A Florida bankruptcy court recently clarified what constitutes a contract to extend financial accommodations for the benefit of the debtor, and the circumstances in which those contracts could be assumed, rejected or terminated. In re Ernie Haire Ford, Inc., 403 B.R. 750 (Bankr. M.D. Fla. 2009).

The issue came before the bankruptcy court after several third-party automobile finance companies terminated their individual contract purchase agreements with the debtor, Ernie Haire Ford, Inc., an auto dealership. Under its prepetition arrangement with the finance companies, the debtor would negotiate a retail installment sales contract with a prospective automobile purchaser and obtain credit information from the purchaser.

Thereafter, the debtor would circulate information regarding the proposed vehicle sales contract and the purchaser's credit information to the finance companies, which would have discretion to enter into the transaction. If one of the finance companies accepted a transaction, the finance company would provide the debtor with the purchase price for the vehicle, and the purchaser would make payments directly to the finance company. The finance company was under no obligation to accept any particular transaction or to finance any of the proposed purchase contracts.

After Ernie Haire filed for bankruptcy protection, the finance companies informed the debtor that they would be closing the debtor's accounts and no longer would be financing transactions related to the debtor. In response, the debtor filed a motion to compel the finance companies to comply with their pre-petition contract purchase agreements.

Financial Accommodations?

In response, the finance companies first argued that their contract purchase agreements with the debtor were not assumable. Specifically, they argued that the contract purchase agreements were agreements to extend financial accommodations to or for the benefit of the debtor. See 11 U.S.C.A. § 365(c)(2) (West 2009) ("The trustee may not assume or assign any executory contract ... if ... such contract is a contract to make a loan, or extend other debt financing or financial accommodations, to or for the benefit of the debtor, or to issue security of the debtor.").

The bankruptcy court, however, found that this type of arrangement did not constitute a contract to make a loan or extend other debt financing. See In re Ernie Haire Ford, 403 B.R. at 755-58. The court determined that contracts qualify for treatment under section 365(c)(2) "only when the principal purpose of a contract is to extend financing to or guarantee the financial obligations of the debtor." Id. at 755. The court noted that "in nearly every instance where a financial accommodation has been found to exist, the debtor has been directly or secondarily liable for the debt incurred." Id. at 757. In this case, the debtor had no obligation to the finance companies under their ultimate contract with the purchaser.

As a result, the bankruptcy court found the agreements at issue did not qualify for treatment under section 365(c)(2).

Right to Terminate

The finance companies next argued that they had no obligation under the contract purchase agreements because these contracts contained language making them terminable at will.

The bankruptcy court disagreed, and instead found that the timing of the finance companies' decision to terminate the contracts—which occurred immediately after the bankruptcy filing—was based solely on the filing of the debtor's chapter 11 petition and therefore violated the congressional policy against ipso facto provisions. Id. at 758-60. Thus, the court refused to recognize the termination.

Finally, the finance companies argued that even if they were not entitled to formally terminate the contract purchase agreements, they were entitled to functionally terminate the agreements by declining to accept any transactions from the debtor to finance new vehicles.

The bankruptcy court again disagreed. Finding that the finance companies could be compelled to honor the contract purchase agreements, the court noted that there was an obligation on the part of the finance companies to operate under the agreements in good faith. "[T]he bankruptcy case of [the debtor] cannot be the reason for rejecting every Consumer Contract without regard to the merits of the individual transaction, with the result of effectively terminating the contract purchase agreements in violation of the automatic stay." Id. at 761.

The court concluded that the finance companies not only were compelled to perform under the terms of the contract purchase agreements, but also were required to perform under those agreements in good faith. Specifically, the court found that although there were no objective criteria in the contracts that would require the finance companies to accept any particular financing transaction, the court could require the finance companies to operate under the agreements in good faith and to, it seems, accept financing agreements in a similar manner and frequency as they would have done pre-petition.

Going Forward

The Ernie Haire Ford case is a notable reminder that depending on the circumstances, non-debtor parties to an executory contract in bankruptcy may have an obligation to go beyond the express terms of a contract to operate under the contract in "good faith."