In a case of first impression, the Sixth Circuit Court of Appeals has held that when a debtor's assets are sold free and clear, a purchaser is not liable for obligations contained in a related but independent contract. Al Perry Enterprises, Inc. v. Appalachian Fuels, LLC, 503 F.3d 538 (6th Cir. 2007).

Al Perry Enterprises Inc. secured coal supply contracts for Bowie Resources Limited ("Bowie") on a commission payment basis. Among the contracts Perry secured for Bowie was a contract with the Tennessee Valley Authority ("TVA"). Following a dispute regarding commission payments on account of the TVA contract, Perry filed a lawsuit against Bowie. The case was ultimately resolved by entry of an agreed judgment whereby Bowie was to continue to pay commissions to Perry in connection with the sale of coal to the TVA (the "Agreed Judgment").

Following entry of the Agreed Judgment, Bowie and several related entities filed for chapter 11 bankruptcy protection in the U.S. Bankruptcy Court for the Eastern District of Kentucky. From the petition date until October 2003, Bowie operated as debtor-in-possession. Perry continued to receive commission payments from Bowie on account of the TVA contract through July 2003. On Sept. 12, 2003, the bankruptcy court entered an order establishing auction procedures for the sale of Bowie's assets, and assumption and assignment of executory contracts and unexpired leases ("Sale Order").

Bowie thereafter entered into an asset purchase agreement (the "APA"). In conjunction with the APA, Bowie filed a statement of cure amounts for certain executory contracts, including the TVA contract, it planned to assume and assign as part of the sale (the "Cure Notice"). The Cure Notice listed the TVA contract as having a zero dollar cure amount. Perry filed an objection to the Cure Notice stating that it was entitled to past and future commissions under the Agreed Judgment. The APA was not consummated and the Cure Objection was continued by the bankruptcy court to be re-noticed for hearing if necessary.

Asset Sale

In October 2003, Bowie filed a motion with the bankruptcy court to sell its assets to Appalachian Fuels ("Appalachian"), which was not party to the APA (the "Appalachian Motion"). The terms of the proposed sale set forth in the Appalachian Motion were substantially identical to the APA, including the provision that all assets were to be delivered free and clear of all liens and obligations. Although notice of the sale was provided to all of Bowie's creditors, Perry did not object to this sale.

The bankruptcy court entered an order authorizing the sale of the debtor's assets, including the TVA contract, free and clear of all liens, claims and encumbrances other than certain specific assumed liabilities (the "Sale Order").

Following the sale, Bowie did not receive further commission payments. Bowie filed the present breach of contract action in the U.S. District Court for the Southern District of Indiana claiming that when Appalachian assumed the TVA contract, it also assumed the obligation for the commission payment under the Agreed Judgment. The case was transferred to the U.S. District Court for the Eastern District of Kentucky. The parties filed cross-motions for summary judgment, and the Kentucky district court referred the matter to the U.S. Bankruptcy Court for the Eastern District of Kentucky, the court that presided over Bowie's bankruptcy proceeding.

The bankruptcy court issued proposed findings of fact, conclusions of law and a judgment to the district court recommending that Perry's motion be denied and Appalachian's motion be granted.

The district court entered a memorandum opinion adopting the bankruptcy court's recommendation. Perry filed the instant appeal.

Sixth Circuit Ruling

On appeal, Perry argued that under basic contract interpretation, Appalachian assumed Bowie's liability to pay sales commissions to Perry when it assumed the TVA contract because the commissions "relate to" and arise "in connection with" the TVA contract. Because Bowie's obligations to pay commissions to it under the Agreed Judgment were dependent on the TVA contract, the assumption of the TVA contract necessarily meant that Appalachian assumed the obligations to pay the commissions.

The Sixth Circuit disagreed with Perry's analysis and held that a free and clear sale under section 363 extinguished Perry's claims because they were not expressly assumed.

The Sixth Circuit based its ruling on several factors.

First, the appeals court noted that under section 363(f) of the Bankruptcy Code, a bankruptcy court has the power to approve a sale of a debtor's assets free and clear of any interest or claims. Perry's claim for commissions for work that was done prior to the petition date was a pre-petition obligation that satisfied the definition of claim under 11 U.S.C. §101(5)(A). Therefore, Perry's failure to raise its claim to the bankruptcy court bars its claim unless Appalachian expressly assumed the obligations of Bowie to pay commission to Perry.

The Sixth Circuit noted that there was no mention in the purchase agreement with Appalachian or the Sale Order of any obligation to pay commissions to Perry. Any obligation on the part of Bowie to pay commission to Perry arose from the Agreed Judgment, not the TVA contract, which was a separate and distinct contract relating to an independent obligation, the court determined. The court found there was no language in the purchase agreement that constituted an assumption of the obligations of Bowie relating to or arising in connection with the Agreed Judgment; therefore Appalachian did not assume the obligations arising thereunder.

This article is presented for informational purposes only and is not intended to constitute legal advice.