“Some people have a way with words, and other people…oh, uh, not have way.”

Steve Martin

At issue in In the Matter of November 2005 Land Investors was the right of a party to recover funds deposited into escrow pursuant to an agreement with a land developer that subsequently filed for bankruptcy protection. After considering the language of the parties’ agreement and the effects of the developer debtor’s sale of its property under section 363 of the Bankruptcy Code, the United States Court of Appeals for the Ninth Circuit concluded that the non-debtor party merely had a contingent right to recover the funds and that such right had been extinguished when the debtor sold its land in the 363 sale.

Background

Prior to its bankruptcy filing, the land developer debtor entered into an agreement with another company to develop a master planned community. The development partner deposited funds to be used for the “Excess Builder Funding” into escrow. The parties entered into a “Conditional Repayment and Funding Agreement,” which governed the terms on which the Excess Builder Funding would be repaid to the debtor’s development partner. Notably, the only provision of the Conditional Repayment and Funding Agreement that expressly contemplated the release of the Excess Builder Funding to the development partner provided that a lender exercising remedies could elect to buy out the development partner by paying it the Excess Builder Funding amount. Another provision addressed when the Conditional Repayment and Funding Agreement would terminate:

This Agreement shall automatically terminate and be of no further force and effect upon the earlier of (i) the date that the Builder Excess Funding equals zero … (ii) the making of an Assumption Election by any applicable Successors pursuant to Section 1.a of this Agreement and (iii) the payment to Builder of the Builder Excess Funding.

After the debtor filed for bankruptcy (its second), it sought to sell its property free and clear of any liens, claims, or interests pursuant to section 363 of the Bankruptcy Code. Although the parties agreed that the property would be sold free and clear of the Conditional Repayment and Funding Agreement, they reserved their rights with respect to the effect of the sale on the development partner’s right to recover the Excess Builder Funding.

Analysis

The development partner conceded that express repayment provision of the Conditional Repayment and Funding Agreement was not triggered by the sale, but argued that the termination provision created a right to payment of the Excess Builder Funding because the debtor effectively was terminating the Conditional Repayment and Funding Agreement by selling the debtor’s property free of any obligations under such agreement. The development partner sought to be compensated for the value of its interest in Excess Builder Funding escrow.

The Ninth Circuit, however, found that the termination provision specified the terms under which the Conditional Repayment and Funding Agreement, but it did not create an independent right to payment because payment of the Excess Builder Funding was not the only way to terminate the agreement. Further, because the repayment right only could be enforced if a lienholder invoked its rights exercise its remedies and buy out the development partner (which both parties agreed had not occurred), the termination of the agreement was irrelevant. Thus, once the debtor sold its property pursuant to section 363(f), the buyout/repayment provision of the Conditional Repayment and Funding Agreement could no longer be triggered, and the agreement no longer had any legal effect. The court held that the Conditional Repayment and Funding Agreement only created a contingent interest that had no value because it expired upon the sale of the property.

The development partner also argued that, pursuant to section 363(e) of the Bankruptcy Code, it was entitled to payment of the Excess Builder Funding because the property’s sale extinguished its contingent interest. The Ninth Circuit found, however, that section 363(e) only requires that the bankruptcy court preserve the amount of a disputed interest pending a determination of the interest’s value. Because the contingent interest in the Excess Builder Funding failed to ripen before the property was sold, the Ninth Circuit determined that it was worthless, and the statutory obligation under section 363(e) had been satisfied.

Conclusion

In hindsight, the words of an agreement are often subject to many different interpretations. This case is a reminder of the importance of ensuring that the words of the agreement accurately reflect the intent of the parties.