In re: United Airlines , Incorporated

In the
United States Court of Appeals
For the Seventh Circuit
____________
No. 03-4339
In the matter of:
U NITED A IRLINES , I NCORPORATED ,
Debtor.
Appeal of:
N ATIONAL P ROCESSING C OMPANY , LLC ,
and N ATIONAL C ITY B ANK OF K ENTUCKY ,
Appellants.
____________
Appeal from the United States District Court for the
Northern District of Illinois, Eastern Division.
No. 03 C 3909—Samuel Der-Yeghiayan, Judge.
____________
A RGUED A PRIL 9, 2004—D ECIDED M AY 11, 2004
____________
Before BAUER , E ASTERBROOK , and K ANNE , Circuit Judges.
E ASTERBROOK , Circuit Judge. Debtors in bankruptcy may
enforce most executory contracts that predate their peti-
tions. The Bankruptcy Code has some exceptions, however.
Section 365(c)(2) (11 U.S.C. §365(c)(2)) is one: a debtor may
not assume “a contract to make a loan, or extend other debt
financing or financial accommodations, to or for the benefit
of the debtor, or to issue a security of the debtor”. National
Processing contends that a credit card merchant agreement

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2 No. 03-4339
is a “financial accommodation” that cannot be assumed in
bankruptcy. Bankruptcy Judge Wedoff rejected this posi-
tion. 293 B.R. 183 (Bankr. N.D. Ill. 2003). The district judge
affirmed. 2003 U.S. Dist. LEXIS 22387 (N.D. Ill. Dec. 11,
2003). These decisions follow the only appellate opinion on
the subject. In re Thomas B. Hamilton Co., 969 F.2d 1013
(11th Cir. 1992). Like the eleventh circuit, we hold that a
trustee in bankruptcy, or a debtor in possession, may
assume a credit-card-processing agreement.
The debtor is United Airlines, the nation’s second-largest
air carrier, which has been in a Chapter 11 reorganization
since December 2002. Two years earlier, National
Processing had signed a five-year contract to handle the
transactions of United’s customers who pay with VISA or
MasterCard credit cards. United verifies each transaction
using automated systems maintained by the VISA and
MasterCard networks. For each completed transaction it
transmits a paper or digital sales record to National
Processing, which enters the information into the VISA or
MasterCard settlement network. The network dispatches
each transaction to the customer’s bank, which advances
funds from the customer’s line of credit and remits to the
network. Each network makes a daily wire transfer to
National Processing of any balance (net of fees and charge-
backs) due to United. And National Processing makes the
balance available in United’s account at its affiliate Na-
tional City Bank of Kentucky.
Issuing banks (that is, the banks that issued the credit
cards to United’s passengers), the interbank networks, and
the merchant bank (National Processing and National City
Bank, which transact with United and other merchants) all
collect fees for their services; these are deducted from the
balance remitted to the merchant. Chargebacks are rever-
sals of transactions. If the passenger has a refundable ticket
and does not fly, United will credit the passenger’s card;
similarly, if United cancels the flight and the passenger

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No. 03-4339 3
does not rebook, a chargeback will occur. If United were to
ground its fleet or substantially curtail its service,
chargebacks would exceed new sales, and the daily balances
in the system would go negative. United would owe the
difference to National Processing, which would distribute
proceeds to the issuing banks and their customers. If
United could not pay, however, then the merchant bank, the
issuing bank, or the customer would bear the loss. National
Processing contends that the rules of the VISA and
MasterCard national associations allocate that loss to the
merchant bank. This means, National Processing contends,
that it has guaranteed United’s (contingent) debts to the
passengers, and because a guaranty is a “financial accommo-
dation” National Processing insists that the cre-
dit-card-processing agreement cannot be assumed. United
would take new bids for this service, and the price of fi-
nancial intermediation (that is, the fees deducted from the
charge for each ticket) likely would rise because the risk of
United’s default is higher now than it was in December
2000.
National Processing’s lead argument is that the credit-
card system operates like a revolving line of credit. Airlines
sell tickets in advance of their flights; the cash flow received
through the credit-card network is a form of net borrowing
until they provide the transportation for which customers
prepay. A line of credit directly with National City Bank of
Kentucky could not be assumed in bankruptcy. United
would need to renegotiate and pay higher interest rates or
give better security. Why not the same legal result for the
same flow of funds in advance of flights, National Process-
ing inquires. The answer is that neither National Process-
ing nor National City Bank lends United (or any other
merchant) one penny. Any loan is made by the issuing
bank, not the merchant bank; the loan is to the issuing
bank’s customer (United’s passenger), not to United.
National Processing does not deposit anything into United’s

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4 No. 03-4339
account at National City Bank until after the issuing bank
has made the loan to its customer and placed the funds in
the interbank system on the customer’s behalf. By acting as
an intermediary, National Processing no more makes a
“financial accommodation” to United than does any other
participant in this process—the Internet service provider
through which data flows, the courier that moves paper
records, the Federal Reserve wire-transfer apparatus, and
the other contributors to a financial network. National
Processing functions as a conduit, not a lender, in this
transaction.
The promise to extend credit that the card-issuing
bank makes to its own customer is not something United
has assumed or could assume even in principle, for no pas-
senger is obliged to buy a future ticket. That many small
loans to passengers add up to a large cash flow for the
carrier does not turn the intermediary’s role into a “finan-
cial accommodation.” Section 365(c)(2) prevents the as-
sumption of a loan commitment or equivalent promise
because the cost of future credit depends on the probability
of repayment, and bankruptcy reveals that the risk of
nonpayment is higher than the would-be creditor likely
assumed. The creditworthiness of the passenger (the
borrower on the credit-card loan) does not change with a
merchant’s bankruptcy, so there is no need to renegotiate
the rate of interest. Because customers prepay for travel
arrangements more often than they prepay for physical
merchandise, the default risk on the merchant side is
higher for a firm such as United than for, say, a grocery
store. This implies a need to concentrate attention on the
back end of the transaction—the chargeback process—
rather than the fact that prepaid tickets create float for a
merchant. And National Processing contends that it guar-
antees United’s contingent obligations should chargebacks
exceed new sales.

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No. 03-4339 5
Although the Bankruptcy Code does not define “financial
accommodation,” it is common ground among the parties
that a guaranty or other form of suretyship fits the bill. See
Uniform Commercial Code §3—419(c) (2002 official draft).
See also, e.g., Thomas B. Hamilton Co., 969 F.2d at 1019.
National Processing contends that if any non-trivial part of
a complex business arrangement can be called a guaranty,
then none of the deal may be assumed in bankruptcy. But
that is not what the statute says. Assumption is impermis-
sible if “such contract is a contract to make a loan, or
extend other debt financing or financial accommodations”.
The statute asks whether the contract as a whole is a
“financial accommodation,” not whether one clause could be
so characterized. To see the difference, think of a contract
that everyone recognizes may be assumed: a lease of
operating assets, such as United’s aircraft. Although many
leases require payment at the start of each month (or other
accounting period), some allow payment in mid- month or
at month’s end, and all leases provide a grace period if
payment is not made on time. Take a lease calling for
payment in mid-month. It would be possible to call the
arrangement a 15-day loan from the lessor to the lessee.
Likewise with an executory contract for the sale of goods,
with payment due 30 days after the goods are delivered.
This contract, too, entails a loan from the vendor to the
purchaser. Except for a contract that provides for a bill of
lading to be delivered only against a letter of credit—a
transaction rare in domestic commerce—almost every lease
and other executory contract has some provision that could
be characterized as a short-term loan to one side or the
other. Credit is implied whenever performance is not
simultaneous, and many executory contracts govern trans-
actions in which performance is sequential rather than
simultaneous. Accepting National Processing’s argument
that assumption is impossible when any non-trivial clause
of a contract entails a loan or guaranty would go far toward
defeating debtors’ entitlement to assume executory con-

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6 No. 03-4339
tracts. Doubtless this is why no one (to our knowledge) has
argued that debtors cannot assume leases and sales
contracts. Well, if a lease may be assumed despite an
implicit loan, a credit-card-processing agreement may be
assumed despite an implicit guaranty.
To say that a credit or guaranty aspect does not prevent
assumption—does not make the contract as a whole one “to
make a loan” or provide “financial accommodations”—has
some potential to invite game-playing. Suppose that a firm
seeking a line of revolving credit asks the bank to add a
clause promising to sell a rabbit’s foot for 50¢. An incidental
sale of merchandise would not change the nature of the
transaction, however, any more than delivery in advance of
payment converts a sale of goods into a contract “to make a
loan”. We think that Thomas B. Hamilton Co. was right to
say that a court must determine the nature of the entire
transaction rather than hunt for features that look like
loans or guarantees. 969 F.2d at 1020. To the extent that
the eleventh circuit called this a quest for the principal or
primary “purpose,” we are skeptical; the contents of busi-
ness entities’ heads are elusive. “Purpose” usually is
covered by quicksand. Who can tell what the negotia-
tors were thinking? Why should their thoughts matter?
Nothing in the statutory text requires resort to anyone’s
purposes. Better to concentrate on the actual features of the
transaction—an objective rather than a subjective ap-
proach. Guaranty plays an objectively small role in the
arrangement between National Processing and United; it
comes into play only when the net balance of payments is
negative, which has never occurred in their experience.
Even if guaranty were to play a larger role, it could be
carved off and the rest of the contract assumed. (Debtors in
bankruptcy can’t cherry-pick favorable features of a con-
tract to be assumed, see In re Crippin, 877 F.2d 594 (7th
Cir. 1989), but may be able to abjure them—to give up a

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No. 03-4339 7
benefit such as a guaranty, and thus to make the other
party to the transaction better off by reducing its obliga-
tions.)
For what it may be worth, we are skeptical that the
contract United has assumed provides for any guaranty of
United’s contingent indebtedness to its customers. One may
search the contract in vain for such a promise. National
Processing concedes that it is not there but insists that it
may be found in (or implied from) the agreements among
merchant and issuing banks in the VISA and MasterCard
networks. These agreements oblige merchant banks to cover
chargebacks placed into the system by issuing banks, and
this obligation—which allocates loss to the merchant bank
if the merchant cannot pay—is the financial equivalent of
a guaranty, National Processing insists. This brings us back
to the point that §365(c)(2) speaks of a contract that is a
financial accommodation, not one that has economic effects
for one party similar to a financial accommodation. From
United’s perspective, it is irrelevant who among customer,
issuing bank, and merchant bank bears any loss. That
allocation is extrinsic to United’s deal with National
Processing and therefore was not “assumed” in the bank-
ruptcy. To put this otherwise: National Processing does not
have a contract with the debtor in bankruptcy obliging the
merchant bank to cover any of the debtor’s obligations.
United would not have any legal claim against National
Processing if an issuing bank (or a passenger) got stuck
with a loss. (Nor, as far as we can tell, would a passenger
have any legal claim against National Processing.)
We grant that the contract between United and National
Processing says that it is subject to and incorporates the
rules of the VISA and MasterCard networks, but in this
sense every check is subject to the UCC’s (and the Federal
Reserve’s) rules for clearing negotiable paper among banks.
That system, like the VISA and MasterCard networks,
handles chargebacks and loss allocation. Yet it would not be

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8 No. 03-4339
sensible to say that those rules mean that the drawee or the
depositary bank (either of which may be stuck with a loss
if an endorsement is bogus or the drawer lacks sufficient
funds) has made a “financial accommodation” to the person
presenting the draft for payment.
National Processing has one last argument. Section
365(a) requires the bankruptcy court’s approval for any
assumption. National Processing asked the bankruptcy
judge to condition approval on United’s willingness to set
aside a reserve of several hundred million dollars to ensure
that it could cover chargebacks in the event it stopped
flying. The bankruptcy judge said no; the district judge
agreed. Section 365(a) requires judicial approval but does
not say that approval must be (or even should be) contin-
gent on steps that reduce the other side’s risk to zero.
Congress did include such a provision elsewhere in §365,
but only for circumstances in which the debtor was in de-
fault. Section 365(b)(1) provides:
If there has been a default in an executory contract
or unexpired lease of the debtor, the trustee [or
debtor in possession] may not assume such contract
or lease unless, at the time of assumption of such
contract or lease, the trustee—
(A) cures, or provides adequate assurance
that the trustee will promptly cure, such
default;
(B) compensates, or provides adequate
assurance that the trustee will promptly
compensate, a party other than the debtor
to such contract or lease, for any actual pe-
cuniary loss to such party resulting from
such default; and
(C) provides adequate assurance of future
performance under such contract or lease.

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No. 03-4339 9
National Processing concedes that United has never
defaulted on its obligations under the agreement but none-
theless contends that the bankruptcy judge should have
required United to provide the same assurances that would
have been required had it done so. That would effectively
remove the “if” clause from subsection (b)(1) and make
adequate assurances a universal requirement. The bank-
ruptcy judge was right to rebuff such a proposal for amend-
ing the statute; it was directed to the wrong branch of
government. To the extent that dicta in Thomas
B. Hamilton Co. say that bankruptcy judges should not
allow assumption of contracts that expose the other party
to “unreasonable risk” (see 969 F.2d at 1021)—whatever
“unreasonable” might mean—we do not go along. That limi-
tation does not appear in subsection (a) and, given sub-
section (b)(1), cannot be imputed to it without abrogating
the statute’s distinction between default and no-default
situations. A bankruptcy judge properly may withhold
approval of assumption when an executory contract is no
longer in the debtor’s interest, or the debtor is unlikely to
perform its obligations, but not on an open-ended ground
such as “unreasonable” risk to the other contracting party.
The risk of a merchant’s deteriorating financial position
is one that this contract anticipates. United agreed to pay
fees substantially exceeding those of supermarkets and
other merchants, reflecting the higher incidence of charge-
backs. Moreover, the contract requires United to establish
a reserve account in the event the credit rating of its bonds
falls. United’s bond rating did fall, and it established
the reserve according to the contract’s specifications. If
National Processing wanted a larger reserve, it should have
negotiated for this ex ante rather than asking the bank-
ruptcy judge to impose it unilaterally. National Processing
also could have negotiated for a shorter term (a lot can
happen in five years, the length of this contract) or for a
higher processing fee in the event risk increases before

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10 No. 03-4339
expiration. But the actual contract is for a fixed term, at a
fixed fee, with only a reserve account as an adjustment for
risk. United has kept its part of the bargain and is entitled
to insist that National Processing do the same.
A FFIRMED
A true Copy:
Teste:
________________________________
Clerk of the United States Court of
Appeals for the Seventh Circuit
USCA-02-C-0072—5-11-04

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