CONTRACT ASSUMPTION DEFENSE -- ABSOLUTE BAR TO BANKRUPTCY AVOIDANCE POWERS

After filing for chapter 11 bankruptcy, the debtor in possession has the option of either assuming or terminating "executory contracts," meaning contracts having future performance obligations. To assume an executory contract, the debtor must first cure all outstanding defaults and provide adequate assurance of future performance. 11 U.S.C. sec. 365(b).

The U.S. Bankruptcy Court for the District of Colorado has affirmed that, once an executory contract is assumed, payments made under the contract cannot be avoided as "preferences." In re Centrix Financial, LLC, Bankr. Case No. 06-16403 (June 15, 2010). In general, payments made by the debtor within 90 days before filing a bankruptcy petition (one year if made to an insider) on account of a pre-existing debt and made while the debtor was insolvent can be avoided as "preferences," meaning the debtor in possession or bankrutpcy trustee may assert a claim against the recipient to recover amounts paid by the debtor prior to filing for bankruptcy. 11. U.S.C. sec. 547.

In addition to holding that payments made on an assumed contract cannot be avoided as preferences, the Bankruptcy Court held that all payments made under the assumed contract were unavoidable, even though only part of the services provided for in the contract were to continue post-petition. In other words, the whole integrated contract was assumed, not just the parts the debtor wanted to keep.

In the Centrix case, the debtor entered into one contract with the defendant for postage metering and mailing services and a second contract for professional services. The debtor intended to assume only the second contract, and the liquidating trustee appointed by the court attempted to avoid as preferences the payments made with respect to the postage metering and mailing services contract . The defendant successfully argued that the two contracts were in fact one integrated contract, because in the second contract's integration clause, the first contract was incorporated in and made a part of the second contract. The court held that the entire integrated contract was assumed, not merely the part intended to be assumed by the debtor.

Posted By: Brent W. Houston, Esq.