Managers and the Legal Environment 7th Edition by David Madsen, Constance Bagley

Exercise 1

Southmark, a Texas corporation, sold the Double Diamond Ranch in Nevada to the Double Diamond Ranch Limited Partnership (Double Diamond), retaining an option to buy back part of the ranch. Southmark later filed for bankruptcy in Texas. As part of its Chapter 11 reorganization plan, it assumed various executory contracts by filing a notice of assumption. The plan provided that all executory contracts not listed were deemed rejected. The notice did not list the option to buy back the ranch.
Double Diamond itself then filed for bankruptcy in Nevada. The committee administering the Double Diamond bankruptcy decided to sell the ranch to South Meadows Properties Limited Partnership. The committee asked the bankruptcy court to allow sale of the ranch free and clear of Southmark's option. A free-and-clear sale was appropriate only if the option was no longer valid because it had been stripped away in the Texas bankruptcy proceeding. The Nevada bankruptcy court held that the option was an executory contract that had been rejected in Southmark's bankruptcy. Therefore, it allowed Double Diamond to sell the ranch to South Meadows free and clear of Southmark's option. Southmark appealed.
If Southmark had given written notice of its intent to exercise the option, but had not yet paid the purchase price before filing for bankruptcy, would the option have been an executory contract? The option agreement expressly provided that the option was for a period of fifteen years "provided, however, that the option granted herein shall terminate in the event Southmark files for protection under Chapter 11 for the Bankruptcy Code." Is an option to buy property an executory contract? Why wasn't the option automatically terminated when Southmark filed under Chapter 11? [Unsecured Creditors Committee of Robert L. Helms Construction Development Co. v. Southmark Corp., 139 F.3d 702 (9th Cir. 1998).]