All’s fair in love bankruptcy and war . . . except when one side decides to keep fighting after there’s been a truce.  The petitioning creditors in In re BG Petroleum, LLC, a recent decision from the Bankruptcy Court for the Western District of Pennsylvania, apparently forgot this rule. In BG Petroleum, the court gave a lesson on the basic principles of contract law in ruling on dueling motions filed by the debtor BG Petroleum, LLC and the petitioning creditors who commenced its involuntary chapter 11 case. 

What Started this Fight?

Prior to the commencement of the debtor’s involuntary chapter 11 case, the petitioning creditors and the debtor entered into a ground lease pursuant to which the debtor took possession and control of each of the creditors’ businesses and assets and was required to make monthly payments to the creditors and pay certain other obligations.  The creditors filed an involuntary chapter 11 petition against the debtor, claiming debts of approximately $5 million on account of taxes and unpaid rent due under the ground lease.  The debtor responded with a motion to dismiss the case and for judgment against the creditors, alleging that they had breached the ground lease by failing to leave adequate cash and accounts receivable at the businesses that were the subject of the lease.

The parties requested to settle their disputes through mediation.  According to the certificate of completion filed by the mediator, the parties successfully reached a settlement at the conclusion of their mediation session.  The settlement would have eliminated the need to continue the bankruptcy proceedings.  The creditors filed a motion for approval of settlement pursuant to Federal Rule of Bankruptcy Procedure 9019.  In response, the debtor filed a limited objection, alleging that the terms set forth in the motion departed from the mutually-executed term sheet signed by the parties.  The debtor characterized the discrepancies between the creditors’ motion and the term sheet as based on mere mathematical errors, not as reflecting bad faith on the part of the creditors.  Nevertheless, the creditors moved to withdraw their motion to approve the settlement.   And so sparked the fight over whether the meditation term sheet constituted an enforceable settlement agreement.

In the meantime, before the enforceability issue was decided, the debtor filed a motion to withdraw its motion to dismiss the involuntary chapter 11 case, claiming that the delay associated with the negotiation process had interfered with its business operations to the point at which chapter 11 relief had become necessary.  The court granted the debtor’s request.

In anticipation of the hearing on the enforceability of the term sheet, the petitioning creditors filed a motion for relief from the automatic stay to take possession of the property and a motion for the appointment of a chapter 11 trustee.  In support of the stay relief motion, the creditors argued that the ground lease and the property subject thereto actually were not property of the debtor’s estate due to prepetition events.  Specifically, the creditors referenced a letter they had sent to the debtor before the commencement of the bankruptcy case notifying the debtor of events of default under the ground lease and providing the debtor with an opportunity to cure.  According to the creditors, the debtor’s failure to cure the defaults had resulted in the termination of the ground lease, thus justifying relief from the stay for the creditors to take possession of the property.  In support of their motion for the appointment of a trustee, the creditors highlighted alleged malfeasance related to the debtor’s financial transactions.

No doubt battle fatigued at this point, the debtor filed an expedited motion to enforce the settlement in accordance with the term sheet.

When is a Truce Really a Truce?

The court relied on Standard Steel, LLC v. Buckeye Energy, Inc. to articulate the principles governing the enforcement of an agreement reached through mediation.  Public policy favors settlements because they promote efficiency and the amicable resolution of disputes.  Moreover, settlements reached through mediation are as binding as if they were reached through litigation. Settlement agreements are binding contracts and, therefore, are construed according to traditional principles of contract law.  As such, when a dispute regarding the binding effect of a settlement arises, the intent of the parties is a question of fact that must be determined by the factfinder.  Under Pennsylvania law, if parties agree on key terms and intend them to be binding, a contract is formed even if the parties intend to adopt a formal document to fill in additional terms at a later date.

No big surprise here – the court held that the term sheet was enforceable.  In short, there was ample evidence that the parties had reached an agreement.  Not only had they done so at the conclusion of their mediation session, but also at the law office of the creditors’ counsel when the parties met to prepare a document that was intended to fill in the gaps left open by the term sheet.

How Do You Know If the Other Side Has Suspended a Ceasefire?

Notwithstanding the court’s finding that the parties had reached an agreement, the petitioning creditors argued that the debtor had repudiated any such agreement by virtue of the debtor’s failure to provide adequate assurance of performance.  Here’s where the court gives us a quote that’s too great not to share: “In essence, the Petitioning Creditors claim that they did a ‘Jerry McGuire’ and demanded that [the debtor] “show them the money” and that [the debtor] anticipatorily repudiated the transaction by failing to timely do so.” Needless to say, the court was unmoved by this argument.  First, the court found that any delay in completing the transaction largely was due to the creditors’ refusal to acknowledge the obvious settlement.  Second, there was no credible evidence that the debtor had overtly and intentionally communicated any repudiation of the agreement.

Relevant to the court’s conclusion is the following excerpt from Comment c to Section 251 of the Restatement of Contracts:

Whether ‘reasonable grounds’ have arisen for an obligee’s belief that there will be a breach must be determined in light of all the circumstances . . . The grounds for [the obligee’s] belief must have arisen after the time when the contract was made and cannot be based on facts known to [the obligee] at that time.  Nor, since the grounds must be reasonable, can they be based on events that occurred after that time but as to which [the obligee] took the risk when [the obligee] made the contract.

The petitioning creditors’ alleged concerns either predated the filing of the involuntary petition or were of the same types of concerns which they knew about before entering into the agreement. Consequently, the court found that (i) the creditors knowingly or otherwise assumed such risks when they made the contract with the debtor, (ii) the creditors’ demand of adequate assurance was inappropriate, and (iii) the debtor had not repudiated the settlement agreement.

What’s Bad War Etiquette?

As for the creditors’ argument that the ground lease had been terminated before the commencement of the debtor’s involuntary bankruptcy case, the court found no evidence that the creditors had taken formal action to take possession of the property subject to the ground lease subsequent to the debtor’s receipt of the notice of default,.  Moreover, the ground lease was the central focus of the settlement agreement.  Clearly, the ground lease was never terminated, and therefore, it constituted property of the debtor’s estate.

With respect to the creditors’ request for relief from the stay, the court found that granting such relief would do nothing more than reward the creditors for acting in bad faith and “throwing roadblocks in the way of consummating the settlement agreement.”

Is Additional Intervention Still Necessary?

The need to appoint a chapter 11 trustee is assessed on a case-by-case basis.  A party moving for appointment of a trustee must demonstrate by clear and convincing evidence the need for such relief under section 1104(a) of the Bankruptcy Code.  Appointing a trustee generally is viewed as an extraordinary remedy, which often gives way to the presumption that a debtor should be permitted to remain in possession.

The petitioning creditors failed to satisfy their burden in showing the need for a trustee.  The creditors did not prove the debtor’s alleged malfeasance.  Further, the creditors’ claims that there was acrimony between the parties and that the debtor’s principals were “desperate men” predisposed to do “desperate things” were not sufficiently compelling to appoint a trustee.

What’s an Armistice?

Bankruptcy can look and feel a lot like a war zone.  Everyone’s battling for a piece of the pie.  BG Petroleum is a friendly reminder, however, that the fighting stops—and for good—after two sides shake on a mutually-executed settlement agreement. That’s the signal to gather your troops and go home.