Filing Bankruptcy to Reject a Mediated Settlement Agreement: Will it Work?

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Standing guard and providing protection?

By: Donald L Swanson

Debtor Amir Safakish filed Chapter 13 bankruptcy for one purpose: to reject a mediated Settlement Agreement [Fn. 1].  The Bankruptcy Court stood guard over and protected the mediated agreement — this time.  But what about similar circumstances in other cases?

Background

Safakish filed suit in state court against creditors over condominium association obligations. The creditors counterclaimed.

The parties mediated their disputes and entered into a Settlement Agreement, signed by the parties, their attorneys, and the mediator. Under that document, the parties agreed to such terms as a mutual release and Safakish paying $275,000 to one creditor, prepaying 12 months of assessments, and selling his condominium unit.

The next day, Safakish told creditors he wanted to cancel or change the Settlement Agreement.

Two weeks later, the creditors notified Safakish of their intent to seek Court enforcement of the Settlement Agreement under California Code of Civil Procedure § 664.6 [Fn. 2].

The next day (April 4, 2018), Safakish filed his Chapter 13 case.

Bankruptcy Proceedings

In the Chapter 13 bankruptcy, Safakish attempted to reject the Settlement Agreement as an executory contract under 11 U.S.C. § 365. His Motion to that effect (Doc. 80) requests an order providing various forms of relief, that include:

– authoring a rejection of the mediated Settlement Agreement;
– declaring the Settlement Agreement terms “VOID” and relieving him of its obligations;
– declaring that an appropriate court must adjudicate the dispute and the claims and cross-claims between Debtor and creditors; and
– determining damages, attorney fees, costs and other remedies, under 11 USC §365.

Executory Contract Rejection Denied

The Court denied Safakish’s rejection attempt (Docs. 119 & 121) on two interesting-and-alternative grounds. Here’s an attempt at summarizing both.

1. The Settlement Agreement was not an executory contract—and, therefore, could not be rejected

Here is the Bankruptcy Court’s rationale for ruling that the mediated Settlement Agreement could not be rejected because it does not qualify as an executory contract under § 365:

Bankruptcy Code § 365(a) authorizes a debtor to assume or reject an executory contract, subject to court approval;

A contract is executory if “the obligations of both parties are so unperformed that the failure of either party to complete performance would constitute a material breach and thus excuse the performance of the other”;

Creditors argued that Safakish repudiated the Settlement Agreement before the bankruptcy filing, resulting in an anticipatory breach of the Settlement Agreement, thereby excusing any future performance by creditors;

Anticipatory repudiation occurs when the promisor, before committing a breach, makes a positive statement indicating he “will not or cannot substantially perform his contractual duties”;

Under California law, anticipatory repudiation of one party discharges the obligation of the other party to perform;

The evidence establishes that Safakish expressly repudiated the Settlement Agreement before filing his bankruptcy;

Therefore, creditors had nothing left to perform by the petition date—their obligations under the Settlement Agreement were discharged by Safakish’s repudiation; and

Since none of the parties had outstanding obligations to perform at the petition date, the contract cannot be considered executory for rejection purposes under § 365.

2. Rejection of the Settlement Agreement is not in the best interests of creditors

Alternatively, Creditors argued that the Settlement Agreement, if it were an executory contract, should not be rejected because rejection is not in the best interests of creditors. The Bankruptcy Court agreed. Here’s its rationale:

Parties stipulate that Safakish was solvent on the bankruptcy filing date—his assets were worth at least $2.4 million more than the amount of his debts;

Safakish would be the primary beneficiary of a rejection;

Rejection would create significant harm to the other Settlement Agreement parties; and

Rejection, therefore, is not in the best interests of creditors.

Creditors’ Motion to Dismiss

Meanwhile, Safakish’s creditors filed a Motion to dismiss his Chapter 13 case (Doc. 119 & 120), alleging that the plan and petition were not proposed in good faith.

The Bankruptcy Court granted creditors’ Motion to dismiss because of Safakish’s “bad faith”: i.e., because Safakish filed bankruptcy for the sole purpose of “trying to reject an executory contract or lease.”

Specifically, the Court found that “Safakish seeks to defeat the state court litigation by gaining an advantage in this court” and that Safakish had “no other need” for filing his Chapter 13 case.

Safakish did not appeal any of the Bankruptcy Court’s orders.

Net Effect

The net effect is that Safakish’s disputes over the mediated Settlement Agreement are unaffected by the bankruptcy, and creditors are free to enforce the Settlement Agreement, back in State court, under California Code of Civil Procedure § 644.6.

But Could It Work?

Whether Safakish’s strategy might work in another case is still an interesting question. The In re Safakish circumstances are unusual, so the result might be different in other cases.

–Motion to Dismiss

What if the debtor had been insolvent, instead of having millions of dollars of equity? And what if multiple creditors were pursuing collection when debtor filed bankruptcy? Under such circumstances, the Motion to dismiss would probably have been denied.

–Motion to Reject Mediated Settlement Agreement

What if, (i) anticipatory repudiation had not occurred so that the mediated Settlement Agreement was still an executory contract that could be rejected under § 365, and (ii) the Bankruptcy Court allowed rejection?

Under such circumstances, what effect would rejection have had on rights of the other parties to the Settlement Agreement:

Would their rights have vaporized?
Would their rights remain fully enforceable?
Or would their rights have some other status and effect?

Mission v. Tempnology at U.S. Supreme Court

Hopefully, the U.S. Supreme Court will help answer questions about executory contract rejection effects, in the case of Mission Product Holdings, Inc. v. Tempnology, LLC, — the Supreme Court recently granted certiorari. See this article:

What Happens When Executory Contracts are Rejected? U.S. Supreme Court to Decide (Mission v. Tempnology).”

Conclusion

Filing bankruptcy to avoid the effects of a mediated Settlement Agreement did not work in the In re Safakish case.

But that case involve unusual facts (i.e., a solvent debtor, an anticipatory repudiation, and a bad faith filing). It’s hard to say what might happen in other contexts.

Hopefully, the U.S. Supreme Court’s resolution of Mission v. Tempnology will help shed light on what happens to the rights of non-bankruptcy parties under an executory contract that is rejected in bankruptcy.

———
Footnote 1: The bankruptcy is In re Safakish, Case No. 18-50769 in the U.S. Bankruptcy Court for the Northern District of California.

Footnote 2: California Code of Civil Procedure § 664.6 provides:

“If parties to pending litigation stipulate, in a writing signed by the parties outside the presence of the court or orally before the court, for settlement of the case, or part thereof, the court, upon motion, may enter judgment pursuant to the terms of the settlement. If requested by the parties, the court may retain jurisdiction over the parties to enforce the settlement until performance in full of the terms of the settlement.”

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