Under section 365(f)(1), a debtor is permitted to assume and assign leases and executory contracts notwithstanding contractual limitations or “applicable law” that restricts such assignment. However, that broad general authorization begins with the limiting language, “except as provided in subsection (b) and (c) of this section….”
Section 365(c)(1)(A) provides that a debtor may not assume and assign an executory contract if “…applicable law excuses a party, other than the debtor, to such contract or lease from accepting performance from or rendering performance to an entity other than the debtor or the debtor in possession….”
This note will not wade into the debate about whether a debtor may assume and perform a contract when section 365(c)(1) would prevent it from being assigned. However, since the notion of “applicable law” is used both in the general authorization and the exception, the question remains how the identical language should be construed to give effect to those two seemingly conflicting provisions.
Some courts have identified the limitation as covering those instances in which the identity of the performing party is crucial to the nature of the performance. A contract to paint a portrait would be an obvious example. However, other courts have found that limitation extends beyond personal performance contracts.
In the recent bankruptcy case of Tactical Intermediate Holdings, Inc., the Department of Defense filed a limited objection to the debtor’s proposed section 363 sale, which included the transfer of a government contract covering flame-resistant apparel. The Defense Department based its objection on federal contracting regulations which prohibit assignment without the government’s consent. They asserted that such regulations qualified as “applicable law” and should prevent the assignment of the contract. The matter was resolved without a ruling, through the inclusion of a clause preserving the Defense Department’s right to reject the transfer. However, the initial scenario presented the question of the proper scope for section 365(c)(1).
If the use of the words “applicable law” in section 365(f) is to retain any effective meaning, then the limitation in section 365(c) should not encompass an all-inclusive prohibition on assignment without consent. The courts which have focused on the importance of personal performance seem to have found the an appropriate balance to give effect to these two seemingly inconsistent provisions. Such a construction would prevent the transfer of agreements where there in a unique quality to the performance of the debtor party rather than inviting disputes about whether some construction of “applicable law” could be read as a limitation.