Contributed by David G. Litvack
In a recent, must-read decision, the United States Bankruptcy Court for the Southern District of Florida ruled that a claimant could not obtain specific performance or money damages under a rejected contract because the contract limited the remedies for breach to specific performance, and specific performance is generally unavailable to a non-debtor counterparty to a contract rejected under section 365 of the Bankruptcy Code.
Prior to its chapter 11 filing, homebuilder TOUSA, Inc. (and its affiliates) entered into two contracts that required TOUSA to build and then sell homes to another homebuilder. After filing for chapter 11 protection, TOUSA received bankruptcy court approval to reject certain executory contracts, including the two contracts at issue. As a result of these contract rejections, the counterparty-claimant to the rejected contracts filed a proof of claim seeking rejection damages. The debtors objected to the claim and asserted that both contracts clearly provided that, in the event of a default, the claimant could only seek a return of certain deposits or equitable relief, such as specific performance. Importantly, the contracts expressly provided that the claimant waived “any right it may now or in the future have, at law, in equity or otherwise, to seek or obtain money damages from Seller.” Notwithstanding this unequivocal language, the claimant asserted that it was entitled to money damages.
Under section 365(g) of the Bankruptcy Code, rejection of an executory contract constitutes a prepetition breach of such contract. Section 365, however, does not state what this means. As a result, courts are left to address issues such as whether the non-defaulting party is limited to asserting a claim for damages or whether it retains a right to specific performance. Section 101(5)(B) of the Bankruptcy Code converts certain rights to specific performance to claims, and section 502(c)(2) of the Bankruptcy Code permits a court to estimate, for purposes of claim allowance, “any right to payment arising from a right to an equitable remedy for breach of performance.” Nothing in the Bankruptcy Code, however, expressly ties these concepts together in the context of a rejected contract.
In TOUSA, the bankruptcy court started with the principle adopted by some courts that rejection of an executory contract typically deprives the non-defaulting party of its rights to specific performance. The bankruptcy court noted that, although section 502(c)(2) contemplates estimation of equitable remedies, this section of the Bankruptcy Code only allows for estimation if a claim “involves a right to payment” in the first instance. Put differently, section 502(c)(2) presupposes that a “right to payment” exists for breach of specific performance before estimation. Accordingly, the bankruptcy court characterized the central dispute between the parties as whether the counterparty had a right to payment, either under the contract or under state law.
Notwithstanding the express waiver in the contracts with respect to money damages, the claimant argued that Florida law creates an exception to this contractual waiver where the remedy of specific performance is impossible. Under this exception, where a seller intentionally breaches a contract in order to sell property at a higher price to a third party, the buyer may be entitled to recover the difference between the original buyer’s offer and the higher price paid by the third party notwithstanding a contractual waiver of money damages. The bankruptcy court, however, rejected this argument and found that TOUSA did not profit from the property at issue to the detriment of the claimant, deeming the exception to be inapplicable. The bankruptcy court held that because the rejected contracts expressly waived the claimant’s right to any money damages claim, and rejection foreclosed any possibility of specific performance, the only remaining remedy for the claimant under the contract was to seek a return of deposits.
It is worth noting that, in this particular case, specific performance was actually impossible because TOUSA, after notice and a hearing, sold the property that was the subject of the two rejected contracts. Specifically, the bankruptcy court noted that the claimant “waived its specific performance entitlement when it was put on notice of the [m]otion to approve the [sale of the properties at issue] and did not object.” It is unclear, however, why this mattered to the bankruptcy court because it held that, as a general matter, rejection of a contract deprives a non-defaulting party of its specific performance remedy. Other courts, however, have held that the notable exception to this rule is where the remedy of specific performance cannot be reduced to monetary damages.
Although the ultimate result is not surprising, attorneys drafting similar contracts are wise to think twice about limiting remedies in a contract solely to specific performance. In the event of a bankruptcy filing, that remedy may prove to be illusory. As the old saying goes, “cash is king,” which holds especially true in the bankruptcy arena.