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In affirming a bankruptcy court order compelling arbitration, a federal district court in Delaware held that an arbitration agreement survives the bankruptcy debtor's rejection of the underlying contract even though rejection of an executory contract is generally regarded as "an all-or-nothing proposition."
In In re Fleming Companies, Inc., No. 05-749-SLR, 2007 WL 788921 (D. Del. Mar. 16, 2007), Fleming and Selby's Market (Selby's) entered into a supply agreement whereby Fleming would supply Selby's with groceries and related merchandise. The supply agreement contained an arbitration clause.
Several years later, Fleming filed for bankruptcy and exercised its right under the Bankruptcy Code to reject the supply agreement as an executory contract. Despite rejecting the supply agreement, Fleming filed a motion to compel arbitration of claims relating to the agreement. The bankruptcy court granted the motion.
On appeal to district court, the principal issue was whether the arbitration clause survived Fleming's rejection of the supply agreement. Selby's argued that the arbitration clause did not survive based on the principle that rejecting an executory contract in bankruptcy is "an all-or-nothing proposition." Fleming argued that the arbitration clause survived rejection based on the rule that "a rejected executory contract is rejected for purposes only of all executory performance obligations remaining under the terms of the contract."
Since there were no Third Circuit cases directly on point, the Court analyzed the issue by reference to the general principles applicable where an executory contract is rejected in bankruptcy. Specifically, the Court concluded that rejection "is not tantamount to termination" because rejection "does not alter the substantive rights of the parties," it merely frees the debtor from the duty of continued performance. Accordingly, an arbitration clause survives a bankruptcy debtor's rejection of the underlying contract.
Having determined that the arbitration clause survived Fleming's rejection of the supply agreement, the Court turned to the question of whether the bankruptcy court should have denied the motion to compel arbitration on the ground that arbitration would conflict with the Bankruptcy Code. Guided by In re Mintze, 434 F.3d 222 (3d Cir. 2006), the Court concluded that the bankruptcy court had no authority to deny enforcement of the arbitration agreement because the claim derived from the contractual relationship of the parties rather than the bankruptcy proceeding. Accordingly, the Court affirmed the order compelling arbitration.
By holding that rejection of the underlying contract did not extinguish the right or obligation to arbitrate, the Court essentially held that the arbitration clause was not an "executory portion[] of the contract." As such, the Court implicitly refuted the view of some commentators that an arbitration agreement is a separate executory contract – either physically or by virtue of the rule of severability – subject to rejection by a bankruptcy estate. See Zach Zunshine, Pre-Petition Arbitration Agreements in Bankruptcy and Hays and Co. v. Merrill Lynch, 7 Ohio St. J. on Disp. Resol. 157, 162-65 (1991).
Of course, there are other reported decisions that also refute this view. See, e.g., Hays and Co. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 885 F.2d 1149, 1153-54 (3d Cir. 1989) ("We see no reason to make an exception for arbitration agreements to the general rule binding trustees to pre-petition non-executory contracts, especially in face of the strong federal policy favoring arbitration and the Arbitration Act, which puts arbitration agreements on the same footing as other contracts."); In re Monge Oil Corp., 83 B.R. 305, 309 (Bankr. E.D. Pa. 1988) (concluding that the existence of an arbitration provision does not render a contract executory).
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