In re Sunterra Corp.

• Decision Date: 18 March 2004
• Docket Number: No. 03-1193.,03-1193.
• Citation: 361 F.3d 257
• Parties: In Re: SUNTERRA CORPORATION, Debtor. RCI Technology Corporation, formerly known as Resort Computer Corporation, Plaintiff-Appellant, v. Sunterra Corporation, Defendant-Appellee.
• Court: U.S. Court of Appeals — Fourth Circuit

361 F.3d 257

In Re: SUNTERRA CORPORATION, Debtor.

RCI Technology Corporation, formerly known as Resort Computer Corporation, Plaintiff-Appellant, v. Sunterra Corporation, Defendant-Appellee.

No. 03-1193.

United States Court of Appeals, Fourth Circuit.

Argued: December 4, 2003.

Decided: March 18, 2004.

COPYRIGHT MATERIAL OMITTED

ARGUED: Jay Alan Shulman, Saul Ewing, L.L.P., Baltimore, Maryland, for Appellant. Kenneth Oestreicher, Whiteford, Taylor & Preston, L.L.P., Baltimore, Maryland, for Appellee. ON BRIEF: Irving E. Walker, Saul Ewing, L.L.P., Baltimore, Maryland, for Appellant. John F. Carlton, Whiteford, Taylor & Preston, L.L.P., Baltimore, Maryland, for Appellee.

Before WIDENER, LUTTIG, and KING, Circuit Judges.

Reversed and remanded by published opinion. Judge KING wrote the opinion, in which Judge WIDENER and Judge LUTTIG joined.

OPINION

KING, Circuit Judge:

RCI Technology Corporation appeals from an order entered in the District of Maryland affirming the bankruptcy court's ruling in favor of Sunterra Corporation. RCC Tech. Corp. v. Sunterra Corp., 287 B.R. 864 (D.Md.2003).¹ RCI contends that the district court erred in ruling that Sunterra, as the Chapter 11 debtor in possession, was entitled to assume a nonexclusive license of copyrighted software.² On appeal, we are called upon to decide whether, pursuant to 11 U.S.C. § 365(c), such a debtor in possession may assume, over the licensor's objection, a nonexclusive software license. In so deciding, we must resolve the issue of whether the disjunctive term "or," as used in the "assume or assign" language of § 365(c), should be construed in the conjunctive as "and." Because we are unable to so construe § 365(c), Sunterra was precluded from assuming the nonexclusive software license, and we reverse and remand.

I.

A.

At all times material to this appeal, RCI conducted business as a software development company for the resort and hospitality industry. RCI's software products were used by entities in this industry, such as Sunterra, for functions such as recording reservations, managing resort properties, and marketing and financing timeshares.³ Sunterra owns or controls more than 150 subsidiaries and related entities, constituting one of the world's largest resort management businesses.

In the 1990s, Sunterra launched a program called Club Sunterra. Membership in the Club allowed timeshare owners at Sunterra resorts to trade their timeshare rights for such rights at other Sunterra resorts. Because tens of thousands of timeshare owners and units were involved in the Club, Sunterra needed to develop an integrated computer system to assist its management of the Club. For this purpose, Sunterra decided to acquire RCI's Premier Software⁴ and modify it into a unique computer program, the SWORD System.

In 1997, RCI and Sunterra entered into a software license agreement (the "Agreement"), pursuant to which RCI granted Sunterra a nonexclusive license to use Premier Software (the "Software"). Under the Agreement, effective December 31, 1997, RCI was required to provide Sunterra a "non-exclusive, worldwide, perpetual, irrevocable, royalty-free license to ... use, copy, modify, and distribute" the Software (the "License"). Agreement § 3.1. Sunterra paid RCI $3.5 million for the License. Because the Software, as marketed, did not meet Sunterra's requirements, the Agreement authorized Sunterra to utilize the Software to develop its own software system. Under the Agreement, Sunterra owned any enhancements it made to the Software (the "Sunterra Enhancements"). Id. §§ 2.15, 3.6.3. Sunterra, in turn, granted RCI a license to use the Sunterra Enhancements. Id. § 3.2.2. Sunterra thereafter invested approximately $38 million in developing the SWORD System.

B.

On May 31, 2000, Sunterra filed a Chapter 11 bankruptcy petition in the District of Maryland. Two years later, on June 21, 2002, the bankruptcy court confirmed Sunterra's Plan of Reorganization, effective July 29, 2002. Prior to the Plan's confirmation, on March 28, 2002, RCI filed a motion to have the court deem the Agreement rejected (the "Motion"). RCI claimed that the Agreement was an executory contract and that Sunterra, as debtor in possession, was precluded by 11 U.S.C. § 365(c) (hereinafter" § 365(c)" or the "Statute") from assuming the Agreement without RCI's consent.⁵ RCI maintained that, because it had refused to consent to assumption of the Agreement, the court was required by law to deem the Agreement rejected.

Sunterra opposed the Motion, asserting that the Statute was inapplicable because the Agreement was not an executory contract.⁶ Sunterra also maintained that it was not precluded from assuming the Agreement because the Statute should be interpreted as prohibiting a debtor in possession from assuming and assigning a contract, and it intended only to assume — not to assign. Finally, Sunterra contended that the Statute did not prohibit assumption of the Agreement because RCI had agreed to permit reasonable assignments thereof.

On June 6, 2002, the bankruptcy court relied on Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir.1985), and held, in a bench ruling, that the Statute did not prohibit Sunterra, as debtor in possession, from assuming the Agreement. It decided that the Agreement was not an executory contract and that, if it were, the Statute did not preclude assumption because Sunterra did not intend to assign the Agreement. The court concluded that prohibiting Sunterra from assuming the Agreement was nonsensical because RCI would not be damaged if Sunterra, as debtor in possession, assumed the very contract rights it had possessed prior to bankruptcy. The following day, on June 7, 2002, the court entered an order denying the Motion. In re Sunterra Corp., No. 00-5-6931-JS (Bankr.D.Md.).

On June 14, 2002, RCI appealed the bankruptcy court's decision to the district court, which, on January 10, 2003, affirmed. RCC Tech. Corp. v. Sunterra Corp., 287 B.R. 864 (D.Md.2003) (the "Opinion"). The district court disagreed with the bankruptcy court's finding that the Agreement was not executory, but concluded that the Statute did not preclude Sunterra, as debtor in possession, from assuming it.

In its Opinion, the district court acknowledged that the Statute, read literally, precluded Sunterra, as debtor in possession, from assuming the Agreement because: (1) copyright law excused RCI from accepting performance from a party other than Sunterra,⁷ and (2) RCI did not consent to Sunterra's assumption of the Agreement. Id. at 865. In explaining its ruling, the court recognized the existence of a circuit split on the issue of whether the Statute should be applied literally. It acknowledged that at least three circuits, the Third, Ninth, and Eleventh, as well as several bankruptcy courts, have followed a "literal test" (generally called the "hypothetical test") in applying the Statute to the assumption of executory contracts.⁸ See In re West Elecs., Inc., 852 F.2d 79, 83 (3d Cir.1988) (characterizing § 365(c)(1)(A) as posing "a hypothetical question"); In re Catapult Entm't, Inc., 165 F.3d 747, 750 (9th Cir.1999) (same); In re James Cable Partners, 27 F.3d 534, 537 (11th Cir.1994) (same); In re Catron, 158 B.R. 629, 633-38 (E.D.Va.1993) (same), aff'd without op., 25 F.3d 1038 (4th Cir.1994). On the other hand, the First Circuit, along with a majority of the bankruptcy courts, have applied the "actual test" in such circumstances.⁹ See Institut Pasteur v. Cambridge Biotech Corp., 104 F.3d 489, 493 (1st Cir.1997) (rejecting the literal test in favor of the actual test); see also In re Catapult, 165 F.3d at 749 n. 2 (collecting bankruptcy court decisions adopting actual test).

In its Opinion, the district court recognized that resolution of the dispute turned on which of the two tests applied. If the literal test applied, Sunterra could not assume the Agreement because RCI was excused, pursuant to applicable copyright law, from accepting performance from a hypothetical third party. On the other hand, if the actual test applied, Sunterra, as debtor in possession, was entitled to assume the Agreement because it did not intend to assign, and RCI would not actually be forced to accept performance from a party other than Sunterra. The court then adopted the actual test, interpreting the disjunctive "or" in the conjunctive as "and," and holding that, because RCI would not, in the circumstances, be forced to accept performance from a party other than Sunterra, the Statute did not preclude it from assuming the Agreement.¹⁰

Finally, the district court addressed Sunterra's contention that, because RCI had agreed that it would not unreasonably withhold its consent regarding future assignments of the License by Sunterra, RCI had impliedly consented for Sunterra, as debtor in possession, to assume the Agreement. The court deemed unpersuasive Sunterra's contention that RCI consented to assumption of the Agreement. It determined, however, that its adoption and application of the actual test rendered the consent issue moot. It thus affirmed the bankruptcy court's ruling that the Statute did not bar Sunterra, as debtor in possession, from assuming the Agreement. RCI has filed a timely appeal, and we possess jurisdiction pursuant to 28 U.S.C. § 158(d).

II.

We review de novo the judgment of a district court sitting in review of a bankruptcy court, "applying the same standards of review that were applied in the district court." In re Shangra-La, 167 F.3d 843, 847 (4th Cir.1999). Accordingly, we review de novo the issue of whether the Agreement was an executory contract. Lubrizol, 756 F.2d at 1045 (observing that issue of whether contract is executory is one of law); Bose Corp. v. Consumers Union of the United States, Inc., 466 U.S. 485, 104 S.Ct. 1949, 80 L.Ed.2d 502 (1984) (observing that issues of law are reviewed de novo). We also review de novo an issue of statutory construction....