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In re Weinstein Holdings Company, LLC Third Circuit Court of Appeals, May 21, 2021 997 F.3d 497

In September 2011, Bruce Cohen and his production company, Bruce Cohen Productions, entered into an agreement (the “Cohen Agreement”) with SLP Films, Inc., a non-debtor special purpose entity formed by The Weinstein Company (“TWC”) to make Silver Linings Playbook (the “Picture”). The parties structured the Cohen Agreement as a “work-made-for-hire” contract, meaning Cohen owned none of the intellectual property in the Picture. In exchange, SLP Films agreed to pay Cohen $250,000 in fixed initial compensation, as well as contingent future compensation equal to roughly 5% of the Picture's net profits (“Contingent Compensation”).

The Picture was successfully released in November 2012 and resulted in an Academy Award for Best Actress for Jennifer Lawrence.  The Bankruptcy Court subsequently found that TWC owned all the rights pertaining to the Picture, including the Cohen Agreement.

In 2017, TWC's business floundered following many credible sexual misconduct allegations against its co-founder, Harvey Weinstein. As a result, TWC tried to sell its business and ultimately found Spyglass Media Group, LLC (“Spyglass”) as the only interested buyer. In March 2018, TWC filed its Chapter 11 bankruptcy petition and asked the Bankruptcy Court to approve the sale to Spyglass under Section 363 of the Bankruptcy Code. The sale closed in July 2018, though the Purchase Agreement gave Spyglass until November 2018 to designate which of TWC's executory contracts it wanted to assume as part of the sale.

Cohen asserted that the Cohen Agreement was an executory contract and the amount necessary to cure all defaults under the Cohen Agreement was approximately $400,000. But Spyglass believed that the Cohen Agreement was not executory and in October 2018, it filed a declaratory judgment action against Cohen seeking a determination that the Cohen Agreement “is not executory and therefore was already [sold] to [Spyglass] pursuant to Bankruptcy Code section 363.”

The Court began its analysis by noting that, in the Third Circuit, the test for determining whether a contract is an executory contract is the Countryman Test—whether each counterparty to the contract has at least one material obligation to perform as determined by governing state law. 997 F.3d at 504.  The Court further found that

"the Countryman test attempts to foolproof the debtor's choice to assume or reject contracts; thus, the debtor only has that flexibility for executory contracts—those contracts where there could be uncertainty about whether they are valuable or burdensome. A helpful perspective is to view executory contracts “as a combination of assets and liabilities to the bankruptcy estate; the performance the nonbankrupt owes the debtor constitutes an asset, and the performance the debtor owes the nonbankrupt is a liability.” Columbia Gas, 50 F.3d at 238 (citing Thomas H. Jackson, The Logic and Limits of Bankruptcy Law 106–07 (1986)). Under this framework, a contract where the debtor fully performed all material obligations, but the nonbankrupt counterparty has not, cannot be executory; that contract can be viewed as just an asset of the estate with no liability. See 3 Collier, supra ¶ 365.02[2](a). Treating it as an executory contract risks inadvertent rejection because the debtor would in effect be giving up an asset by rejecting it. Id. On the other extreme, where the counterparty performed but the debtor has not, the contract is also not executory because it is only a liability for the estate. Id. Treating it as an executory contract risks inadvertent assumption, for the debtor would effectively be agreeing to pay the liability in full when the counterparty should instead pursue the claim against the estate like other (typically unsecured) creditors. It logically follows that where “the only remaining obligation is the [debtor's] duty to pay”—the contract is not executory. See In re Teligent, Inc., 268 B.R. 723, 732 (Bankr. S.D.N.Y. 2001); see also Lubrizol Enter., Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043, 1046 (4th Cir. 1985). Thus, only where a contract has at least one material unperformed obligation on each side—that is, where there can be uncertainty if the contract is a net asset or liability for the debtor—do we invite the debtor's business judgment on whether the contract should be assumed or rejected. See Mission Prod. Holdings, Inc. v. Tempnology, LLC, ––– U.S. ––––, 139 S. Ct. 1652, 1658, 203 L.Ed.2d 876 (2019)In re Penn Traffic Co., 524 F.3d 373, 382 (2d Cir. 2008)."

Id. at 505.

The Court then applied this test to the Cohen Agreement and considered whether, under New York’s substantial performance test, each party had at least one remaining obligation under the Cohen Agreement that would constitute a material breach if not performed.  The Court found that TWC’s obligation to pay Cohen contingent compensation was clearly material because the amount of the Cohen’s contingent compensation greatly exceeded the fixed initial compensation. Id. at 507.

But the Court found that Cohen did not have any unperformed material obligations under the Cohen Agreement. The Court noted that “the essence of the Cohen Agreement was for Cohen to produce the Picture in exchange for money” and Cohen “contributed almost all his value when he produced the movie.” Id. The Court found that Cohen’s remaining obligations were “all ancillary after-thoughts in a production agreement.”  Id. The Court further found that (i) Cohen’s agreement to refrain from seeking injunctive relief about the exploitation of the Picture was redundant because Cohen had no intellectual property interest in the Picture, (ii) Cohen’s indemnification obligations were immaterial because the statute of limitations had likely run on any third party claims and (iii) the restrictions on Cohen’s ability to assign the agreement were ancillary boilerplate provisions.  Id.

The Court next considered Cohen’s argument that the parties had agreed in the Contingent Compensation provision of the Cohen Agreement that all of Cohen’s obligations were material. That provision provides that

"[i]f the Picture is produced with [Cohen] as the producer thereof and [Cohen] fully perform[s] all required services and obligations hereunder and in relation to the Picture, and [is] not otherwise in breach or default hereof, [Cohen] shall be entitled to receive [Contingent Compensation]."

The Court first noted that parties to an agreement can contract around a default rule such as the substantial performance rule—"that they can agree that what to the ordinary person is immaterial is nonetheless not so.” Id. The Court further found that “where the contract makes plain that certain unperformed obligations are material, we can conclude the contract is executory without further analysis.” Id. at 508 (citing In re General DataComm Industries, Inc., 407 F.3d 616, 623-24 (3d. Cir. 2005)). “Put another way, a breach can be considered material if ‘upon a reasonable interpretation of the contract, the parties considered the breach as vital to the existence of the contract.’” Id. (citing 23 Richard A. Lord, Williston on Contracts § 63:3 (4th ed. 2018)).

Turning to the Cohen Agreement, the Court rejected Cohen’s “forceful” argument because “the parties did not clearly and unambiguously avoid the substantial performance rule for evaluating executory contracts.”  The Court found that, in contrast to the cases upon which Cohen relied “where courts deferred to the parties’ agreement that all terms in the contract are material dealt with the remedies or termination section [of the agreement]”, the language Cohen relied on in the Cohen Agreement was “a nine-word phrase buried in a long covenant provision. Id. The Court further found that the distinction between a covenant and termination is meaningful.  Id. “When parties say that breach of a provision would result in termination or rescission of the contract, they make clear that the provision is material.” Id. “By contrast, covenants address the parties’ obligations (i.e., what they must and must not do) and typically are not a natural place to look when determining which of those obligations the parties consider to be material.”  Id. at 508-09.

The Court also found that the requirement that Cohen not be in default was better viewed as a condition to payment of the Contingent Compensation, not an obligation. “There is a distinction ... between failure of a condition and a breach of a duty .... “[I]f the remaining obligations in the contract are mere conditions, not duties, then the contract cannot be executory for purposes of § 365.”  Id. at 509 (quoting In re Columbia Gas Sys. Inc., 50 F.3d 233, 241 (3d Cir. 1995)).

The Court then concluded as follows:

"To be clear, we recognize that parties can contract around a state’s default contract rule regarding substantial performance, and by doing so they can also override the Bankruptcy Code’s intended protections for the debtor. However, that result can only be accomplished clearly and unambiguously in the text of the agreement. For the reasons explained above, we do not believe the Cohen Agreement avoided New York’s substantial performance rule."

Id. at 509. Accordingly, the Court held that the Cohen Agreement was not an executory contract because “Cohen’s remaining obligations were immaterial and ancillary to the purpose of the contract ….” Id.