The purchaser of assets from one bankruptcy debtor objected to the plan of reorganization filed by a related bankruptcy debtor because the plan did not recognize the purchaser’s rights in a deep water well pursuant to a lease between the two debtors.  The bankruptcy court determined that the buyer did not acquire any rights to the well, the district court affirmed, and the buyer appealed to the 8thCircuit.

One debtor (Agriprocessors) was a kosher meatpacking company, and the second debtor (Nevel) owned property with a deep water well that was used by the meatpacking facility.  Both Agriprocessors and Nevel filed bankruptcy.  Agriprocessors sold its assets, and the buyer (SHF) later objected to a plan of reorganization filed by Nevel because it did not recognize SHF’s right to use the deep water well.

SHF contended that it and Nevel were parties to a “Deep Water Well Lease – Water Lines and Access Easements” contract that gave it the exclusive right to use the well in exchange for an annual payment and a non-exclusive right to access the well for maintenance and other purposes.  SHF contended that the contract was neither executory nor a lease so that Nevel could not reject it under Section 365 of the Bankruptcy Code, and further argued that Nevel waived any right to assert that the contract had already been rejected in the Agriprocessors bankruptcy.

The bankruptcy court concluded that the contract, which was between Agriprocessors and Nevel, was deemed rejected when the Agriprocessors’ chapter 11 trustee failed to assume the agreement within the required time period.  Since this occurred prior to the Agriprocessors sale of assets to SHF, it never acquired any rights to the contract.  The bankruptcy court also rejected the argument that Nevel waived the rejection since there were no facts supporting the waiver.

According to the 8th Circuit, the appeal boiled down to whether SHF had any rights to the deep water well.  It concluded that the bankruptcy court was correct because as a matter of law the contract was deemed to have been rejected in the Agriprocessors bankruptcy prior to the sale of its assets to SHF.

In particular, under Section 365 of the Bankruptcy Code when the lease was not timely assumed by the chapter 11 trustee, it was deemed rejected and the trustee was required to immediately surrender the property to Nevel as the lessor.  Further, it was clear that the chapter 11 trustee did not assume the lease since defaults must be cured as a condition of assumption, and the trustee never cured the outstanding payment defaults.

SHF attempted to argue that the agreement was not actually a lease.  However, the 8th Circuit agreed with the bankruptcy court that, in addition to being called a lease by the parties, it was the functional equivalent of a lease, and the related easement was inseparable from the lease.

Next SHF argued that because Agriprocessors was owned by one brother and Nevel was owned by another brother, the court should have given “close, careful scrutiny” to the failure to assume the contract.  However, the heightened scrutiny for insider transactions was not applicable since the independent Chapter 11 trustee, not the insiders, in effect rejected the lease by choosing not to assume it.

Finally SHF argued that bankruptcy court erred in determining that Nevel did not waive termination of the lease through Agriprocessors rejection.  The 8th Circuit responded by emphasizing the heavy burden required to show clear error:

“To be clearly erroneous, a decision must strike us as more than just maybe or probably wrong; it must… strike us as wrong with the force of a five-week-old, unrefrigerated dead fish.”  …We smell nothing fishy in the bankruptcy court’s factual findings.

The court also found compelling the fact that the well lease and easement was not specifically listed as an asset acquired by SHF (which it concluded was because the contract had already been rejected).

Consequently, the 8th Circuit affirmed the district court’s affirmance of the bankruptcy court’s decision.

It can be difficult to do due diligence in the context of a bankruptcy sale.  However, this case illustrates the importance of trying to identify assets that are critical to the acquired business and then making sure that those assets are included as part of the sale.