Opinion ID: 3012006
Heading Depth: 2
Heading Rank: 2

Heading: The Bankruptcy Filing

Text: The Estate next contends that, even if an exclusion of Leah or Victor did not cause the dissolution of the Legends Partnership, the partnership was dissolved when Victor filed a bankruptcy petition under Chapter 11 of the Bankruptcy Code. This argument raises the question of whether the bankruptcy of a general partner results in the dissolution of the partnership. At first glance, Pennsylvania law appears to provide a clear answer. Under S 8353, the bankruptcy of a partner, unlike the general expulsion of a partner, does in fact cause the automatic dissolution of the partnership. 15 Pa.C.S. S 8353(5). Our analysis would end neatly right here if our concerns extended only to the application of Pennsylvania law. We must also consider, however, the role of federal bankruptcy law and the impact of its interplay with state partnership law. As a survey of the case law reflects, in attempting to reconcile the Bankruptcy Code with state law on this issue of partnership dissolution, courts have been 10 largely divided. Compare, e.g., In re Nizny, 175 B.R. 934, 939 (Bankr.S.D.Ohio 1994) (holding that filing of federal bankruptcy case by partner does not dissolve general partnership); In re Hawkins, 113 B.R. 315, 316-17 (Bankr.N.D.Tex. 1990) (same); In re Todd, 118 B.R. 432, 435 (Bankr.D.S.C. 1989) (same); In re Corky Foods Corp., 85 B.R. 903, 904 (Bankr.S.D.Fla. 1988) (same); In re Safren, 65 B.R. 566, 569-70 (Bankr.C.D.Cal. 1986)(same), with Phillips v. First City, Texas-Tyler, N.A. (In re Phillips), 966 F.2d 926, 929 (5th Cir. 1992) (holding that partner’s federal bankruptcy filing causes dissolution of partnership); In re Burnett, 241 B.R. 438, 439 (Bankr.E.D.Ark. 1999) (same); In re Sunset Developers, 69 B.R. 710, 712-13 (Bankr.D.Idaho 1987) (same); Finkelstein v. Security Properties, Inc., 888 P.2d 161, 164 (Wash.Ct.App. 1995) (same). The contrary holdings of the Bankruptcy Court and the District Court in this case further reflect the confusion and controversy that has surrounded this issue. We review their findings as a starting point for our analysis. In holding that Victor’s bankruptcy filing did not cause the dissolution of the Legends Partnership, the Bankruptcy Court reasoned that the Partnership Agreement constitutes an executory contract and, as such, cannot be dissolved pursuant to 11 U.S.C. S 365(e)(1).2 That section of the Bankruptcy Code states: Notwithstanding a provision in an executory contract . . . or in applicable law, an executory contract . . . of the debtor may not be terminated or modified . . . at any time after the commencement of the case solely because of a provision in such contract . . . that is _________________________________________________________________ 2. The District Court agreed with the Bankruptcy Court’s holding that the Partnership Agreement constitutes an executory contract, which appears to be consistent with the majority rule. See, e.g., Summit Inv. & Dev. Corp. v. Leroux, 69 F.3d 608, 610 n.3 (1st Cir. 1995); In re Siegal, 190 B.R. 639, 643 (Bankr.D.Ariz. 1996); Nizny , 175 B.R. at 936; Clinton Court, 160 B.R. at 60; Corky Foods Corp., 85 B.R. at 904. But cf. In re Smith, 185 B.R. 285, 293 (Bankr.S.D.Ill. 1995) (finding that limited partnership agreement should not be considered executory contract if limited partner is purely passive investor not owing substantial future performance to limited partnership). In any case, the parties do not contest this issue on appeal. 11 conditioned on . . . the commencement of a case under this title. 11 U.S.C. S 365(e)(1)(B). In other words,S 365(e)(1) invalidates ipso facto provisions, which, in this context, are provisions of law or contract which specify thata bankruptcy filing per se will terminate or modify an executory contract. In re Clinton Court, 160 B.R. 57, 59 (Bankr.E.D.Pa. 1993). Because S 8353(5) of Pennsylvania’s UPA provides for the dissolution (or modification) of a partnership agreement upon the bankruptcy of a partner, the Bankruptcy Court concluded that S8353(5) is an ipso facto provision and that S 365(e)(1) prevented it from causing the dissolution of the Legends Partnership. In stark disagreement with the Bankruptcy Court, the District Court held that Victor’s bankruptcy did, in fact, constitute an event sufficient to cause the dissolution of the partnership. In doing so, the court relied heavily on the following language in a footnote in Crutcher: While this court held, in In re Clinton Court , 160 B.R. 57, 58-60 (Bankr.E.D.Pa. 1993), that a bankruptcy filing by a partner should not preclude a partnership from filing a bankruptcy case, on the grounds that this result would violate 11 U.S.C. S 365(e)(1), the partnership is not a debtor here. Thus, S 365(e)(1) does not come into play. It therefore appears that . . . the partnership would necessarily have to be held to have been dissolved as of [the date the partner filed individually for bankruptcy]. Crutcher, 209 B.R at 352 n.2. Noting that the partnership is not a debtor in this case, the District Court similarly concluded that S 365(e)(1) does not apply and, thus, that Victor’s bankruptcy filing resulted in the dissolution of the partnership under S 8353(5). In considering the applicability of S 365(e)(1), we find that the District Court’s reliance on Crutcher is misplaced. As the District Court explained, Crutcher does appear to suggest that S 365(e)(1) does not come into play when the partnership is not a debtor. 209 B.R. at 352 n.2. However, we see no support outside of Crutcher for that proposition. 12 In fact, such a holding appears contrary to Clinton Court, the case to which Crutcher cites on this point. In Clinton Court, more than two years after one of two partners of a general partnership filed for bankruptcy, the partnership itself filed for bankruptcy. 160 B.R. at 58. Citing to S 8353(5), a secured creditor of the partnership claimed that the partnership had been dissolved upon the individual partner’s bankruptcy filing. Id. Clinton Court rejected that argument, finding that S 365(e)(1) prevented the partner’s bankruptcy from causing the dissolution of the partnership. Id. at 60. While it is true that the partnership was a debtor in Clinton Court, there is no reason to believe that the applicability of S 365(e)(1) depended upon the partnership’s debtor status. Indeed, the facts underlying Clinton Court show otherwise. If S 365(e)(1) were to come into play only when the partnership is a debtor, then the individual partner’s bankruptcy filing, which occurred over two years prior to the partnership’s bankruptcy, would have caused the partnership to dissolve as a matter of law under S 8353(5). Because the court in Clinton Court held that the individual partner’s bankruptcy filing did not dissolve the partnership at a time when the partnership was not a debtor, it would be entirely inconsistent for the court to have regarded a partnership’s debtor status as a necessary condition for the applicability of S 365(e)(1). Thus, we reject the District Court’s conclusion that, as a result of the partnership’s non-debtor status, S 365(e)(1) is inapplicable to this case. We see no reason why the statute’s applicability should hinge upon whether the partnership itself has filed for bankruptcy. This is not to say, however, that we have now settled the question of whether S 365(e)(1) prevented the dissolution of the Legends Partnership. Courts have held that, under certain circumstances, other subsections of the Bankruptcy Code, namely SS 365(e)(2)(A) and 365(c), precludeS 365(e)(1) from invalidating ipso facto provisions that would dissolve a partnership.3 See, e.g., Sunset Developers, 69 B.R. at 712_________________________________________________________________ 3. We note that this position is in contrast with the recommendation of the National Bankruptcy Review Commission, an independent 13 13 (holding that S 365(c) prevented S 365(e) from applying to partnership agreement); Finkelstein, 888 P.2d at 165 n.3 (holding that [s]ection 365(e)(2) clarifies Congress’ intention to prevent only private contracts from counteracting the Bankruptcy Code, not to prevent state law, such as partnership law, from determining the status of a partnership); cf. In re Harms, 10 B.R. 817, 821-22 (Bankr.D.Colo. 1981) (holding that limited partnership dissolved on day of general partner’s bankruptcy filing because, [u]nder Section 365(c) of the Bankruptcy Code, executory [limited] partnership agreements cannot be assumed by a debtor-in-possession without the consent of all the limited partners). We now consider the impact of these subsections in this case. As we discussed above, S 365(e)(1)(B) provides that an executory contract of a debtor cannot be terminated or modified by a provision of law or contract that is conditioned upon the commencement of the debtor’s case under the Bankruptcy Code. The scope of this anti-ipso facto provision is limited, however, by S 365(e)(2), which reads, in relevant part: (2) Paragraph (1) of this subsection does not apply to an executory contract . . . of the debtor, whether or not such contract . . . prohibits or restricts assignment of rights or delegation of duties, if-- _________________________________________________________________ commission established through the Bankruptcy Reform Act of 1994, Pub. L. No. 103-394, 108 Stat. 4106 (1994). In its Final Report, filed in 1997, the Commission recommended that [i]pso facto provisions relating to partnerships, LLCs, and the rights or interests of partners or LLC members should not be enforceable under the Bankruptcy Code. National Bankruptcy Review Commission, Bankruptcy: The Next Twenty Years S 2.3.22, at 432 (1997). The Commission went on to explain: This position is consistent with the Bankruptcy Code treatment of ipso facto provisions in other types of property interests. [Footnote omitted.] Just because a partner or LLC member has sought relief under the Bankruptcy Code, there is no compelling interest served by mandating an automatic dissolution of the partnership or buyout of the debtor partner’s interest. Id. S 2.3.22, at 435. 14 (A)(i) applicable law excuses a party, other than the debtor, to such contract . . . from accepting performance from or rendering performance to the trustee or to an assignee of such contract . . . , whether or not such contract . . . prohibits or restricts assignment of rights or delegation of duties; and (ii) such party does not consent to such assumption or assignment . . . . 11 U.S.C. S 365(e)(2)(A) (emphasis added). In interpreting this limitation on S 365(e)(1), we must also consider the impact of S 365(c), which closely tracks the language of S 365(e)(2). In relevant part, S 365(c)(1) states: (c) The trustee may not assume or assign any executory contract . . . of the debtor, whether or not such contract . . . prohibits or restricts assignment of rights or delegation of duties, if-- (1)(A) applicable law excuses a party, other than the debtor, to such contract . . . from accepting performance from or rendering performance to an entity other than the debtor or the debtor in possession, whether or not such contract . . . prohibits or restricts assignment of rights or delegation of duties; and (B) such party does not consent to such assumption or assignment . . . . 11 U.S.C. S 365(c)(1) (emphasis added). As the Ninth Circuit noted in In re Catapult Entertainment, Inc., 165 F.3d 747 (9th Cir. 1999), the proper interpretation of S 365(c)(1) has been the subject of considerable disagreement among courts and commentators. Id. at 749; see generally William J. Norton, Jr., Norton Bankruptcy Law and PracticeS 155:2 (2d ed. 2001); Lawrence D. Cherkis et al., Collier Real Estate Transactions and the Bankruptcy Code P 4.07[2] (2001); Daniel J. Bussel & Edward A. Friedler, The Limits on Assuming and Assigning Executory Contracts, 74 Am. Bankr. L.J. 321 (2000). We find that it is not necessary in this case, however, to delve into the complex issues of statutory interpretation that have arisen from the contours 15 of S 365. Because there is no evidence that Leah did not consent to remaining partners with Victor during the period in which he had become a debtor, we hold that neither SS 365(c)(1) nor 365(e)(2)(A) precluded or limited the application of S 365(e)(1). By their own terms, S 365(c)(1) and S 365(e)(2)(A) are applicable to executory contracts only when the non-debtor party does not consent to [the] assumption or assignment at issue. 11 U.S.C. S 365(c)(1)(B) and S 365(e)(2)(A)(ii). In the partnership context, at issue is whether a partner who becomes a debtor after filing for bankruptcy will assume the same partnership role that he had prior to becoming a debtor. When a partner files for bankruptcy, a co-partner may not want to continue in the partnership with the debtor because, upon securing bankruptcy-court protection, a general partner who becomes a debtor-inpossession of her personal estate necessarily assumes responsibilities to her creditors that conflict with her responsibilities to her co-partners. Phillips, 966 F.2d at 929 (citing Harms, 10 B.R. at 822). Subsections 365(c) and 365(e)(2) will prevent a debtor in bankruptcy from continuing to serve as a partner, however, only when a non-debtor partner does not consent to continue in the partnership with the debtor. In this case, there is no evidence whatsoever that Leah objected to having Victor remain as her general partner after he had filed his bankruptcy petition. In fact, the record demonstrates that Leah, with full knowledge that Victor had filed for bankruptcy, continued to regard Victor as her general partner. The partnership tax returns for 1997 and 1998, both of which were signed and filed by Leah, continued to list Victor as a general partner despite his debtor status. Although she had ample opportunity, Leah took no steps indicating that she did not consent to Victor’s continuing status as a general partner after he filed his bankruptcy petition. In light of these facts, we find that Leah effectively consented to remain partners with Victor despite his debtor status and, thus, that S 365(c)(1) and S 365(e)(2)(A) do not apply. That being the case, we conclude that S 365(e)(1) is fully applicable here and, therefore, Victor’s bankruptcy filing did not result in the dissolution of the Legends Partnership. 16