Contributed by Adam Lavine
In a recent case, In re Hawker Beechcraft, Inc., No. 12-11873, 2013 WL 2663193, (Bankr. S.D.N.Y. June 13, 2013), Judge Bernstein of the Bankruptcy Court for the Southern District of New York held that a debtor could assume two master purchase agreements between the debtor and one of its suppliers, but reject individual purchase orders issued by the debtor under those same agreements. In reaching this holding, the court relied on the doctrine that a debtor may assume certain portions of an agreement while rejecting others, so long as each such portion constitutes a divisible, independent contract under applicable non-bankruptcy law.
Hawker Beechcraft, a leading aircraft manufacturer and servicer that emerged from bankruptcy in February 2013, was a party to two prepetition master purchase agreements with one of its suppliers. Among other things, the master agreements set forth the general terms that would be incorporated into any purchase orders issued by Beechcraft for the manufacture and delivery of various aircraft components. Beechcraft sought to assume the master agreements and 395 purchase orders, but it wanted to reject another 928 purchase orders. The purchase orders Beechcraft sought to reject were for parts for discontinued aircraft lines.
Section 365 of the Bankruptcy Code authorizes a debtor to assume or reject an executory contract or unexpired lease. Generally, executory contracts and unexpired leases must be assumed or rejected in their entirety. Many courts, however, allow parts of a single contract to be assumed or rejected separately if the contract is “divisible” or “severable” under applicable state law. The Delaware bankruptcy court recently addressed the issue of divisibility under Florida law in a decision we covered on May 29, 2013.
Beechcraft argued that each of the master agreements and the purchase orders were separate and divisible contracts, and, as a result, it had the ability to (i) assume the purchase orders for the components that it wanted (i.e., require the supplier to deliver such components in exchange for the contract price) and (ii) reject the purchase orders that it did not want (i.e., effectively cancel the orders for such components and leave the supplier with a prepetition claim for damages). The supplier argued that Beechcraft could not cherry-pick the purchase orders it wanted to assume in this way because the master agreements and the purchase orders constituted a single, indivisible contract. In other words, the supplier wanted Beechcraft either to (i) assume all purchase orders and therefore pay for, and accept delivery of, all the ordered components (including ones for discontinued aircraft), or (ii) reject all purchase orders and leave the supplier with a substantial prepetition damages claim.
Judge Bernstein began his analysis in Hawker Beechcraft by noting that whether an agreement is divisible is governed by state law. In this case, the master agreements and purchase orders were explicitly governed by Kansas law. Under Kansas law, “a contract is divisible by its terms [if] (1) performance of each party is divided into two or more parts, (2) the number of parts due from each party is the same, and (3) the performance of each part by one party is the agreed exchange for a corresponding part by the other party.”
In applying Kansas’ divisibility standard to the master agreements and purchase orders, the court focused its analysis on identifying the obligations incurred, and the consideration exchanged, under each master agreement and purchase order. With respect to the master agreements, the court noted that the master agreements did not actually obligate Beechcraft to issue any purchase orders. Rather, the court determined that each master agreement constituted a distinct option contract pursuant to which the supplier granted Beechcraft an option to place orders for various aircraft components. As consideration for these options, Beechcraft provided, among other things, certain equipment to be used in the manufacture of the components. In contrast to the master agreements, each purchase order obligated Beechcraft to purchase a particular component or components, and the purchase price was consideration for the delivery of such components. That each master agreement and purchase order involved independent obligations and separate consideration was identified by the court as persuasive evidence that, under Kansas law, the master agreements and purchase orders constituted divisible contracts.
To further support its holding, the court pointed to specific provisions of the master agreements and purchase orders, which, according to the court, revealed the parties’ intent to treat the master agreements and purchase orders as independent contracts. For example, with respect to the master agreements, the court highlighted various provisions that distinguished between performing, terminating, or assigning the master agreements (on the one hand) and the purchase orders (on the other hand). According to the court, if the master agreements and purchase orders were intended to be a single, indivisible contract, the parties would have had no reason to distinguish between the master agreements and purchase orders in this way. With respect to the purchase orders, the court noted that each purchase order contained an integration clause, which stated that the purchase order “contains the entire agreement of the parties.” The court viewed the integration clause as additional support for its finding that each purchase order was intended to be a separate and distinct agreement.
Finally, the court also noted that its holding was supported by certain non-bankruptcy cases. See e.g., Carlisle Corp. v. Uresco Constr. Materials, Inc., 823 F. Supp. 271 (M.D. Pa. 1993); S.A.M. Elecs., Inc. v. Osaraprasop, 39 F. Supp. 2d 1074, 1086 (N.D. Ill. 1999). These cases, like Hawker Beechcraft, involved the question of whether a master agreement and the purchase orders issued pursuant to that agreement constituted separate agreements under applicable state law. In each case, the applicable court found the master agreements and the purchase orders to be separate contracts under applicable state law.
Hawker Beechcraft serves as a reminder that debtors (and potential debtors) should be on the lookout for contracts that it may want to assume in part and reject in part, if doing so would be advantageous to the goals of its restructuring. Indeed, by invoking the divisibility doctrine, Beechcraft successfully secured a supply of parts to be used in its reorganized business, while rejecting purchase orders for parts related to aircraft that would not be part of its reorganized business. Further, both debtors and contract counterparties alike should remember that whether a debtor may assume an agreement in part and reject an agreement in part will ultimately depend on applicable state law.