Is it a binding contract? Don’t be so sure! | Nelson Mullins Riley & Scarborough LLP

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In the still choppy waters of the Compatriot test to determine whether a contract is enforceable, the United States District Court for the Central District of Louisiana recently plunged its toe. The question before the court was whether the bonds issued to an oil and gas company were enforceable. The district court, upholding the lower bankruptcy court, ruled that they were not. The analysis of this opinion makes it possible to understand why sureties are not enforceable and to draw lessons from it for both creditors and debtors.

The case, Argonaut Insurance Co. v. Falcon V, LLC, et al. (Regarding Falcon V LLC), MD La, No. 20-00702-BAJ-SDJ, results from the post-confirmation stage of a Chapter 11 matter. Argonaut Insurance Company (“Argonaut”) has provided surety bonds to the debtor as part of its relations with certain donors of mining rights. These bonds provided that the debtor would pay premiums, Argonaut would provide the bonds, and if a lessor made a claim on a bond, after paying on the bond, the debtor would indemnify Argonaut. Above all, the surety bonds were irrevocable.

At the onset of bankruptcy, the debtor sought relief on the first day to continue the surety bond program, describing it as an essential service that must continue in order for the debtor to remain in business. The bankruptcy court approved the continuation of the program and the debtor continued to pay the premiums throughout the case. Argonaut filed proof of claim in the event that it argued that the obligations were non-assumable and non-assignable “financial accommodations”.

The debtor was able to successfully confirm a reorganization plan, which Argonaut did not oppose. One of the provisions of the plan provided that enforceable contracts which were not expressly rejected were automatically assumed by the reorganized debtor. The plan included a list of enforceable contracts that did not include the bond program.

After the plan was confirmed, the debtor continued to pay premiums to Argonaut for a few months, but then stopped making payments. Argonaut responded by requiring the reorganized debtor to obtain discharge of obligations or provide additional security for them, as provided for in indemnification agreements entered into under the surety bond program. The reorganized debtor responded by claiming that Argonaut’s claims violated the discharge injunction under the plan. See Articles 524 and 1141 of the Bankruptcy Code. Argonaut then filed a petition with the bankruptcy court for a declaration that the obligations were included in the enforceable contracts automatically assumed by the plan. The bankruptcy court ruled that the bonds were not enforceable contracts and, therefore, were not automatically assumed by the plan. On appeal, the district court confirmed.

In upholding the bankruptcy court, the district court turned to the Compatriot test to determine if the obligations were enforceable contracts. Under the Compatriot test, a contract is enforceable if two aspects are satisfied: (1) the performance must remain due to a certain extent by both parties to the contract; and (2) the failure of one party to perform would constitute a material breach of the contract, thereby excusing the other party from performance. Under this heading, the district court had little difficulty in concluding that the bail program had failed on both tracks.

First, the district court ruled that there were no continuing obligations of Argonaut to the debtor. As part of the program, Argonaut was required to post a bond when the premiums were paid by the debtor. But these deposits were then deposited with the first payment of the premium and were thereafter irrevocable. At the time of the bonding, however, Argonaut was owed no further performance to the debtor for any reason. At most, Argonaut had a conditional obligation to make payments to lessors if a claim was made, and then to seek compensation from the debtor. Since the bonds only flowed one way after the bond was posted, the district court ruled that the first part of the bond Compatriot the test was not satisfied.

Second, because the sureties were irrevocable, a breach by the debtor did not create a material breach that would excuse the performance of Argonaut. If the debtor did not pay, Argonaut was actually required to step in and pay or perform the obligations to which the obligations applied, and then seek compensation from the debtor. Since there was no exemption from execution for Argonaut in the event of default by the debtor, the second part of the Compatriot the test also failed.

This case presents a unique learning opportunity for creditors and debtors. For debtors, it highlights the importance of the discharge order and the impact of a good development of a recovery plan. For creditors, it presents two lessons: (1) don’t assume that a contract is enforceable, and (2) don’t take inconsistent positions in a deal just to get what you want at that particular point in the case. It was Argonaut who initially argued that the links were not assumable. When forced to fall back on the automatic hypothesis argument under the plan, he made a total of eighty from that position. Although the district court did not find that Argonaut was foreclosed from taking the compensatory position, it nevertheless pointed out the inconsistency.

Argonaut made an interesting point, however, which was supported by the Surety & Fidelity Association of America as friend, which can be addressed to the circuit court, in the event of an appeal from Argonaut: that the Compatriot test was developed for bilateral and non-tripartite contracts and, therefore, does not correspond to this situation. If the circuit court were to take up the appeal, it is likely that this will be the main issue to be addressed. Argonaut may not have had his last day in court on this matter, but, as of now, the bonds are not enforceable.


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