Following the rule that swap agreements should be netted after contract termination, a New York bankruptcy court has held that such agreements also should be netted following rejection in bankruptcy.

“Although rejection of an agreement does not equal termination,” Bankruptcy Judge Arthur J. Gonzalez acknowledged in In re Enron Corp., 349 B.R. 96 (Bankr. S.D.N.Y. Aug. 2, 2006), “this does not affect the determination of…rejection damages. Termination of swap agreements generally requires that the parties’ positions be netted.”

“Rejection leads to a similar result,” he stated.

The case concerned three natural gas purchasing agreements between Enron North America Corp. (“ENA”) and the Citrus Trading Corp. The contracts involved either a direct agreement by Citrus to purchase gas from an Enron entity, or a gas purchasing agreement to which Enron became a successor party.

One of the agreements was valuable to Enron because it was in-the-money to Enron; the other two were valuable to Citrus because they were in-the-money to Citrus.

Enron filed an objection to Citrus’s proof of claim, claiming it was entitled to a set-off against Citrus’s in-the-money positions under the two agreements, because the three agreements constituted a single agreement.

Citrus argued that no set-off should occur because the agreements were separate and governed by different master agreements. The rejection of a contract by the debtor under section 365 of the Bankruptcy Code results in a claim for breach of contract held by the other party, and the end of any contract obligations owed by the other party, Citrus noted.

Hence, Citrus argued, it did not owe anything under the agreement at issue.

Enron pointed out that previously in the case, Citrus had argued ENA should not be able to cherry-pick different pieces of the transaction, assuming those pieces ENA deemed favorable and rejecting those pieces it deemed unfavorable. Thus, argued Enron, Citrus could not now take a contrary position.

The court agreed with Enron that the in-the-money positions under the three contracts should be netted to determine the amount of Citrus’s claim.

“Rejection of a contract by the debtor amounts to a breach immediately prior to the petition date,” the court stated. “Under general contract law, damages are intended to give the benefit of the bargain to nonbreaching parties by awarding a sum of money that will put them in as good a position as they would have been had the contract been performed.”

Noting the rule that termination of a contract requires netting, the court stated that “rejection requires netting too because, if Citrus received rejection damages only based on its in-the-money positions under the swap agreement without taking into account ENA’s in-the-money position under the same swap agreement, Citrus would receive more than what it bargained for. “ENA’s in-the-money positions must therefore be taken into consideration to compute Citrus’s rejection damages.”

The decision emphasizes the rule that contracts must be rejected in their entirety, and that to the extent netting is possible, it should be applied in establishing rejection damages.