Developer Authorized to Reject Settlement Deal with HOA

One of the powerful tools ­vailable to a debtor in bankruptcy is the ability to review existing pre-bankruptcy contracts and determine which contracts should be assumed or rejected. Any party can breach its obligations under a contract; however, in bankruptcy, when a debtor decides to reject—meaning breach the contract, the damages in most cases can be treated like any other unsecured claim and be discharged along with all other pre-bankruptcy claims. Of course, it is often not that simple. Section 365 of the Bankruptcy Code, the provision that addresses executory contracts, is one of the most lengthy and complex provisions of the Bankruptcy Code. Often, the court must first determine if the contract is “executory.” In a recent decision of the U.S. Bankruptcy Court for the District of New Mexico, the court was asked to determine whether a state court settlement agreement between the debtor and a homeowner’s association was rejected in the debtor’s bankruptcy case, and the consequences of rejection. In a decision issued in In re Spoverlook, dated Oct. 7, the court rejected the argument ­advanced by the homeowner’s association that rejection would violate a state court order, and approved rejection of the ­settlement agreement.

Facts: Developer and HOA Litigation

According to the opinion, the debtor was the developer of a 260-acre residential ­project in the mountains north of Albuquerque, New Mexico. Beginning in 2003, residents began purchasing lots in Phase I of the project. The debtor also owned a parcel of open land called “Tract D”, situated between the project and another high-end residential development, and adjacent to a highway. Following the financial ­downturn in 2008, the debtor was not able to perform its obligations under the restrictive covenants encumbering the project properties. Specifically at issue was the debtor’s inability to convey certain common area properties to the homeowners. The San Pedro Overlook Community Association (HOA) sued the debtor in New Mexico state court to compel the debtor to, among other things, convey the common areas to the HOA.