A Contract Divided

By: Chris Bolz

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

The United States Bankruptcy Court for the Southern District of New York held in In Re Hawker Beechcraft that the debtors were permitted under section 365 of the Bankruptcy Code to assume master agreements and some purchase orders while rejecting other purchase orders because such orders were divisible contracts.[1]  The debtors were aircrafts manufactures that purchased some of their parts from a supplier.[2] In connection with these purchases, the debtors and the supplier also entered into two master agreements.[3]  Under the master agreements, while the supplier agreed to manufacture parts, the debtor was not obligated to purchase any of the manufactured parts.[4]  The debtors commenced their chapter 11 bankruptcy cases and ultimately confirmed a joint plan of reorganization.[5]  Under the plan, the debtors would assume the master agreements and 395 purchase orders while rejecting 928 purchase orders.[6]  The supplier objected to this plan, arguing that the master agreements and all of the purchase orders constituted a single indivisible contract that must be assumed or rejected cum onere.[7] The bankruptcy court, however, overruled the supplier’s objection and held that the master agreements were divisible contracts and that the purchase orders were distinctly separate contracts from one another.

Under section 365(a) of the Bankruptcy Code, a debtor in possession, “may assume or reject any executory contract or unexpired lease of the debtor.”[8]  The debtor is possession must assume or reject a contract in its entirety.  The case hinged on whether or not the agreements were divisible, individual contracts or whether they were one, indivisible contract.  If the contract was indivisible, then the debtor could not decide to accept some of the purchase orders while rejecting others. An executory contracts must be accepted or rejected in its entirety.  However, this does not mean that every contract is viewed as an indivisible whole.  A “contract” may in fact be several individual contracts in which case they may be individually assumed or rejected. “Whether contract or lease provisions are severable is often determined under a three-factor test: (1) the differing nature and purpose of parts to the agreement; (2) the separate and distinct consideration which may be attributed to different parts of the agreement; and (3) the noninterrelatedness of obligations of the parties to the agreement.”[9] Ultimately, state law governs whether an agreement is divisible or indivisible for the purpose of assumption or rejection under section 365.[10] 

In Hawker Beechcraft, the court applied Kansas law to determine whether the agreements constituted a single indivisible executory contact.  Under Kansas law, “[w]hether or not a contract is entire or divisible is a question of construction to be determined by the court according to the intention of the contracting parties as ascertained from the contract itself and upon a consideration of all the circumstances surrounding the making of it.”[11]  Since contracts rarely express the parties’ intention regarding divisibility, under Kansas law, courts look to “whether, had the parties thought about it as fair and reasonable persons, they would be willing to exchange the performance in question irrespective of what happened afterwards or whether the divisions made were merely for the purpose of requiring periodic payments as the work progresses” to determine the parties’ intentions.[12]

Hawker Beachcraft is significant because it demonstrates that the determination of whether a contract is divisible is governed by state law and will be a fact-specific.  In addition, the case also demonstrates the desirability of having divisible contracts; the debtor was able to assume the master agreements and the best of purchase orders while rejecting the rest.  Had the court found that the master agreements and the purchase orders comprised a single contract, the debtor would have likely been forced to reject the contract cum onere because the benefits of assuming the 395 purchase orders would have been outweighed by the benefits of rejecting the other 928 purchase orders. 

[12] Id.