In Re Columbia Gas System Inc. Columbia Gas Transmission Corporation, Debtors. Enterprise Energy Corporation v. United States of America, on Behalf of the I.R.S., Thomas E. Ross, Trustee
Docket: 93-7409
Court: Court of Appeals for the Third Circuit; March 9, 1995; Federal Appellate Court
In the case of In re Columbia Gas System Inc., the United States Court of Appeals for the Third Circuit addressed whether a class action settlement agreement qualifies as an executory contract under 11 U.S.C. § 365. The Internal Revenue Service (IRS) argued that the settlement did not constitute an executory contract, a position supported by both the bankruptcy and district courts. The appeal was filed by members of the class action.
The background involves Columbia Gas System, Inc. and its subsidiary, Columbia Gas Transmission Corporation (TCO), which operates within the natural gas sector. In July 1985, Enterprise Energy Corporation and other companies initiated a class action against TCO, representing 2,163 natural gas producers in the Appalachian region who claimed TCO breached their gas purchase contracts by invoking a cost recovery clause, leading to payments below the maximum price stipulated under the Natural Gas Policy Act of 1978.
After extensive discovery over five years, the parties reached a Stipulation of Proposed Class Action Settlement, approved by the district court on June 18, 1991. This approval included a release of claims against TCO related to the cost recovery clause for the period from July 10, 1985, to July 10, 1991. The court retained jurisdiction over matters concerning the settlement's interpretation and administration. The order became final and unappealable on July 18, 1991. The appellate court affirmed the lower courts' decisions regarding the nature of the settlement agreement.
The settlement agreement mandated TCO to deposit $30 million into an escrow account to fully release TCO from class members' claims arising before January 1991. TCO was to pay $15 million by March 21, 1991, and another $15 million by March 23, 1992, with the second payment not contingent on any obligations from class members. TCO made the first payment but subsequently filed for bankruptcy. Class members could only access their share of the escrow after executing a release of claims and a supplemental contract. The agreement specified that individual payments from the escrow were contingent on these executed documents. Although the claims were extinguished by the court order accepting the settlement, the supplemental contracts addressed amendments regarding future gas deliveries, which were crucial for class members relying on TCO as their main purchaser. By July 31, 1991, class members involved in forty-one contracts had executed the necessary documents when TCO filed for Chapter 11 bankruptcy. Subsequently, class members motioned to compel TCO to assume or reject the settlement agreement under 11 U.S.C. Sec. 365. TCO agreed to assume the settlement, but the IRS objected, leading the bankruptcy court to determine the agreement was not executory under Sec. 365, thus denying the motion. The class members appealed, and the district court affirmed the bankruptcy court’s ruling, stating the contract was not executory, preventing TCO from assuming or rejecting it. The appeal process was detailed, confirming jurisdiction in both the bankruptcy and district courts under relevant statutes.
The appeal concerns whether the settlement agreement qualifies as a contract and if it is executory, allowing TCO to assume or reject it under Section 365 of the Bankruptcy Code. The IRS contends that the settlement is a court judgment rather than a contract, arguing that since it merged into the court's judgment, it cannot be an executory contract as defined by the Bankruptcy Code. The bankruptcy court appeared to agree, suggesting that "executory contract" generally does not apply to judicial orders. However, the district court disagreed, asserting that for bankruptcy purposes, the judicially approved settlement should be treated as a contract.
The analysis begins by questioning whether the settlement would be considered a contract outside of bankruptcy, noting that the Bankruptcy Code does not alter the essential nature of legal relationships. If the settlement is considered a contract under nonbankruptcy law, it retains that status in bankruptcy unless a federal interest dictates otherwise. Judicially approved settlement agreements share characteristics of voluntary contracts and are interpreted under traditional contract principles.
The settlement agreement at issue involved consensual obligations between parties, with court approval, and did not constitute a judgment on the merits, distinguishing it from cases cited by the bankruptcy court. The rights and obligations of the parties are tied to mutual performance, meaning there exists potential for breach by the debtor, which could create a claim against it. Although not every settlement agreement is deemed a contract, the outlined factors support treating this settlement as a contract for Section 365 purposes.
The core issue is whether the settlement agreement was executory when TCO filed for bankruptcy on July 31, 1991. The Bankruptcy Code does not define "executory contract," and its legislative history suggests a broad interpretation, encompassing contracts with unperformed obligations on both sides. However, many courts have recognized that this broad definition may be overly expansive, as nearly all contracts involve some level of unperformed obligations. Courts and commentators have since sought to define "executory contract" by examining the purpose of Section 365.
Executory contracts in bankruptcy are characterized as a blend of assets and liabilities for the bankruptcy estate. The debtor or trustee may choose to assume an executory contract, which requires them to accept both the asset (the nonbankrupt's performance) and the liability (the debtor's obligations) and perform accordingly. Assumption is favored when the contract represents a net asset for the estate; otherwise, it should be rejected. The cost of fulfilling the debtor's obligations is classified as an administrative expense, prioritized for payment from estate assets.
If the nonbankrupt party has fully performed, the situation changes; the debtor only faces a liability—a claim from the nonbankrupt against the estate. Conversely, if the debtor has fully performed, the nonbankrupt's performance is treated as an asset. The definition of an executory contract under Section 365 is that both parties must have unperformed obligations, with non-performance by either constituting a material breach excusing the other from performance. If the nonbankrupt has substantially performed, they become a general creditor rather than a party to an executory contract.
The critical assessment of unperformed obligations occurs at the time of the bankruptcy petition. The priority of claims, such as those from the IRS and class members, hinges on whether the contract is executory. If executory, TCO's unperformed $15 million payment would be classified as an administrative expense, granting class members higher payment priority. If not executory, their claims would be unsecured and lower in priority.
TCO's obligations were deemed executory upon filing for bankruptcy due to its failure to make the second $15 million payment and complete necessary administrative tasks, with the payment being a material obligation. The materiality of the class members' unperformed obligations remains less clear, as both parties must have significant unperformed obligations for the contract to retain its executory status.
Class members had unfulfilled obligations under the settlement agreement, with only 41 of 852 contracts processed before TCO's bankruptcy. The remaining 811 contracts required class members to execute releases and supplemental contracts to receive their shares of the escrow fund. Class members argued that their obligations were material, asserting that failing to perform would be a material breach. The legal distinction between a condition and a duty is crucial; non-fulfillment of a condition does not constitute a breach unless there is a duty to fulfill that condition. The Restatement clarifies that a contracting party's failure to meet a condition does not subject them to liability unless there is an independent promise to perform. If the remaining obligations are merely conditions, the contract cannot be deemed executory under Sec. 365 since no material breach would exist.
Interpretation of whether a contract term is a promise or a condition depends on the specific facts of each case. Courts may consider extrinsic evidence if the settlement agreement lacks clear language. The settlement stipulated that if a class member did not execute a release, TCO would retain that member's portion of the $30 million, and their cause of action against TCO would remain extinguished post-final court order on July 18, 1991. The agreement indicates that the execution of releases is a condition for payment rather than a duty; payments from the escrow fund depend on TCO receiving a duly executed release. If funds allocated to a contract are not distributed, they revert to TCO. The agreement's language, particularly references to "subject to final Court approval," underscores that the parties intended the court's approval to be the critical condition, with the extinguishment of claims occurring upon that approval, rather than execution of the releases.
A class member's failure to execute a release results in the loss of their share of the settlement fund; however, TCO still benefits from the class member's inability to sustain a cause of action. The district court noted that if the case were merely a transaction of money for a release, it would be clear that the contract is not executory. TCO remains obligated to place $15 million into escrow regardless of individual class members’ actions. The releases serve as conditions for class members to receive their settlement shares, not as mechanisms that could materially breach the contract.
Additionally, class members are required to complete supplemental contracts for future gas sales with TCO, but these contracts are deemed ministerial, intended to apply the settlement agreement's terms specifically to each member without altering the original relationship. The district court concluded that executing these contracts would be a mere formality, similar to the release execution. A failure by individual class members to execute the supplemental contracts does not constitute a material breach of the settlement agreement but rather a failure of a condition, relieving TCO of the obligation to pay that member.
The supplemental contracts primarily benefit class members, as they establish higher prices than previous contracts, and their execution is unlikely to be seen as a breach. While the supplements aim to prevent disputes and might benefit TCO, they are not essential to classify the settlement agreement as executory. Any failure to execute the supplements does not breach the settlement agreement, and if the agreement were deemed executory, assuming it would only marginally benefit TCO without granting new rights beyond the district court's prior order.
The Ohio District Court's order applied to the entire class and became final and unappealable, binding all members. Their failure to fulfill prerequisites for receiving settlement funds does not constitute a breach of the agreement with TCO but signifies the failure of conditions precedent for settlement rights. The assumption of such agreements would not increase the bankruptcy estate's assets. The court affirmed the district court's judgment, published in Enterprise Energy Corp. v. United States ex rel. IRS (In re Columbia Gas System, Inc.), 146 B.R. 106 (D.Del.1992). The class is defined as all owners and operators of natural gas wells in the Appalachian region who have contracts with Columbia Gas Transmission Corporation and are affected by price reductions.
Referencing Section 365 of the Bankruptcy Code, the trustee may assume or reject executory contracts with court approval. The IRS's claim against the estate is significant, potentially amounting to $500 million over five years. The bankruptcy court determined that the settlement agreement is not a contract, as judicial orders are not considered executory contracts. The class contends that the IRS failed to preserve the appeal point by not cross-appealing the district court's ruling on the settlement agreement's contractual status, but the court disagrees, citing precedent that allows an appellee to argue any issue in support of the decree without a cross-appeal.
The court further clarifies that a condition affecting an obligor's duty does not automatically impose a duty on the obligee, and non-occurrence does not equate to a breach unless such duty exists. The settlement agreement is likened to an insurance contract where statutory provisions prevent a breach from excusing performance. Even if the class's failure to execute certain documents were a breach, the court order's operation would prevent that breach from excusing either party's performance. Additionally, TCO's recovery of unspent funds does not constitute a justification for non-performance, thereby not making the contract executory by the standards set in Sharon Steel Corp. v. National Fuel Gas Distribution Corp. The case In re Sudbury, Inc. is cited as relevant, with the debtor asserting that its insurance-related agreements were not executory contracts.
Insurers contended that their policies were executory and that premium claims should receive administrative expense priority. They argued that bankruptcy did not absolve their coverage obligations and that the debtor's unpaid premiums did not render the policies executory. The insurers claimed the debtor had responsibilities under cooperation clauses in the event of a claim, but the court ruled these obligations were insufficient to classify the policies as executory. The court noted that a debtor's failure to meet these obligations would only provide a defense to a specific claim, not invalidate the insurers' overall obligations. The insurers' primary concern was achieving administrative expense priority rather than enforcing cooperation clauses. The court drew an analogy between the supplemental contracts and cooperation clauses, indicating that a failure to comply would relieve the insurers of a single claim but not their broader obligations under the insurance policies. The case was distinguished from Sharon Steel, where an executory contract was found due to reciprocal future obligations, highlighting that not all contracts that appear executory are considered so under the Bankruptcy Code. The court emphasized the need for a precise definition of executory contracts for bankruptcy purposes, noting that while all contracts can be executory to some extent, this expansive interpretation is not applicable under the Bankruptcy Act.
