GERALDINE MUND, Bankruptcy Judge.
This litigation centers on a note (the "Note") and other contract rights that the debtor ("Debtor" or "Robert") received on account of the sale of his business in 2001. Debtor and his wife ("Erika") divorced in 2007 and Debtor assigned the payments from the Note to Erika in lieu of child and spousal support. (She received some payments on the Note, but the buyers of the business ultimately stopped paying in 2009.) Over the course of the next five years, Robert and Erika each filed for chapter 7 relief (at different times and in different divisions), entered into two separate court-approved agreements with Debtor's trustee ("Trustee") over entitlement to the proceeds of the Note and responsibility for enforcing the Note, and entered into a new support and child custody arrangement in Superior Court. Trustee has now brought a motion for approval of a compromise with the buyers of Debtor's business, which Debtor opposes. Debtor has brought a motion to compel Trustee to abandon the Note and other contracts rights from the sale of the business, on the grounds that they are an executory contract that trustee has rejected by operation of law. Debtor has also brought a motion to disallow Erika's claim.
The details of this history are set forth in the following timeline:
8/17/01 — Robert enters into a Stock Purchase Agreement with Skyline Displays Northwest, LLC and Jeff and John Backstrom (collectively, the "Purchasers") to sell them his shares in Sales Presentations Northwest, Inc. ("SPNW") for $1.83 million, payable over a period of years. The Stock Purchase Agreement refers to a number of ancillary documents, including the Note and an Employment and Noncompetition Agreement (the "Employment Agreement"). (The Stock Purchase Agreement and all such ancillary documents are collectively referred to as the "Sales Agreement.") Under the Sales Agreement, Robert was to be employed as a salesman and management assistant with a monthly salary of $5,000 ("Salary Payments"), until the outstanding balance owing on the Note fell below $650,000. Employment Agreement ¶¶ 3 & 4.
12/6/07 — Erika files for dissolution, Ventura County Superior Court Case D324378.
12/13/07 — Erika and Robert enter into the "Stipulation for Child and Spousal Support and Order Thereon," which is signed by the Superior Court judge. Under this agreement (the "Family Law Settlement Agreement"), Robert is relieved of all child and spousal support obligations in exchange for assigning all proceeds of the
4/3/08 — Robert files this chapter 7 case. The Trustee asserts entitlement to both the Salary Payments and the payments under the Note. Pursuant to a preliminary injunction issued by this court, the Trustee receives $80,112.90 in Note payments and $18,543.12 of Salary Payments.
Late 2008 — Purchasers stop making Salary Payments or payments on the Note.
2/13/09 — Erika files claim 11-1 in Robert's bankruptcy case for a priority claim under § 507(a)(1) and § 507(a)(8) of $1,449,129.60. The claim is for child and spousal support from 11/1/07-9/5/19 (based on the dissomaster calculation of 10/29/08 using data from Debtor's wage-earning history and including all expenses), plus reimbursement of a number of enumerated expenses, including some child expenses, mortgage payments, tax payments, attorneys' fees and judgments.
4/17/09 — This Court approves a compromise between the Trustee, Robert and Erika under which the Trustee is authorized to enter into the Settlement Agreement and Release with defendants in an avoidance action: Robert, Erika, the Purchasers, SPNW, and Olympic Heights Investments (1:08-ap-01328-GM). Under the terms of this agreement (referred to as the "Fraudulent Transfer Settlement Agreement"), the Trustee is to receive 65% of all payments from the Note due and paid from 11/30/07, while Erika keeps the other 35%. Trustee is also to receive 65% of all of the Salary Payments due and paid from 4/3/08, with the balance going to Robert.
3/11/10 — This Court approves a Litigation Agreement between Robert, Erika, and the Trustee. The Purchasers are in default on the Fraudulent Transfer Settlement Agreement, so the Trustee grants Robert and Erika the authority to sue and to manage the legal action against the Purchasers. Robert and Erika are to advance all litigation expenses and attorneys' fees, but will be reimbursed if successful.
6/22/10 — Erika files a chapter 7 case in the Santa Barbara Division (9:10-bk-13146-RR).
2/2/11 — Erika receives her bankruptcy discharge.
3/23/12 — Robert and Erika stipulate in the Superior Court concerning the location and education of their child and that spousal support from 12/20/11 will be reduced to $0 and child support from that same date will be payable at a set amount [the court cannot tell from Ex. B what that amount is]. It also provides that because Robert has contributed to the attorney's fees and costs, his first support payment will be due 5/1/12.
Debtor argues that the claim has been satisfied by the original 2007 stipulation, which allocated the proceeds and income from the Note to Erika, to be divided between child support (65%) and spousal support (35%). The debtor asserts that it was up to the Erika to enforce the Note and related agreements, but she has not done so. Debtor has paid over $20,000 to counsel in Washington to enforce the terms of the Note and related agreements, while Erika made no payment and rendered no material assistance. Debtor also argues that in March 2012 the debtor and Erika stipulated to reduce spousal support to $0 and child support to $984 per month. (Debtor also argues that the Litigation Agreement is an executory contract that was rejected by operation of law. The court will discuss this issue in considering
The claim is supported by documentation. It shows over $1 million of past-due support payments. As to the divorce settlement, that only deals with future support payments from 12/11, not prepetition ones.
Although Debtor has a right to object to the claim, Trustee believes that it is premature since this may be an administratively insolvent estate and the litigation in Washington is still pending. As to the asserted amount of the claim, the $1,449,129.60 amount is not broken down or supported in a way that the Trustee can determine if it is correct. And if the Debtor did satisfy the claim, then the claim will be moot.
The claim should be limited to the amounts owing as of the petition date and contains no evidence supporting the amount of $8,190 for monthly child support and alimony. Since the dissolution action was filed on 12/6/07, the claim should only be for a four month period. The settlement agreement is res judicata as to the amount of child support and alimony owed to Erika. The amounts Erika received under the Note ($95,272.50) have satisfied the prepetition obligation. as well as any post-petition amounts until the 3/12 stipulation, since they were based on the payments under the Note. The new stipulation established the child support at $984 and no spousal support, commencing 12/20/11. They were to advance litigation expenses. Clearly this is an executory contract since performance is due on both sides. This contract was never assumed.
The objection to the claim is premature because the estate is insolvent. Also the Trustee questions the validity of the stipulation in the dissolution action since Debtor asserts that the obligation has been fully satisfied. And lastly, even if the stipulation is valid, most of the claim deals with the debtor's post petition obligation. The Litigation Agreement did not require Robert and Erika to pursue legal action against the purchasers of the business, but they were to keep the Trustee advised and to seek approval from the Trustee as to any settlement.
Section 507(a)(8) does not apply because Erika is not a "governmental unit."
The claim can only be for amounts owing up to the date of bankruptcy. At the present time it is unclear what this should be. The newest settlement in the Superior Court does not cover this, since it only deals with certain post-petition amounts. The Family Law Settlement Agreement would seem to mean that no pre-petition amounts are owed, but the Fraudulent Transfer Settlement Agreement changes that formula and thus may impact the effectiveness of the Family Law Settlement Agreement. Unless the parties get a new ruling from the Superior Court as to the amount due from the date of the filing of the dissolution until the date of Robert's bankruptcy, the Family Law Settlement Agreement stands and Erika is owed nothing more as a prepetition creditor.
The Court does not wish to foreclose Erika's opportunity to go to family court and receive a determination of these issues. The motion to disallow is granted with leave to amend no later than January 31, 2013.
Debtor moves the Court for an order compelling the Trustee to abandon the Stock Purchase Agreement, including the Note, the Employment Agreement, and personal guaranties that came out of the prepetition sale of SPNW. The Stock Purchase Agreement required that Debtor would remain as an employee and director emeritus of SPNW and he had continuing duties thereunder, as did the Purchasers. The Stock Purchase Agreement is an executory contract and was not assumed by the Trustee, so it has been rejected pursuant to Bankruptcy Code § 365(d)(1). Abandoned property reverts to Debtor. Erika's trustee never assumed the Litigation Agreement, so that has been rejected in her bankruptcy and it was never assumed in this bankruptcy.
Trustee, joined by Erika, opposes Debtor's motion on the grounds that the Stock Purchase Agreement is not an executory contract. Debtor had already fully performed prepetition by selling his stock. Because Debtor never performed any work for SPNW under the Employment Agreement, the Salary Payments received were actually part of the purchase price for the shares of stock. To be executory, some performance must remain due on both sides. All that remained was for the Purchasers to pay, so this is not executory. Alternatively, Debtor has waived any rights to challenge the Sales Agreement as an executory contract when he entered into the Fraudulent Transfer Settlement Agreement over 3 years ago. The Sales Agreement is not burdensome to the estate or of inconsequential value, so there is no reason to abandon under § 554(b).
Debtor argues the Note is part of an executory contract. There are 10 agreements that are part of the Stock Purchase Agreement and the Note was only one of them. There are duties still to be performed by all Parties as part of the total Sales Agreement. Furthermore, Debtor cannot waive the time to assume.
Debtor also argues that enforcing the Note would be burdensome to the estate, but that the Trustee has unfairly foisted that burden on Debtor to date. Basically the Trustee has done nothing. If he wants to preserve and maintain these property rights, he needs to start paying the administrative costs of pursuing of the Washington action. Since the Trustee has no money to pay these costs, they are burdensome to the estate and the Sales Agreement should be abandoned.
Neither the Fraudulent Transfer Settlement Agreement nor the Litigation Agreement are executory contracts in that they are both post-petition. Further, the Trustee is a party to both of them, so he does not need to assume them even if they were pre-petition (which they aren't). To the extent that Debtor is seeking an order compelling the Trustee to abandon these agreements, the motion is denied.
The various documents that comprise the Sales Agreement must be taken as one contract. The Stock Purchase Agreement, in fact, not only refers to the Note and Employment Agreement, but contains actual promises to pay the monies due under those documents. See Exhibit A to Motion to Compel. If the Sale
Executoriness is a question of federal law. See, e.g., Griffel v. Murphy (In re Wegner), 839 F.2d 533, 536 (9th Cir.1988). The Ninth Circuit uses the Countryman test for "executoriness," essentially that there is material performance due on both sides of the contract at the petition date:
Unsecured Creditors' Committee v. Southmark Corp. (In re Robert L. Helms Constr. & Dev. Co.), 139 F.3d 702, 705 (9th Cir.1998) (quoting Griffel v. Murphy (In re Wegner), 839 F.2d 533, 536 (9th Cir.1988)).
Courts have defined "material performance" as "the essence of what the other party sought and expected when he entered into the ... Agreement, and without it, the party will lose the benefit of the bargain that he thought he had struck." In re WorldCom, 343 B.R. 486, 496-97 (Bankr.S.D.N.Y.2006) (quoting In re Teligent, 268 B.R. 723, 730-31 (Bankr.S.D.N.Y. 2001)). In a similar vein, material performance has been defined as the "bargained for" objective or consideration. See, e.g., In re Conseco, Inc., 2005 WL 2737507 at *5, 2005 U.S. Dist. Lexis 24584 at *15 (N.D.Ill.2005), aff'd 458 F.3d 573 (7th Cir.2006) (applying Indiana law); In re Waldron, 36 B.R. 633, 637 (Bankr. S.D.Fla.1984). Some courts, such as the Seventh Circuit in Conseco, have turned to applicable state contract law. The Sales Agreement is governed by Washington law (Stock Purchase Agreement ¶ 9.6), which defines material breach as one "serious enough to justify the other party in abandoning the contract ... one that substantially defeats the purpose of the contract." Park Ave. Condo. v. Buchan Devs., 117 Wn.App. 369, 71 P.3d 692 (2003) (quoting 6A Wash. Pattern Jury Instructions: Civil 302.03, at 127 (1997)).
It is undisputed that, on the 4/3/08 petition date, Purchasers had material performance remaining under the Sales Agreement: they owed at least $750,000 under the Note, as well as salary and fringe benefit obligations under the Employment Agreement. The question is whether Debtor also had material performance obligations remaining. Debtor had long before delivered his equity interest in SPNW to the Purchasers, so any remaining obligations were under the Employment Agreement (Exh. H to Motion to Compel), which would continue in effect until the Note was paid down below $650,000:
Employment Agreement ¶ 2; see also Stock Purchase Agreement ¶ 5.5.
In addition, during his employment, Debtor had non-compete and confidentiality obligations under the Employment Agreement. Employment Agreement ¶¶ 6, 7. The Stock Purchase Agreement also provides for Debtor to serve as a "non-voting director emeritus" of SPNW during his employment. Stock Purchase Agreement ¶ 5.5.
Debtor's emeritus directorship cannot be material performance which was still due by Debtor under the Sales Agreement, because the Stock Purchase Agreement treats it is as a right of Debtor's, rather than an obligation: "Sjoquist
A majority of cases have held that restrictive covenants in employment contracts, such as non-compete, confidentiality and non-interference, are not sufficiently material to render a contract executory under the Countryman test. Shults & Tamm v. Brown (In re Hawaiian Telcom Communs., Inc.), 2012 WL 273614 at *4, 2012 Bankr.LEXIS 380 at *11 (Bankr. D.Haw. Jan. 30, 2012) ("The majority of cases examining non-competition and non-solicitation obligations hold that these provisions are not sufficiently material under the Countryman test."); see, e.g., In re Spectrum Info. Technologies, 190 B.R. 741, 749-50 (Bankr.E.D.N.Y.1996) (non-debtor employees' duties of non-competition, confidentiality, public statement and non-interference insufficient); In re Drake, 136 B.R. 325 (Bankr.D.Mass.1992) (employment agreement arising from sale of debtor's business non-executory, where debtor's only duty is non-competition); In re Bluman, 125 B.R. 359 (Bankr.E.D.N.Y. 1991) (debtor's non-compete covenant and agreement to assist buyer for year after sale of debtor's business did not render agreement executory). Non-materiality is not an automatic conclusion: on reconsideration, the bankruptcy court in Shults & Tamm gave parties an opportunity for discovery and briefing on materiality. 2012 WL 1110065, *1-2, 2012 Bankr.LEXIS 1417, *3-4 (Bankr.D.Haw. Apr. 2, 2012).
However, in the case before me, Debtor has presented no evidence that these provisions were material to Purchasers. Even if Debtor's non-compete and confidentiality covenants had been a "bargained for objective" of Purchasers in the 2001 Sales Agreement, it is difficult to imagine that in 2001, it was a material inducement to the Purchasers that the Debtor would be barred from competing or disclosing confidential information seven or more years after they took over ownership of the company.
Debtor's affirmative duties as a salesman and managerial assistant might be more likely to be found material, but Debtor has not presented evidence or even asserted that he performed any sale or managerial duties for the company under the Employment Agreement since the 2001 sale. In In re Spectrum Info. Technologies, 190 B.R. 741 (Bankr.E.D.N.Y. 1996), the court found that similar continuing consulting obligations of previously terminated employees were insufficient to
Spectrum Info., 190 B.R. at 751.
Like the consulting obligations in Spectrum, Debtor was not prohibited from accepting full-time employment elsewhere nor was Debtor required to render the services at SPNW's place of business. The Spectrum court identified the key inquiry for these cases: this employment was simply not a material purpose underlying the Sale Agreement (evidenced by the fact that Purchasers apparently sought little or none of Debtor's services) and Debtor's failure to perform at most would have entitled Purchasers to a claim for damages. The immateriality of Debtor's services is reinforced by the fact that Debtor was paid the same amount regardless
An Arizona bankruptcy court did decide that an employee's obligations to his previous employer were sufficiently material to make their agreement executory, but this case is distinguishable by that court's emphasis on employee's actual performance of these obligations:
In re Bryant Universal Roofing, 218 B.R. 948 (Bankr.D.Ariz.1998). Unlike this Debtor, the employee in Bryant actually attended board meetings and helped his employer sells some assets.
It is also possible that the $5,000 salary paid to Debtor for many years, whether or not he performed any work under the Employment Agreement is merely a clever allocation of the purchase price done for tax purposes or other structuring issues. See, e.g., In re Drake, 136 B.R. 325, 327 (Bankr.D.Mass.1992)("Trustee ... argue[s] that the Agreement [paying debtor $6,250/month for 60 months in exchange for non-compete covenant] is a disguised buy-sell for tax purposes"; agreement held non-executory).
Even if the Sales Agreement was held to be executory and thus deemed rejected under § 365(d)(1), that rejection does not effectively abandon it to Debtor. Some courts have held, as Debtor argues, that rejection removes the contract from the estate, so that control reverts back to the Debtor. See, e.g., Stoltz v. Brattleboro Housing Authority, 259 B.R. 255, 258 (D.Vt.2001), aff'd 315 F.3d 80 (2d Cir. 2002); In re Scharp, 463 B.R. 123 (Bankr. C.D.Ill.2011). However, this conclusion seems contrary to the language of § 365(g). This court accordingly agrees with a Ninth Circuit affirmation on this issue:
In re Phillips, 2010 WL 3041968, *3, 2010 U.S. Dist. LEXIS 89834, *8-9 (W.D.Wash. July 30, 2010), aff'd 460 Fed.Appx. 636 (9th Cir.2011); see also First Ave. West Bldg. LLC v. James (In re OneCast Media, Inc.), 439 F.3d 558, 563 (9th Cir.2006) ("The statutory breach of contract simply put the estate in the position of a breaching party to the executory contract. Rejection under the Bankruptcy Code did not divest the estate from the breaching party's rights under the terms of the contract and applicable state law.") (quoting In re Thompson-Mendez, 321 B.R. 814, 819 (Bankr.D.Md.2005).)
Even if the Sales Agreement was an executory contract subject to rejection by operation of § 365(d)(1) and even if such rejection would revest the Sales Agreement in Debtor, Debtor has entered into two separate
And, while he did not expressly agree to Trustee receiving 65% of the Note payments, he was a party to two contracts that did so. At a minimum, such conduct should constitute waiver or grounds for estoppel. Waiver and estoppel are available to defeat rejection by operation of § 365(d)(4). See, e.g., In re VMS Nat'l Properties, 148 B.R. 942 (Bankr.C.D.Cal.1992)(citing numerous cases including In re Car-Gill, Inc., 125 B.R. 133 (Bankr.E.D.Pa.1991), In re Austin, 102 B.R. 897 (Bankr.S.D.Ga.1989); In re T.F.P. Resources, Inc., 56 B.R. 112 (Bankr.S.D.N.Y.1985)). There is no reason why waiver of § 365(d)(1) should not be governed by the same principles. See Bankruptcy Law Manual § 9.47 (considering waiver of §§ 365(d)(1) and (d)(4) together).
The following are "the requirements of a waiver: (1) the existence at the time of the waiver of a right, privilege, advantage or benefit; (2) the actual or constructive notice thereof; and (3) the intention to relinquish such right, privilege, advantage or benefit." In re George, 177 F.3d 885 (9th Cir.1999)(quoting VMS,
The Sales Agreement is not an executory contract. Even if it were and the contract was deemed rejected by operation of law, rejection of that contract simply constitutes a breach as of the filing of the petition. Rejection is not abandonment by the estate and does not revest the Sales Agreement and rights thereunder in Debtor. Furthermore, after the petition date, Debtor entered into a binding agreement allocating 65% of the Salary Payments to the Trustee and acknowledging the allocation of 65% of Note payments to Trustee. Debtor's motion to compel abandonment is denied.
Debtor, Trustee and Erika's chapter 7 trustee filed an arbitration against the Purchasers to enforce the various agreements. A settlement has now occurred, which the parties wish this court to approve. In June, Debtor, Erika's trustee, the Trustee, SPNW, SDN, and the Backstroms entered into a settlement agreement ("2012 Settlement Agreement"). Basically SPNW, SDN and each of the Backstroms will sign and deliver a Confession of Judgment in favor of Debtor, the Trustee and Erika's trustee in the amount of $1.9 million plus interest to accrue. With respect to the Backstroms, this is only on behalf of their individual property and not their marital communities. Debtor, the Trustee and Erika's trustee reserve their claims against the Backstroms' marital communities. A mediation will take place within 60 days to establish the amount of the judgment ultimately to be paid and the form/manner of payment. Debtor, the Trustee and Erika's trustee have not determined how to divide any proceeds as between the Salary Payments and the Note Payments. (The two trustees have tentatively agreed that monies received should be split 65% to Robert's Estate and 35% to Erika's Estate, but any final agreement on allocation will be subject to bankruptcy court approval.). Trustee testifies that, in his business judgment, the proposed compromise is fair and reasonable and also that it in the best interests of the estate. See Declaration of David Hagen annexed to the Motion for authority to compromise.
Debtor does not object to the amount, but he does not believe that the Note is an asset of the estate because Trustee did not assume the Sale Agreement in a timely manner. (Debtor accordingly brought a motion to compel abandonment discussed above.) He also raises the following other difficulties with the 2012 Settlement Agreement:
Debtor wants the Court to approve the Confession of Judgment for $1.9 million, but reserve jurisdiction to resolve who are the proper parties as well as the distribution of the proceeds.
For the reasons discussed above, the Court has ruled that the Sales Agreement is not an executory contract and so was not rejected by Trustee under § 365(d)(1). Nor would Debtor obtain rights to these contracts upon rejection. Thus, rights to payment under the Sale Agreement are property of the estate, which Trustee has authority to compromise.
"The purpose of a compromise agreement is to allow the trustee and the creditors to avoid the expenses and burdens associated with litigating sharply contested and dubious claims." Martin v. Kane (In re A & C Properties), 784 F.2d 1377, 1380-81 (9th Cir. 1986). Before approving a settlement agreement, the bankruptcy court is charged with considering the "fairness, reasonableness, and adequacy" of the agreement. Id. at 1381.
The Court agrees with the Trustee's judgment that the proposed compromise is a fair and reasonable one and in the best interests of the estate. Although there is no certainty of collection under the terms of the 2012 Settlement Agreement, there will be a confession of judgment for $1.9 million. There is no guarantee of success in litigation and no more certainty of collection. Litigation counsel on this matter has testified that litigation would most likely result in a judgment of $1.6 to $2.2 million. See Declaration of Adam R. Asher annexed to the Motion for Authority to Compromise. So this settlement is squarely within the range of an expected judgment, but without the expenses of litigation. It is not clear what portion of the Backstroms' assets are in their marital communities (and not a part of this settlement), but the Trustee has reserved his rights in this regard. The 65%-35% agreement follows the prior settlement agreements which divide things in that proportion, but the motion is not asking the Court to determine the distribution at this time. As to any issues that Erika has against the trustee in her bankruptcy case, she needs to deal with those in that case. Trustee's motion for authority to compromise is granted.
