Rejection of Contract Precludes Refund of Unearned Payments Under Kentucky Law
Rejection of Contract Precludes Refund of Unearned Payments Under Kentucky Law
A recent decision by the U.S. Bankruptcy Appellate Panel for the Sixth Circuit showcases the potential pitfalls of failing to evaluate a debtor’s potential claims against a counterparty before rejecting the contract under Section 365(a) of the Bankruptcy Code.
In OGGUSA, INC., fka GenCanna Global USA, Inc. v. Louisville Dryer Company, GenCanna was forced into an involuntary petition under Chapter 11, to which it consented.
GenCanna was a party to a contract with LDC for the manufacture of equipment for use in GenCanna’s cannabinoid business. During the time LDC was manufacturing the equipment, GenCanna experienced financial difficulties, which led to a delay in construction of the facility where the equipment was to be housed. Eventually, LDC accused GenCanna of defaulting, although the parties afterwards agreed that GenCanna was not in default when such allegation was made (prior to bankruptcy).
During the bankruptcy, GenCanna treated the contract with LDC as executory and rejected it pursuant to Section 365(a). However, GenCanna demanded that LDC return $1,790,023 of allegedly unearned progress payments.
After LDC refused, GenCanna initiated an adversary proceeding seeking to recover the payments. In the face of Kentucky law’s bar against the recovery of damages by a party that breached the relevant contract first, GenCanna argued that LDC had repudiated the contract before GenCanna rejected it in bankruptcy.
The bankruptcy court, as well as the BAP disagreed, given that LDC had not shown an unequivocal and clear intent to cease performance under the agreement, as required under Kentucky law.
Since GenCanna breached the contract first (by rejecting it), the BAP that concluded there was no principled basis on which to require LDC to refund any payments received under the contract, particularly since it did not pursue on appeal a claim for unjust enrichment.