One of the main benefits of bankruptcy is the ability of a debtor to reject its burdensome contracts.  Although a debtor’s right of rejection appears to be relatively straightforward, section 365 of the Bankruptcy Code can raise a number of issues.  One such issue is whether the contract is executory.  If the contract is not executory, a debtor may not avail itself of section 365’s rejection powers.  Usually it is the debtor who argues in favor of the executory nature of a contract; however, this was not the case in In re ATP Oil & Gas Corporation.  There an insurance company refused to indemnify the debtor on the ground that the debtor had rejected the agreement giving rise to the insurer’s indemnification obligations.  Because the bankruptcy court found that the agreement was not an executory contract, it disagreed.  

Background

ATP, an oil and gas producer, entered into a Master Service Agreement with Greystar Corporation for the supply of personnel and equipment related to hydrocarbon development.  The MSA dictated the terms under which Greystar would provide personnel and equipment, as called for by individual work orders issued by ATP.  The MSA required Greystar to, among other things, defend and indemnify ATP for claims involving bodily injury to Greystar employees sustained while working for ATP and also to name ATP as an additional insured on its insurance policies.  Greystar obtained insurance with Gemini Insurance Company that covered claims made from October 1, 2012 to October 31, 2013.

In August of 2012, ATP commenced a chapter 11 case in the United States Bankruptcy Court for the Southern District of Texas.  In December 2012, a Greystar employee was injured when working on a platform owned or operated by ATP.  The employee subsequently filed suit against ATP for the personal injuries he alleged to have sustained.  ATP tendered the lawsuit to Gemini, among others of Greystar’s insurers, and requested that Gemini defend and indemnify ATP.  Gemini refused.

Almost two years later and after ATP’s case was converted to a chapter 7 liquidation, ATP’s chapter 7 trustee filed an adversary proceeding against, among other insurers, Gemini seeking a declaratory judgement that Gemini had a duty to defend or indemnify ATP against the employee’s lawsuit.

Greystar’s Duty to Defend

Under the insurance policy Gemini issued to Greystar, Greystar was permitted to include additional insured parties so long as (1) a written agreement existed between Greystar and the additional insured party executed before the events giving rise to the claim occurred and (2) the agreement was in effect during the policy period (i.e., October 1, 2012 to October 31, 2013).  No one disputed that the MSA constituted a written agreement between Greystar and ATP that required Greystar to defend and indemnify ATP.  Instead, the dispute focused on whether the MSA was in effect during the policy period.  According to Greystar, the MSA was an executory contract deemed rejected under section 365(d)(1) of the Bankruptcy Code when the chapter 7 trustee did not assume or reject it within 60 days after the order for relief.  Because section 365(g)(1) of the Bankruptcy Code provides that a deemed rejection operates as a breach effective immediately before the date of the filing of the petition (August 2012), Greystar argued that the MSA was not in effect during the policy period.  The chapter 7 trustee, on the other hand, contended that the MSA was an executory contract and that it had been assumed and assigned as part of an approved chapter 11 sale process.

Although the bankruptcy court found no record of the purported assumption and assignment of the MSA, the court nonetheless denied Greystar’s rejection argument.  Central to Greystar’s contention, the court stated, was that the MSA was an executory contract susceptible to assumption or rejection under section 365 of the Bankruptcy Code.  This, according to the court, was simply not the case.

The court explained that, although the Bankruptcy Code does not define “executory contract,” the Fifth Circuit applying section 365 has stated “an agreement is executory if at the time of the bankruptcy filing, the failure of either party to complete performance would constitute a material breach of the contract, thereby excusing the performance of the other party.”  Examining the terms of the MSA, the court ruled that the MSA did not require performance by either party, but, rather, set forth an agreement to comply with the terms of the MSA to the extent the parties entered into contracts in the future.  In other words, the MSA did not obligate either party to do anything independent of an accompanying work order.  The bankruptcy court concluded that because no performance was due under the MSA, it was not an executory contract subject to deemed rejection under section 365 of the Bankruptcy Code.

Conclusion

The ATP decision is not only important for debtors, especially in the Southern District of Texas, to keep in mind but also for all parties thinking of entering master service agreements.  First, as to debtors, they should not take for granted that a master service agreement is – or is not – executory.  Rather, they should study the terms of such agreements to determine whether they can make a colorable argument one way or the other when determining whether they may assert their section 365 powers.  Second, as to non-debtors drafting master service agreements, if they believe rejection or assumption of these agreements may play an important role in the event of a future bankruptcy filing, drafters of these agreements should consider including terms that obligate each party to the agreement to take action because, absent these terms, there is a chance the master service agreement may not be deemed executory – at least before the United States Bankruptcy Court for the Southern District of Texas.