IN RE WAGSTAFF MINNESOTA, INC. Bankruptcy No. 11-43073.
In re: Wagstaff Minnesota, Inc., et al., Chapter 11 Bankruptcy, Debtors. KFC Corporation, Appellant, v. Wagstaff Minnesota, Inc. et al., Official Committee of Unsecured Creditors of Wagstaff Minnesota, Inc. et al., General Electric Capital Corporation et al., Appellees.
United States District Court, D. Minnesota.
January 3, 2012.
Susan G. Boswell, Esq., Quarles & Brady LLP, and Ralph V. Mitchell, Jr., Esq., Lapp, Libra, Thomson, Stoebner & Pusch, Chartered, appeared for Appellees General Electric Capital Corporation et al.
ORDER Jointly Administered
JOAN N. ERICKSEN, District Judge.
KFC Corporation (KFCC) appeals a final order of the United States Bankruptcy Court for the District of Minnesota. Appellees (Debtors) join together in opposition. For the reasons set forth below, the Court reverses the decision of the bankruptcy court.
Debtors own and operate 77 restaurants (Outlets) as KFCC franchisees. Debtors defaulted on their original franchise agreements, KFCC terminated the agreements, and the parties negotiated and executed a new set of documents that form the basis of the dispute on appeal. Specifically, the parties disagree as to whether this set of documents should be considered one indivisible contract.
Debtors defaulted on the original franchise agreements at various times prior to October 2009. On June 2, 2010, KFCC and Debtors entered into a Prenegotiation and Forbearance Agreement that provided for a time in which to negotiate reinstatement of the franchise agreements for the limited purpose of the sale of the Outlets. On August 13, 2010, the parties signed a Reinstatement Agreement, an Addendum to Reinstatement Agreement, and a Letter Agreement. The Addendum to Reinstatement Agreement provides that the Kentucky Fried Chicken Franchise Agreement signed pursuant to the Reinstatement Agreement will expire on August 1, 2011. On November 5, 2010, the parties signed new Kentucky Fried Chicken Franchise Agreements effective on August 13, 2010—the same day as the other reinstatement documents. The parties provided the Court with a sample set of these four documents for one of the Outlets. In each new Kentucky Fried Chicken Franchise Agreement, the phrase indicating that the expiration date was to be twenty years from the date of execution is crossed out and replaced with the date that each Outlet's original franchise agreement would have expired. For example, the sample New Franchise Agreement provided to the Court has an expiration date of June 6, 2022.
The four documents discussed below were executed for each individual Outlet. All of the documents have the same effective date of August 13, 2010.
Debtors filed for Chapter 11 bankruptcy on April 30, 2011. On July 27, 2011, the bankruptcy court held an expedited hearing, determined that the documents were two separate agreements, and granted Debtors' motion under bankruptcy law to reject the Reinstatement Agreement, Addendum, and Letter Agreement. The bankruptcy court's order left the New Franchise Agreement in effect, thereby allowing Debtors to continue operating the Outlets with the potential to assume the New Franchise Agreement in later bankruptcy court proceedings. In an oral statement in open court, the bankruptcy court concluded that the documents span different subject matters and have different purposes. (Bankr. Proceedings Tr. 52:21-53:15, 57:7-16, 59:9-19, July 27, 2011) The bankruptcy court also noted that the presence of an integration clause and assignability provision in the New Franchise Agreement and a merger clause in the Reinstatement Agreement indicate the documents are separate contracts. (Bankr. Proceedings Tr. 55:23-56:11, 58:4-18, 58:21-59:9) It could not reconcile the different termination dates if the documents were viewed as one agreement. (Bankr. Proceedings Tr. 57:17-58:1) The bankruptcy court ruled that there were two separate agreements and granted Debtors' motion to reject the Reinstatement Agreement and its supporting documents.
On appeal, KFCC argues that the bankruptcy court erred in treating the Reinstatement Agreement and its supporting documents as separate from the New Franchise Agreement and in allowing Debtors to reject only the former. This Court sits in review of bankruptcy court decisions pursuant to 28 U.S.C. § 158(a) (2006). The Court reviews the bankruptcy court's conclusions of law de novo and its factual findings for clear error. Dapec, Inc. v. Small Bus. Admin. (In re MBA Poultry, LLC),
The bankruptcy court did not rely on extrinsic evidence in reaching its decision. It did not conduct an evidentiary hearing or expressly identify any ambiguities in the agreements. Rather, the bankruptcy court based its reasoning on the plain language of the contracts, the purpose of the documents, and practical considerations. The bankruptcy court did not make factual findings, and therefore, this Court reviews the decision de novo.
Under Bankruptcy Code section 365(a), a trustee may assume or reject any executory contract, subject to the court's approval. 11 U.S.C. § 365(a) (2006). It is undisputed that the Reinstatement Agreements at issue here are executory contracts. Rejection of a contract frees the debtor from the obligation to perform and provides the non-debtor party with only an unsecured claim for any damages due to breach of contract. Id. § 365(g). The purpose of allowing a debtor to reject some contracts is to "release the debtor's estate from burdensome obligations that can impede a successful reorganization." NLRB v. Bildisco & Bildisco,
Contract interpretation is a matter of state law. Id. The parties agree that Kentucky law applies to issues of contract interpretation in this case. Determining whether several documents form one indivisible contract is a matter of contract interpretation governed by state law. In re Pollock,
A. Plain language of the agreements
Under Kentucky law, a contract is given its plain meaning where it is not ambiguous. Hoheimer v. Hoheimer,
KFCC argues that the four documents at issue refer to the same subject matter—Debtors' continuing operation of the Outlets pending Debtors' sale of the Outlets. Debtors argue that the subject matter of the agreements should be viewed more narrowly. Namely, that the New Franchise Agreement concerns the operation of and license for the Outlets, whereas the Reinstatement Agreement, Addendum, and Letter Agreement relate to Debtors' financial and sale obligations to KFCC. These agreements must be examined in the context surrounding their execution. See Veech, 128 S.W.2d at 911. When Debtors and KFCC executed the Reinstatement Agreements, Debtors had breached, and KFCC had terminated, the original franchise agreements. Consequently, the Reinstatement Agreements were necessary to give Debtors the right to operate the Outlets. Likewise, the New Franchise Agreements were key assets for Debtors in marketing and completing the sales contemplated in the Reinstatement Agreements and their supporting documents. Debtors would not have been able to continue operations or sell the Outlets without the agreements. Thus, these documents all relate to the continuing operation of the Outlets by Debtors pending Debtors' sale of the Outlets. The Court declines to accept the narrow view of subject matter proffered by Debtors and adopted by the bankruptcy court.
The Court now turns to whether the parties intended to create one or more than one contract at the time of execution. The intent of the contracting parties is stated in the plain language of the Addendum. The first sentence states: "Franchisee has voluntarily entered into this Reinstatement Agreement for the special and limited purpose of selling the KFC Outlet located at [specific location]." This statement could not be plainer as to the parties' intent that the transaction was for the purpose of selling the Outlets. Although discussing several clauses in the agreements, it is not clear whether the bankruptcy court considered this most straightforward statement of the parties' intent located in the contract itself. Debtors argue that the statement of intent in the Addendum only relates to the intent behind the Reinstatement Agreement and not the intent of the New Franchise Agreement. The plain text of the documents, however, contains several other indications that corroborate the parties' intent, as it is plainly stated in the Addendum, to form one contract.
1. Language of incorporation and cross-references
KFCC argues that the New Franchise Agreement is incorporated into the Reinstatement Agreement by reference and that incorporation proves the documents are one indivisible contract. Debtors counter that the incorporation language is merely for specific identification of the New Franchise Agreement rather than to make its terms part of the Reinstatement Agreement. The Reinstatement Agreement requires Debtors to:
(Reinstatement Agreement III.C, ECF No. 1 Doc. 15 at 51) Where a document is incorporated into a contract by reference, the instruments are treated as one. Knight, 233 S.W.2d at 970. The clause here uses the word "incorporated" and the phrase "as though set forth verbatim." These words should be given their plain meaning. The incorporation clause explicitly references the changed date of expiration. This indicates that the rest of the provisions in the New Franchise Agreement are incorporated as they are written. If the clause was merely identifying the New Franchise Agreement, there would be no need to mention specific provisions therein. The incorporation language provides a strong indication on the face of the contract that the agreements were intended to be one contract.
Furthermore, the Reinstatement Agreement cross-references the New Franchise Agreement. The incorporation clause in the Reinstatement Agreement is prefaced with the command that Debtors "execute" the New Franchise Agreement. In addition to the reality that Debtors would have no franchise agreement without this directive in the Reinstatement Agreement, it indicates that the New Franchise Agreement is an essential part—indeed, a requirement—of the Reinstatement Agreement. Additionally, the Reinstatement Agreement uses the phrase "any Franchise Agreement(s) executed pursuant hereto" in several places. That the New Franchise Agreement is executed pursuant to the Reinstatement Agreement does not prove that the documents are one. Nevertheless, this language makes clear that the New Franchise Agreement is strongly linked to the Reinstatement Agreement. Debtors assert that the absence of any reference to the Reinstatement Agreement or Letter Agreement in the New Franchise Agreement indicates that the parties did not intend them to be part of one contract. Although Debtors are correct that a cross-reference in the New Franchise Agreement to the Reinstatement Agreement would be a strong indication that they were one, the absence of such a reference does not conclusively prove they are separate agreements. See Bailey v. R.R. Co., 84 U.S. (17 Wall.) 96, 108 (1872) (stating "nor is it necessary that the instruments should in terms refer to each other if in point of fact they are parts of a single transaction").
2. Integration and conflict clauses in the agreements
Both the New Franchise Agreement and the Reinstatement Agreement contain integration clauses that Debtors argue are in conflict with each other. The New Franchise Agreement states in relevant part:
(New Franchise Agreement section 20.5, ECF No. 1 Doc. 15 at 35) The Reinstatement Agreement provides:
(Reinstatement Agreement part VII.G, ECF No. 1 Doc. 15 at 54) Debtors argue that these clauses signify that the agreements are separate because they cannot be reconciled if the agreements are interpreted as one contract. Debtors point out that the integration clause in the New Franchise Agreement is very broad as it "supersedes all prior and contemporaneous understandings and agreements of the parties," and it would supersede the Reinstatement Agreement entirely. The bankruptcy court agreed, concluded that the integration clause in the New Franchise Agreement controls, and stated that the comparable clause in the Reinstatement Agreement only spoke to the parol evidence rule.
KFCC argues that the language of the integration clause in the Reinstatement Agreement expressly includes the New Franchise Agreement. It includes the phrase "and the agreements executed pursuant hereto." KFCC explains that, because the New Franchise Agreement is pursuant to the Reinstatement Agreement, the documents are part of one agreement such that the integration clauses are not in conflict. Debtors counter that the mere mention of another agreement in an integration clause does not mean the documents are merged. The purpose of the integration clause in the Reinstatement Agreement, as the bankruptcy court concluded and as is common in contract practice, could well have been to prevent parol evidence rather than to explicitly integrate the documents. But the reference to the contemplated New Franchise Agreement certainly provides an indication that the documents are parts of one contract. Furthermore, the integration clause in the New Franchise Agreement, upon which the bankruptcy court relied, is equally concerned with parol evidence. Both integration clauses are formulated as standard provisions to protect a contract from the admission of parol evidence. This, however, does not resolve the alleged conflict between the integration clauses in the agreements.
KFCC points to the Addendum, which states:
(Addendum part IV, ECF No. 1 Doc. 15 at 66) KFCC argues that this conflict resolution clause requires any perceived conflict between the integration clause in the New Franchise Agreement and the integration clause in the Reinstatement Agreement to be resolved in favor of the Addendum. Debtors contend that the conflict provision in the Addendum is superfluous if the agreements are all part of the same contract—if they are one contract, then there can be no conflict. Because they are separate documents, irrespective of whether they are one contract, the potential for conflict exists. The language in the conflict clause specifically contemplates the New Franchise Agreements. The parties practiced careful contracting by including the conflict clause to avoid any unforeseen conflicts. To interpret the conflict clause in the Addendum in any other way would be to disregard the plain language of this precautionary provision.
3. Merger clause in the Reinstatement Agreement
KFCC argues the bankruptcy court misconstrued the merger clause in the Reinstatement Agreement. The merger clause provides: "This Agreement shall not be merged into any Franchise Agreement(s) executed pursuant hereto." (Reinstatement Agreement part VII.J, ECF No. 1 Doc. 15 at 54) KFCC asserts that the clause prevents extinguishment of the Reinstatement Agreement by absorption into the New Franchise Agreement. Debtors contend that a merger clause is the same as an integration clause, and the New Franchise Agreement and the Reinstatement Agreement, therefore, explicitly cannot be one contract. "[T]he standard method to integrate an agreement and thus to limit the relevance of surrounding circumstances is to include a merger clause in the final writing." A & A Mech., Inc. v. Thermal Equip. Sales, Inc.,
Although these cases demonstrate that a purpose of a merger clause is to integrate an agreement for purposes of the parol evidence rule, that is not the only reason to include such a clause. When viewed in the context of the Reinstatement Agreement as a whole, the merger clause here was not intended to serve its usual function. See Mitchell, 74 S.W. at 217 ("It is not proper, in construing a contract, for a court to seize upon some expression in it, and allow that to control, in disregard of other provisions of it."). The Reinstatement Agreement contains what was termed earlier the "integration clause," which states it constitutes the entire agreement of the parties in order to prevent the introduction of extrinsic evidence. Then, several sections later the "merger clause" appears. The merger clause would be superfluous if it had the same effect as the integration clause. See City of Louisa v. Newland,
4. Assignability provision in the New Franchise Agreement
Because the New Franchise Agreement is assignable, the bankruptcy court determined that it was separate from the Reinstatement Agreement. The New Franchise Agreement allows the franchise agreement to be assigned to a subsequent purchaser with KFCC's consent. (New Franchise Agreement section 16, ECF No. 1 Doc. 15 at 31-33) KFCC argues that this indicates that the New Franchise Agreement is part of a larger reinstatement contract because its consent is required prior to any assignment of the New Franchise Agreement. See In re Buffets Holdings, Inc.,
It is true that the assignment provision indicates that the New Franchise Agreement can be a stand-alone contract—but not as between the contracting parties. The express ability to assign the New Franchise Agreement comports perfectly with the parties' intent as stated in the Addendum. Debtors were supposed to sell the Outlets. And the Outlets are far more saleable if a franchise agreement, unburdened by references to the prior owners, can be transferred and assumed pursuant to the sale. The assignment provision facilitates the sale of the Outlets. The necessity of KFCC approval of a contemplated sale weighs in favor of viewing the documents as one agreement.
5. Cross-default provisions
KFCC argues that the presence of a cross-default provision in the Letter Agreement indicates that the agreements should be interpreted to be one contract. A cross-default clause in an agreement is "inherently suspect" in the context of bankruptcy. Lifemark Hosps., Inc. v. Liljeberg Enters. (In re Liljeberg Enters.),
The Letter Agreement states: "Franchisee agrees that the following events shall constitute an event of default under any Outlet's Franchise Agreement." (Letter Agreement 2, ECF No.1 Doc. 15 at 60) The paragraph goes on to list numerous ways franchisees can default on the agreement that are not present in the New Franchise Agreement. Additionally, the final paragraph of the Letter Agreement provides that: "your failure to meet any of the above requirements will result in immediate termination of the Reinstatement Agreements, this Letter Agreement and the Franchise Agreements for the Outlets." (Letter Agreement 3, ECF No.1 Doc. 15 at 61) These clauses in the Letter Agreement plainly state that failure to comply with the requirements in the Reinstatement Agreement, Addendum, and Letter Agreement result in termination of the New Franchise Agreement. The parties unambiguously expressed their intention that but for the provisions in the Reinstatement Agreement, Addendum, and Letter Agreement there would be no reinstatement of the franchise agreement. KFCC would not have entered into the New Franchise Agreement without the Reinstatement Agreement and the Letter Agreement complete with its cross-default provisions. This is a strong indication that these documents form one indivisible contract. See In re T & H Diner, Inc.,
6. Difference in the termination date
Debtors focus on the difference in the termination date of the New Franchise Agreement in the various documents. The bankruptcy court stated that this difference was confusing to reconcile. (Bankr. Proceedings Tr. 57:24, July 27, 2011) The Addendum and Letter Agreement state the New Franchise Agreement terminates on August 1, 2010. But the New Franchise Agreement itself contains an expiration date twenty years after the date of execution of the original (terminated) franchise agreement for each Outlet. The difference in dates was intentional. The incorporation clause of the Reinstatement Agreement varies the date in the New Franchise Agreement to coincide with the expiration of the original franchise agreement for each Outlet. The parties' contemplation of the expiration date is also evidenced in the New Franchise Agreements by the striking through of the standard twenty-year term and insertion of the correct expiration date. This difference was deliberate, and it can be explained by looking at the dates in the context of the contract as a whole.
The plain language of the Addendum states that the purpose of the contract is for the sale of the Outlets. Any sale would include the transfer of a franchise agreement. Debtors' rights under the original franchise agreements extended twenty years past the date of execution. Thus, Debtors—pursuant to the Reinstatement Agreement—have a franchise agreement extending to that date that they can sell. The assignability clause in the New Franchise Agreement allows for such a transfer. Sale of a franchise agreement that expires on August 1, 2010, the same day set as the deadline for sale of the Outlets, would make no sense. Although the dates are clearly different, contractual provisions must be interpreted in context and in light of the contract as a whole. See Newland, 705 S.W.2d at 919. When the different dates are considered in light of the purpose stated in the Addendum, the alteration of the date in the incorporation clause in the Reinstatement Agreement, and the assignment provision in the New Franchise Agreement, the difference exists for a sensible reason. The New Franchise Agreement is as marketable to a third-party as was the first franchise agreement; it is unencumbered by references to Debtors. The franchise agreements—old and reinstated—contemplate that a new owner will receive an assignment of the franchise. The Kentucky Fried Chicken Franchise Agreement at section 16 contains the detailed requirements for assignment of the agreement to include the prior written consent of KFCC. The Court does not conclude that the different termination dates are irreconcilable. Rather, the parties had to include different dates in order to effectuate a contract for the operation of the Outlets while Debtors attempted to negotiate their sale.
Debtors point to the different consideration required by the Reinstatement Agreement and New Franchise Agreement as an indication that they are separate contracts. Separate consideration is an indication of separate agreements. Bitzer v. Moock's Ex'r & Trustee,
B. Resolving ambiguities in the contractual language
An ambiguity exists where there is "more than one different, reasonable interpretation." Cent. Bank & Trust Co. v. Kincaid,
1. Common sense
In determining the intent of the parties, the Court should consider "the common sense of the situation." Eades, 161 S.W.2d at 922. One relevant factor is whether the party opposing divisibility would have entered into the transaction without the agreement to be excluded. See Knight, 233 S.W.2d at 971. In this case, Debtors breached their original franchise agreements by failing to pay royalties and advertising costs due to KFCC. Debtors' breaches triggered the negotiations between the parties for the Reinstatement Agreement. The agreement the parties reached gave Debtors the chance to try to sell the Outlets while at the same time, among other requirements, upgrading the locations and signing promissory notes for the outstanding debt owed to KFCC. The parties agreed to include New Franchise Agreements in the transaction. And these New Franchise Agreements were identical to the original franchise agreements to include the same termination date. By signing New Franchise Agreements with an assignment clause, Debtors would have the ability to transfer the license to use KFCC's trademarks in any sale. Why would the parties enter into identical franchise agreements when Debtors had already proven they were incapable of performing under the original franchise agreements? KFCC would not receive the benefit of its bargain if the agreement could be separated such that a stand-alone contract existed which only included terms identical to those of a contract just breached by the Debtors. It may be that as between a hypothetical third-party buyer and KFCC, the New Franchise Agreement is a stand-alone contract. But between KFCC and Debtors—the contracting parties—the New Franchise Agreement is inextricably linked to the Reinstatement Agreement. See Koppers Co. v. Asher Coal Mining Co., 11 S.W.2d 114, 115 (Ky. 1928) ("Contracts must be construed from the standpoint of the parties."). The entire transaction imagined by the parties was based on the Reinstatement Agreement. The New Franchise Agreement was a necessary addition to make the Outlets marketable to third-party purchasers in order to effectuate the sale contemplated in the Reinstatement Agreement. Common sense dictates that, as between Debtors and KFCC, the New Franchise Agreement is not an independent agreement but instead is wholly dependent on the Reinstatement Agreement provisions.
Debtors argue that the New Franchise Agreement cannot be a separate agreement for some people and not others. But if this is true, the contract imagined by the parties would be impermissible. In Kentucky, parties enjoy great freedom of contract. United Servs. Auto. Ass'n v. ADT Sec. Servs., Inc.,
Debtors urge the Court to consider the public policy reasons behind the applicable Bankruptcy Code provisions. The intent of the parties is the relevant inquiry in determining whether the documents make one indivisible contract. The relevant time of the parties' intent is when they entered into the contract, not at the time Debtors filed for bankruptcy. Thus, bankruptcy policy has no bearing on the analysis of the contracting parties' intent. Bankruptcy policy does not permit the parties or the courts to rewrite contracts in order to facilitate reorganization. See Bistrian v. Easthampton Sand & Gravel Co. (In re Easthampton Sand & Gravel Co.),
Even if bankruptcy policy were relevant, several bankruptcy courts have similarly resolved issues of multiple documents related to a franchisee. See, e.g., In re FPSDA I, LLC,
The contract structured by the parties is a commonsense method to accomplish their plainly stated intention of having Debtors operate the Outlets for the limited purpose of sale.
2. Doctrine of contra proferentem
Debtors contend that any ambiguities in the agreement should be construed against KFCC, the drafting party, under the doctrine of contra proferentem. See McMullin v. McMullin,
Based on the files, records, and proceedings herein, and for the reasons stated above, IT IS ORDERED THAT: The August 25, 2011 Order of the Bankruptcy Court is REVERSED. LET JUDGMENT BE ENTERED ACCORDINGLY.
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