exercised" when the bankruptcy petitions were filed. But, the easy answer does not resolve the underlying issue — what is the effect of the rejection?

There seems to be little equity or logic in the Helms distinction about whether an option is executory or not, if the distinction governs the rights that flow from rejection. If rights are lost due to being connected to an exercised "executory" contract, this leads to a quixotic result. An option which is closer to being performed by having been exercised is "executory," and the rights are lost upon rejection, but one that has not been exercised (i.e., where the performance is not as advanced) can retain the rights. The Helms decision would lead to the following result:

(a) an option contract which is not exercised at the time the bankruptcy petition is filed, but is exercised the following day, is not executory — so the nondebtor\'s rights are not subject to § 365(a) rejection, and the nondebtor can enforce its rights in the property; but,

(b) if the option is exercised the day before bankruptcy, the nondebtor can not enforce its rights in the property if the option is rejected (or, at least that is the unstated premises of the ruling in Helms).

In bankruptcy, rights often depend on whether a creditor falls on one side or another of an arbitrary time line, as in the case of preferences.¹⁰ However, there is no statutory or common law justification for such a draconian result with respect to property rights created by contract merely because they involve contracts which are "executory." This is the subject of Part 4.2 of this Memorandum.

4.2. Rejection of a Right of...