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Delaware Court Holds Rejection Eliminates Non-Debtor's Exclusive Right to Provide Services to the Debtor

Nine Point Energy Holdings, Inc. and its affiliates (collectively, "Nine Point" or "Nine Point debtors") constituted an oil and gas production and exploration company that sought to reorganize in chapter 11 through a going concern sale of substantially all of their assets. To maximize value, Nine Point sought to sell those assets free and clear of its midstream services contracts, which included provisions that prevented Nine Point from acquiring midstream services from anyone other than its counterparty, Caliber North Dakota, LLC ("Caliber"). The dispute over Nine Point's ability to do so was the driving factor in its bankruptcy case.

One of the issues involved in the dispute was whether the U.S. Supreme Court's decision in Mission Product Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652 (2019), prevented the contracts' rejection from eliminating Caliber's exclusive right to provide midstream services to Nine Point. The U.S. Bankruptcy Court for the District Delaware held that it did not. On appeal, the Delaware District Court agreed in Caliber North Dakota, LLC v. Nine Point Energy Holdings, Inc. (In re Nine Point Energy Holdings, Inc.), 2021 WL 3269210 (D. Del. July 30, 2021). The district court held that Mission Product's holding did not apply because the exclusivity provisions' only value was the leverage it created for Caliber to force Nine Point to perform Nine Point's rejected executory obligations, which would defeat the purposes of section 365 of the Bankruptcy Code. This case is an important clarification on the implications of Mission Product as it confirms that creative contracting cannot prevent a debtor from exercising, and receiving the benefits of, its rejection rights under the Bankruptcy Code.

Rejection and Mission Product

Section 365(a) provides debtors with a broad grant of authority to assume or reject executory contracts and unexpired leases. Section 365(g) further explains that rejection "constitutes a breach" of the underlying contract immediately before the bankruptcy filing, and counterparties to rejected contracts are generally treated as prepetition creditors with respect to the damages that flow from rejection.

A circuit split emerged, however, over the impact of rejection on individual provisions in rejected contracts—particularly provisions granting a counterparty a non-exclusive license to use the debtor's intellectual property, which may entitle the licensee to the protections set forth in section 365(n) of the Bankruptcy Code. The Seventh Circuit, in Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, 686 F.3d 372, 376-77 (7th Cir. 2012), focused on the treatment of rejection as breach. Because breaches outside of the bankruptcy context do not "vaporize[]" a nonbreaching party's rights, the court reasoned, rejection similarly could not eliminate the patent and trademark license. The First Circuit, however, took the opposite position in In re Tempnology, LLC, 879 F.3d 389 (1st Cir. 2018), holding that it would frustrate the Bankruptcy Code's underlying objective of "releasing the debtor's estate from burdensome obligations," id. at 402, to allow a licensee to retain non-exclusive rights to use a trademark post-rejection. Thus, the court concluded, rejection in the context of a trademark licensing agreement would constitute a rescission of the underlying contract.

In Mission Product, the Supreme Court resolved the "breach-versus-rescission" dispute in favor of the "rejection as breach" jurisdictions. There, the debtor, Tempnology, LLC ("Tempnology"), entered into an agreement giving Mission Product Holdings, Inc. ("MPH") a non-exclusive license to use Tempnology's trademarks. After filing for bankruptcy, Tempnology sought to reject this agreement and asked the bankruptcy court to hold that rejection would eliminate the non-exclusive license granted to MPH. MPH argued that rejection did not eliminate the non-exclusive license. 

The Supreme Court held that rejection constitutes a breach of contract and that breach did not eliminate MPH's non-exclusive license. To analyze the latter question, the Court conjured a hypothetical for how breach is treated in the nonbankruptcy context. In its hypothetical, a dealer leases a photocopier to a law firm and agrees to service it every month in exchange for a monthly fee. During the term of the lease, however, the dealer stops servicing the photocopier. The law firm is left with a choice: It can continue paying the dealer rent while suing for breach damages, or it can terminate the contract and return the photocopier (simultaneously halting payment and suing for damages). Critically, the Court noted, the choice is with the law firm, not the breaching dealer, whether to continue enjoying the rights granted under the contract.

Applying this hypothetical in the bankruptcy context, the Court explained that if the dealer had filed for bankruptcy and chosen to reject its lease with the law firm, the rejection would relieve the debtor from the obligation to service the copier. However, the firm would have a choice either to: (i) keep the copier and continue paying the rental fees and file a claim against the estate for damages incurred from no servicing going forward; or (ii) return the copier and file a claim against the estate for damages. The Court acknowledged that the first option typically would not be attractive to the firm because its breach claim likely would be treated as a general unsecured claim. The Court held that a counterparty to a rejected contract does not have to give up non-exclusive licensing rights it received under a rejected prepetition contract.

Nine Point

On March 15, 2021, the Nine Point debtors filed chapter 11 bankruptcy cases in Delaware. The same day they filed for bankruptcy, certain of the Nine Point debtors sought to reject their midstream services contracts and filed an adversary proceeding seeking, among other things, a ruling that the rejection would allow Nine Point to sell its assets free and clear of those contracts. Caliber opposed the relief, arguing, among other things, that even if the contracts could be rejected, under Mission Product, its exclusive right to provide midstream services to Nine Point would remain in force. Caliber also drew parallels to covenants not to compete, which some courts have held survive rejection. See, e.g., Sir Speedy, Inc. v. Morse, 256 B.R. 657, 660 (D. Mass. 2000) (holding that debtor was not relieved of obligations under noncompete clause even though the underlying franchise agreement was validly rejected); In re Spooner, 2012 WL 909515, at *4 (Bankr. N.D. Ohio Mar. 16, 2012) ("[R]elieving Debtor of the burdensome obligation of refraining from engaging in competitive activities cannot be accomplished by rejecting the Non-Compete Agreement.").

The bankruptcy court held that Caliber's exclusivity rights would not survive rejection. The court distinguished Mission Product because the non-debtor counterparty there "had the right to continue to use that license after rejection, notwithstanding the fact that the debtor was relieved of its obligation to perform." Nine Point Energy Holdings, Inc. v. Caliber Measurement Services LLC (In re Nine Point Energy Holdings, Inc., 2021 WL 2212007, at *6 (Bankr. D. Del. June 1, 2021). In Nine Point, by contrast, Caliber had "no right to use the [exclusivity rights] except in its performance of the contracts." Id. 

Affirming the bankruptcy court's order, the district court similarly distinguished Mission Product. The district court explained that the non-exclusive license at issue in Mission Product did "not allow a non-debtor to force the debtor to perform under a contract after its rejection." Caliber North Dakota, LLC v. Nine Point Energy Holdings, Inc. (In re Nine Point Energy Holdings, Inc.), 2021 WL 3269210, at *8 (D. Del. July 30, 2021). "The fundamental flaw in Caliber's argument," the court continued, "is that an 'exclusivity' provision requires future performance by both parties. Thus, while it is possible to view an exclusivity provision as something that belongs to Caliber, it only has meaning if it is an obligation of [Nine Point]." Id. at *8 n.7. Because rejection allows a debtor to eliminate its executory obligations under the contract, the district court reasoned, rejection eliminates contractual rights that would allow the counterparty to compel performance of those obligations by the debtor.

Outlook

The courts' rulings in Nine Point present an important clarification of the Mission Product holding. Rights granted prepetition that would effectively allow a non-debtor to thwart rejection do not survive rejection. In analyzing whether particular contractual rights will survive rejection, one needs to examine whether the underlying rights confer value or can be effectively enforced without the debtor's subsequent performance of its rejected executory obligations. While noncompete clauses or non-exclusive licenses confer value without the need for subsequent affirmative action by a debtor, an obligation that a debtor buy services exclusively from the counterparty does not confer value unless the debtor uses those services. As a result, rejection eliminates these types of exclusivity obligations.

The courts' decisions also have practical implications on the ability of parties to contract around section 365 of the Bankruptcy Code. Creative provisions designed to prevent a debtor from later exercising its rejection rights effectively will likely not survive rejection under the Nine Point courts' analyses.

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Jones Day represents the Nine Point debtors in their chapter 11 cases.

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