Feb. 19, 2009 – In an article entitled Section 365 Executory Contract Assumption Defense to a Bankruptcy Preference Claim, we discuss the absolute defense to a preference claim created when a bankrupt company or its trustee “assumes” an “executory contract”.  That defense was firmly established in a 2003 decision by the Third Circuit Court of Appeals in the bankruptcy case of In re Kiwi International Air Lines Inc., so the defense is sometimes called the Kiwi defense.

The Kiwi defense is a defense that we believe may be underutilized.  As we explain elsewhere on this web site, the facts needed to establish the 3 most common defenses are “fixed” at the time of the bankruptcy filing.  As to establishing the subsequent new value, ordinary course of business and contemporaneous exchange defenses, there is nothing that the supplier can do but pull together books and records.

The Kiwi defense is different.  It depends in part on facts that arise after the bankruptcy petition is filed.  There are two essential post-petition elements.  First, the supplier has to establish that its contract with the bankrupt customer remains “executory” after the bankruptcy filing.  (See the Section 365 article for a discussion of “executory”.)  Second, the decision maker for the debtor’s estate (the debtor in possession or the trustee) needs to be convinced that an assumption of the “executory contract” is important to the reorganization or sale of assets.

The reason we think this defense is underutilized is because suppliers don’t know that the defense exists or don’t understand the defense.  There may be a “supply contract,” “purchase agreement” or like contract that establishes mutual, continuing obligations between the parties, but after the bankruptcy filing, the supplier and the debtor are on autopilot and continue along without any thought about the contract.

The other reason we think the defense is missed is because it usually requires thought and planning in the early stages of a bankruptcy proceeding and certainly well before getting the first preference demand letter.

There never is any assurance that a Kiwi defense strategy will work.  But we have a hard time imagining a situation where the Kiwi defense should be overlooked.