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Michael Enright

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MONTH-IN-BRIEF (Oct 2021)

Sometimes It May Be Better to Just Walk Away

By Michael Enright

Contract counterparties often are urged by debtors to continue doing business postpetition, for the mutual benefit of the parties, and to avoid disruptions in business. The counterparties may rely on the idea that a postpetition breach by the debtor will yield an administrative claim, lessening the risk to the counterparty. But the world of administrative expenses has burdens and risks that might dissuade a well-informed party to a contract with the debtor from proceeding with the prepetition agreement any longer than the law requires. For example, in In re Ditech Holding Corp., Case No. 19-10412 (Bankr. S.D.N.Y. Oct. 21, 2021) the debtor provided loan servicing for the claimants pursuant to long-standing agreements. After the petition date, the debtor and the claimants entered into postpetition extensions of the termination dates of the agreements, and continued the prepetition contractual relationship. The contracts as extended expired by their own terms prior to the effective date of the debtor’s plan, and so were not assumed or rejected pursuant to the plan. When the nondebtor parties to the contract filed administrative claims asserting that the debtor had not lived up to the performance that they were due under the contract terms during the postpetition period, Judge Garritty disallowed their administrative expense claims, holding that the claims arose when the contracts were initially entered into, and so were relegated to prepetition general unsecured status, despite the postpetition performance and alleged postpetition breaches. As Judge Garrity put it “under Second Circuit case law, the claims are contingent prepetition claims, which are not afforded administrative expense priority under section 503(b)(1)(A) of the Bankruptcy Code.” Judge Garrity also held that the written extension agreements entered into postpetition did not create new postpetition contracts, and so would not entitle the contract counterparties to administrative expense status either. The decision is a stark reminder to anyone analyzing the uncertainties of postpetitition performance of a prepetition contract that careful consideration of available safeguards should be undertaken at the outset.

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