Restructuring

Contributed by Blaire Cahn
Claims litigation is often a messy business.  With facts that include two chapter 11 cases, two state court litigations, and a motion for sanctions, the decision by the United States Court of Appeals for the Second Circuit in In re Best Payphones, Inc. is a good illustration of this point.
This case centers on a contract between Best Payphones and Manhattan Telecommunications for dial tone service.  Manhattan Tel was not the original counterparty to the contract, but purchased the contract from North American Telecommunications in North American’s chapter 11.  Before the purchase, Best and Manhattan Tel had a difficult history.  Manhattan Tel had sued and obtained judgments against Best for unpaid charges in connection with a 1999 contract.  Best objected to the assignment of its contract from North American to Manhattan Tel in part because of the pending litigation over the 1999 contract, as well as a related concern that Manhattan Tel would terminate Best Payphones’ service under the North American contract because of non-payment of the amounts related to the 1999 contract.  Best’s objection was overruled, and the North American bankruptcy court approved the assumption and assignment on April 25, 2001.  The order was not entered until May 16, 2001.
Let’s just say that the relationship between Best and Manhattan Tel did not get any better following the court’s approval of the assignment.
On May 8, 2001, Manhattan Tel sent Best a disconnection notice based on three debts:  the charges owed in connection with the 1999 contract and two unpaid invoices related to the North American contract.  The disconnection notice provided that Best should call Manhattan Tel with any questions.  Best did not contact Manhattan Tel, but instead contracted with another service provider.  Manhattan Tel sued Best again, this time for breach of the North American contract.
At the end of 2001, approximately six months after Manhattan Tel acquired the North American contract, Best sought chapter 11 protection.  Manhattan Tel filed a claim for lost profits in Best’s bankruptcy case.  Not content with a simple claim objection, Best then filed a letter indicating its intention to seek sanctions against Manhattan Tel’s counsel.  Almost ten years after Best’s chapter 11 filing, and following decisions by the United States Bankruptcy Court for the Southern District of New York and the United States District Court for the Southern District of New York in favor of Manhattan Tel, the Second Circuit ultimately addressed both Manhattan Tel’s lost profit claim and Best’s proposed motion for sanctions.
Best argued that Manhattan Tel’s claim should not be allowed for two primary reasons.  First, the disconnection notice amounted to an unequivocal repudiation of the North American contract.  As a result, Best was freed from its obligations under the terms of the agreement to provide Manhattan Tel with notice and an opportunity to cure prior to termination.  The Second Circuit was not persuaded by this argument.  While Manhattan Tel breached the North American contract by requiring payment of the 1999 charges, the breach did not amount to an unequivocal repudiation such that notice would have been futile.  Because the disconnection notice provided that Best should call with questions about the bill, it is ambiguous as to whether Manhattan Tel was unequivocally demanding payment of the 1999 contract charges.
Second, Best contended that Manhattan Tel did not have any rights under the contract at the time of the breach because (i) the North American bankruptcy court did not orally approve the assignment, and the written order had not been entered until after the breach, (ii) compliance by Manhattan Tel with certain telecommunications regulations was a prerequisite to the assignment, and (iii) FCC regulations and New York State law required Best’s approval for an effective assignment.
The Second Circuit dismissed each of these arguments.  It found that, while some ambiguity existed as to whether the North American bankruptcy court orally approved the transaction, the parties believed it had been approved, the court “so ordered” the record, and the court waived the relevant stay period for the order, an action that would have been meaningless without a corresponding approval of assignment of the contract.  In addition, the Second Circuit found that, although the sale order required the parties to comply with certain regulatory requirements, the effectiveness of the assignment was not expressly conditioned on such compliance.  Further, the Second Circuit pointed out that because Best conceded to the Bankruptcy Court that the contract was an executory contract and therefore freely assignable Best waived any consent based argument.  In addition, Manhattan Tel obtained an order from the FCC waiving any consent requirements and the terms of the North American contract provide for its assignability.
With respect to Best’s motion for sanctions, the Second Circuit concluded that, although Best’s letter was not styled as a motion, it served effectively the same function and permitted Best to preserve its arguments for review by an appellate court.  Of course, given the Second Circuit’s ruling, it rejected Best’s substantive assertions about sanctions.
This case serves as a reminder that claims litigation often requires fact intensive inquiry in which courts evaluate the conduct of the parties with the benefit of hindsight.  Courts are faced with difficult decisions when neither party has clean hands and must ultimately determine how to allocate the limited resources of a debtor’s estate.  At the end of the day, both parties paid a price for what appeared to be their dysfunctional relationship and lack of communication.  After ten years of litigation, Manhattan Tel “won” by having an allowed claim of $238,082.43 plus interest in Best’s chapter 11 case, a claim estimated to receive 100% under Best’s plan.  And Best?  Its estate fronted a ten-year war against Manhattan Tel, an expense that might have been saved if Best had only picked up the phone and called Manhattan Tel.