Court Opinion

ID: 4283917
Source: CourtListenerOpinion
Date Created: 2018-06-13 15:00:23.555609+00
Date Added: 2024-06-11T14:35:12.334380
License: Public Domain

17-2410-bk
In Re: Nanodynamics (Wallach v. Smith)

                    UNITED STATES COURT OF APPEALS
                        FOR THE SECOND CIRCUIT

                             SUMMARY ORDER
RULINGS  BY SUMMARY ORDER DO NOT HAVE PRECEDENTIAL EFFECT. CITATION TO A SUMMARY ORDER
FILED ON OR AFTER JANUARY 1, 2007, IS PERMITTED AND IS GOVERNED BY FEDERAL RULE OF
APPELLATE PROCEDURE 32.1 AND THIS COURT=S LOCAL RULE 32.1.1. WHEN CITING A SUMMARY
ORDER IN A DOCUMENT FILED WITH THIS COURT, A PARTY MUST CITE EITHER THE FEDERAL APPENDIX
OR AN ELECTRONIC DATABASE (WITH THE NOTATION ASUMMARY ORDER@). A PARTY CITING A SUMMARY
ORDER MUST SERVE A COPY OF IT ON ANY PARTY NOT REPRESENTED BY COUNSEL.

     At a stated term of the United States Court of Appeals for
the Second Circuit, held at the Thurgood Marshall United States
Courthouse, 40 Foley Square, in the City of New York, on the
13th day of June, two thousand eighteen.

PRESENT: DENNIS JACOBS,
         DENNY CHIN,
         RAYMOND J. LOHIER, Jr.,
              Circuit Judges.

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IN RE: NANODYNAMICS, INC.,
         Debtor.

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MARK S. WALLACH, 169 Delaware Avenue,
Buffalo, NY, 14202, Chapter 7 Trustee
of NanoDynamics, Inc.,
         Plaintiff-Appellant,

             -v.-                                           17-2410-bk

DAVID SMITH,2403 Ridgepointe Drive,
Jonesboro, AR, 72404, JENNIFER SMITH,

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2403 Ridgepointe Drive, Jonesboro, AR,
72404,
          Defendants-Appellees.

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FOR APPELLANT:                    Robert J. Feldman, Gross
                                  Shuman P.C., Buffalo, N.Y.

FOR APPELLEES:                    Christopher P. Schueller,
                                  Esq. (Kathleen A. Murphy,
                                  Esq., on the brief), Buchanan
                                  Ingersoll & Rooney PC,
                                  Pittsburgh, PA.

     Appeal from a judgment of the United States District Court
for the Western District of New York (Vilardo, J.).

     UPON DUE CONSIDERATION, IT IS HEREBY ORDERED, ADJUDGED AND
DECREED that the judgment of the district court be AFFIRMED.
     Mark S. Wallach, as Chapter 7 Trustee of NanoDynamics,
Inc., appeals from the judgment of the United States District
Court for the Western District of New York, which affirmed an
order of the Bankruptcy Court dismissing Wallach’s claim for
$700,000 plus interest on the balance of a pre-petition stock
subscription agreement. We assume the parties’ familiarity
with the underlying facts, the procedural history, and the
issues presented for review.

     David and Jennifer Smith (the “Smiths”) executed a stock
subscription agreement (the “Agreement”) with NanoDynamics,
Inc. (“Debtor”) to purchase 2.5 million shares of stock at $1
per share. Under the Agreement, the Smiths would complete
payment in stages by March 31, 2009, and Debtor would issue the
number of shares corresponding to the money paid within five
business days of each receipt of funds. The Smiths failed to
complete payment by March 31, 2009, but did pay a total of $1.8
million in various amounts between March 9, 2009, and June 8,
2009. All but one of these payments occurred after the March
31, 2009 deadline. Rather than terminating the Agreement or
suing for breach, the Debtor continued to issue shares of stock
within five business days of each payment.

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     On July 27, 2009, when the Debtor filed a voluntary petition
under Chapter 7 of Title 11 of the Bankruptcy Code, a balance
of $700,000 remained untendered on the Agreement, and the
petition listed the Agreement as an executory contract.
Wallach filed an amended complaint on February 28, 2011 alleging
that the Smiths were in breach of the Agreement as of the
contractual deadline (April 1, 2009), and were liable for the
remaining balance plus interest under New York Business
Corporation Law (“BCL”) § 628(a) and Section 542 of the
Bankruptcy Code. The Smiths denied liability and asserted a
number of counterclaims and affirmative defenses. The
Bankruptcy Court’s final opinion and order dismissed the claims
for breach of contract and BCL § 628 on the ground that 11 U.S.C.
§ 365(c)(2) expressly prohibits a trustee from assuming and
collecting upon a contract for the issuance of stock. The
district court affirmed, concluding that “[b]ecause § 365(c)(2)
decides the case, th[e] Court need not consider whether the
Agreement was invalid due to the debtor’s violation of the
federal securities laws.” Wallach v. Smith, 15-CV-1080(LJV),
2017 WL 2957829, at *6 (W.D.N.Y. July 11, 2017).

     On review of the District Court’s July 2017 decision
affirming the December 2015 order of the Bankruptcy Court, see
In re Nanodynamics, Inc., No. 09-13438 K, 2015 WL 8602618
(W.D.N.Y. Bankr. Dec. 11, 2015), we accept the bankruptcy
court’s factual findings unless clearly erroneous and review
its conclusions of law de novo. Bell v. Bell (In re Bell), 225
F.3d 203, 209 (2d Cir. 2000).

     Wallach claims entitlement to the remaining balance of
$700,000 plus interest as a matter of contract law,
notwithstanding that performance on the contract by Debtor is
no longer possible. He relies on the common law rule that a
“trustee in bankruptcy had authority to bring and maintain [an]
action upon the stock subscription,” even if “the corporation
is bankrupt and a stock certificate cannot be issued,” Allen
v. Ryan, 219 A.D. 634, 635-36 (4th Dep’t 1927); see In re
Hannevig, 10 F.2d 941, 945 (2d Cir. 1925); and explains that
this rule was codified in the New York Business Corporation Law,
which provides that a “subscriber for shares of a corporation
shall be under no obligation to the corporation for payment for

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such shares other than the obligation to pay the unpaid portion
of his subscription....” BCL § 628 (emphasis added); see
Chrysler Corp. v. Fedders Corp., 73 A.D.2d 504, 507 (1st Dep’t
1979) (Section 628 “put[] into statutory form the common-law
recognition of the fact that liability for unpaid subscriptions
is contractual and, therefore, should run in favor of the
corporation.”); Lewis v. Dansker, 68 F.R.D. 184, 192 (S.D.N.Y.
1974).

     This authority is unavailing. Section 365 of Bankruptcy
Code, codified in the 1978 Bankruptcy Reform Act (“BRA”),
provides in plain terms that a “trustee may not assume or assign
any executory contract ... if such contract is a contract ...
to issue a security of the debtor.” 11 U.S.C. § 365(c)(2).
Section 365 would thus specifically supersede any rule that
would otherwise permit a trustee in bankruptcy to assume an
executory contract for the sale of stock. See In re Telligent,
Inc., 268 B.R. 723, 737 (Bankr. S.D.N.Y. 2001) (concluding after
a comprehensive review of the legislative history of the BRA
that Section 365(c)(2) was specifically designed to defeat “a
pre-petition agreement obligating the non-debtor to advance new
cash or credit in exchange for the debtor’s” stock). Congress
enacted the BRA in part as a response to industry concerns about
the enforcement of unjust contracts such as the very Agreement
sought to be assumed here. See In re Ardent, Inc., 275 B.R.
122, 125-26 (Bankr. D.D.C. 2001); H.R. Rep. No. 95-595, at 348
(1977); Bankruptcy Reform Act of 1978: Hearings on S. 2266
Before the Subcommittee on Improvements in Judicial Machinery
of The Judiciary, 95th Cong. 521, 858 (1977). Wallach (a
trustee) therefore cannot sue for money damages on the unpaid
portion of an executory contract for the sale of stock under
the common law rule or the BCL.

     Wallach argues in the alternative that the proscription of
Section 365(c)(2) does not apply to this case because the
Agreement is non-executory, and the Bankruptcy Code only
prevents the assumption of an executory contract. See 11
U.S.C. § 365(c)(2). There are multiple tests for determining
whether an agreement is an “executory contract” within the
meaning of Section 365(c). The so-called Countryman Test
defines an executory contract as “a contract under which the
obligation of both the bankrupt and the other party to the

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contract are so far unperformed that the failure of either to
complete performance would constitute a material breach
excusing the performance of the other.” In re Ellipsat, Inc.,
480 B.R. 1, 6 (Bankr. D.D.C. 2012) (internal citations omitted);
see also In re Spectrum Inf. Techs., Inc., 190 B.R. 741, 746-47
(Bankr. E.D.N.Y. 1996). The Second Circuit has also employed
a less demanding inquiry characterized as the “some performance
due” test, which defines an executory contract as one “on which
performance remains due to some extent on both sides.” Eastern
Air Lines, Inc. v. Ins. Co. of Penn. (In re Ionosphere Clubs,
Inc.), 85 F.3d 992, 998-99 (2d Cir. 1996) (quoting NLRB v.
Bildisco & Bildisco, 465 U.S. 513, 522 n.6 (1984)). Courts
examine the executory status of a contract as of the date the
bankruptcy petition was filed. In re Ellipsat, Inc., 480 B.R.
at 7 (citing In re Exide Techns., 607 F.3d 957, 962 (3d Cir.
2010)).

     We need not resolve the question of which test applies
because the Agreement is an executory contract under either
test. Cf. In re Telligent, 268 B.R. at 732. It is undisputed
that neither side tendered complete performance on the
Agreement; $700,000 remained unpaid and 700,000 shares unissued
when the Debtor filed under Chapter 11. Default on an
obligation to make substantial monetary payments in exchange
for shares is a material breach that renders a contract
executory. See id. at 731 (“the buyer’s breach of its payment
obligation [is] material, making the contract executory on that
side”); see also In re Bluman, 125 B.R. 359, 362 (Bankr. E.D.N.Y.
1991); In re Ardent, 275 B.R. at 124.

     Wallach points out that since the Smiths materially
breached the contract as of April 1, 2009, the Debtor was
relieved of its obligations and had the option to rescind, and
argues that this breach makes the contract non-executory. But
a material breach by one party does not necessarily transform
an executory contract into a non-executory one. “If the
injured party chooses to go on” after an alleged breach, “he
loses his right to terminate the contract because of the
default.” Apex Pool Equip. Corp. v. Lee, 419 F.2d 556, 562 (2d
Cir. 1969). Under these circumstances, the animate contract
remains executory. See id.; see, e.g., In re RLR Celestial
Homes, Inc., 108 B.R. 36, 45 (Bankr. S.D.N.Y. 1989) (“[A]

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contract is not deemed terminated and no longer executory simply
because the debtor has defaulted or breached the contract before
the commencement of a bankruptcy case.” (internal citations
omitted)).

     Whether or not the Debtor could have proven a breach on
April 1, 2009 and proceeded to terminate or rescind the
Agreement, it did not do so. It elected instead to forbear any
action against the Smiths and accept partial performance of $1.8
million over the course of three separate transactions. And
the Debtor duly performed on its obligations under the Agreement
by issuing its stock within five days of each allotted payment.
In sum, the conduct of the Debtor in the months intervening
between April 1, 2009 and the declaration of bankruptcy on July
27, 2009 shows that it considered the contract very much
executory, and it listed the Agreement as an “executory
contract” on its initial bankruptcy filing on July 27, 2009.
App’x at 73, 127. Section 365(c)(2) precludes the trustee from
assuming the Agreement and enforcing it against the Smiths, so
the claims arising under the Agreement were properly dismissed.

     Accordingly, and finding no merit in Wallach’s other
arguments, we hereby AFFIRM the judgment of the district court.

                             FOR THE COURT:
                             CATHERINE O’HAGAN WOLFE, CLERK

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