- within Real Estate and Construction topic(s)
- in Australia
- within Coronavirus (COVID-19) topic(s)
As more commercial tenants seek bankruptcy protection, the question of assuming or assigning their leases and what defaults need to be cured gets debated. Not all Circuits have decided these issues. The topic of non-monetary defaults seems to get the most attention.
In bankruptcy, assumption or rejection allows a debtor (tenant) to decide whether to keep or terminate unexpired, nonresidential real property leases to maximize business profitability. Assumption means the debtor continues the lease, curing all defaults. Rejection terminates the lease, allowing the debtor to walk away, with damages capped by statute.
Does a debtor/trustee have to cure a default relating to a "going dark" provision or cure other non-monetary defaults in a nonresidential real property lease to assume or assign (or to take other action with respect to) that lease under section 365 of the Bankruptcy Code?
As discussed in detail below, relevant case authority answers the question in the negative to the frustration of commercial landlords.
Before passage of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCA) in 2005, there was a split in authority as to a debtor's (or trustee's) ability to cure an historical nonmonetary default, such as "going dark," under former section 365(b)(2)(D). For example, in Worthington v. General Motors Corp. (In re Claremont Acquisition Corp.), 113 F.3d 1029 (9th Cir. 1997), the debtor sought to assume a lease even though it had breached the obligation not to close its car dealership for more than seven consecutive days. The court denied assumption, holding that the debtor was "not excused" from its obligation to cure the breach (even though it was an historical breach that was incurable). Id.at 1034-35. In contrast, the court in Eagle Ins. Co. v. BankVest Capital Corp., 360 F.3d 291 (1st Cir. 2003), was faced with a historical non-monetary default not susceptible to cure (i.e., the failure to deliver computer equipment on time). In approving assumption, the court declined to follow Claremont, finding that the policies behind the Bankruptcy Code "suggest [ that Congress ] meant § 365(b)(2)(D) to excuse debtors from the obligation to cure non-monetary defaults as a condition of assumption." Id. at 300.
BAPCA resolved this split by adding new language to section 365(b)(1) of the Bankruptcy Code, which now reads:
(b)(1) If there has been a default in an executory contract or unexpired lease of the debtor, the trustee 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 other than a default that is a breach of a provision relating to the satisfaction of any provision (other than a penalty rate or penalty provision) relating to a default arising from any failure to perform nonmonetary obligations under an unexpired lease of real property, if it is impossible for the trustee to cure such default by performing nonmonetary acts at and after the time of assumption, except that if such default arises from a failure to operate in accordance with a nonresidential real property lease, then such default shall be cured by performance at and after the time of assumption in accordance with such lease, and pecuniary losses resulting from such default shall be compensated in accordance with the provisions of this paragraph;
(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 pecuniary loss to such party resulting from such default; and
(C) provides adequate assurance of future performance under such contract or lease.
11 U.S.C. § 365(b)(1) (emphasis added).
Commentary in Collier on Bankruptcy discusses the change:
It is suggested ... that the reference to nonmonetary obligations and the impossibility of cure by subsequent performance means that the provision relates to continuous operation provisions and other provisions that are similar in that they involve nonmonetary obligations and cannot be retroactively cured.
3 Collier on Bankruptcy ¶ ¶ 365.06[3][c] (Richard Levin & Henry J. Sommer, eds., 16th ed. 2024).
Based on a plain reading of the current section 365(b)(1)(A), a debtor's breach of a lease by "going dark" does not prevent the debtor or Trustee from assuming a lease even though this historical default could never be cured. Going forward, however, section 365(b)(1) requires that the debtor or Trustee cure such default "at and after the time of assumption" and pay compensation to Landlord for "actual pecuniary loss" resulting from the default.
If the debtor has closed operations and a Trustee is permitted to assume and assign the lease as part of a section 363 sale, then the "going dark" default will be cured by the new lessee's restarting the operation, as well as paying compensation for any "actual pecuniary loss" caused by the default. If the debtor can cure and continue its operations, it won't have to turn back the clock to turn on the lights.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
