§ 28.04 Assumption and Its Effects on Landlords and Tenants
| Jurisdiction | United States |
| Publication year | 2022 |
§ 28.04 Assumption and Its Effects on Landlords and Tenants
[1]—Assumption of the Lease by the Tenant—Adequate Assurance
[a]—General Rule
A trustee or debtor-in-possession may assume an executory contract or unexpired lease after a tenant default only if, at the time of assumption, the trustee or debtor-in-possession: (1) cures or provides "adequate assurance" that the default will be cured "promptly"; (2) compensates or provides "adequate assurance" that the trustee will "promptly" compensate the landlord for any "actual pecuniary loss . . . resulting from such default"; and (3) provides "adequate assurance" of future performance under such lease.1 Bankruptcy and insolvency related defaults need not be cured, as they are unenforceable "ipso facto" provisions.2 For example, a clause providing that a tenant will be in default if it commences either a bankruptcy or an insolvency proceeding is not enforceable against a trustee or debtor-in-possession/tenant, once a bankruptcy case is filed.3
[b]—Prompt Cure
The Bankruptcy Code requires a trustee or debtor-in-possession to cure defaults upon assumption of a lease, if such defaults are not cured at the time of assumption, the trustee or debtor-in-possession must provide "adequate assurance" that the defaults will be cured "promptly." Courts generally have allowed a trustee or debtor-in-possession significant leeway and provided them with the time needed for the payment of cure based on anticipated cash flow or other factors.
"The debtor-in-possession or trustee must provide adequate assurance" that defaults will promptly be cured. This requires a nonspeculative and sufficiently substantive foundation to assure the landlord it will receive the defaulted amount.4
Among other things, courts take into consideration the amount of money at stake, the degree of assurance that the default will be cured, the debtor's past acts (for example, the debtor's failure to pay rent during the post-petition/pre-assumption period), and the length of the cure period proposed by the tenant as compared to the time remaining on the lease term.5 Immediate cure may not be required, as opposed to "cure" within a reasonable period of time.6
Courts often establish a procedural deadline for the filing of cure amount claims. Failing to timely file a cure amount claim in response to a notice delivered by a trustee or debtor-in-possession may have dire consequences for a landlord, as a tenant may assume a lease and the landlord may be barred from recovering unpaid past due rent.7
Practice Pointer: If you are a landlord, or counsel to a landlord, pay attention to motions being filed by a tenant that has filed for bankruptcy relief, to avoid missing a deadline that may estop a landlord from recovering monetary defaults under an unexpired lease that is being assumed. Such notification may be included in a motion file by the trustee or debtor-in-possession pursuant to Section 365 to assume, or it may be included in a standalone form of notice of a claims bar date.
[c]—What Must Be Cured
After enactment of the 2005 amendments to the Bankruptcy Code, a debtor/tenant must cure not only monetary defaults, as was the case under prior law, but also is required to cure any curable nonmonetary defaults.8 Nonmonetary defaults often involve historical breaches that cannot be cured—e.g., failure to perform an obligation within a certain time period or failure to maintain operations or licenses.9 Prior to the 2005 amendments, courts disagreed on whether Section 365(b) (2)(D) exempted nonmonetary defaults from Section 365(e)(2)(B)'s cure requirement when the nonmonetary default cannot possibly be cured.10
The 2005 amendments resolved the split among the courts regarding Section 365(b)(2)(D), by providing that only "penalty rates" and "penalty provisions" are excluded from Section 365(b)(1)(A)'s requirement that the trustee or debtor-in-possession must cure all monetary and nonmonetary defaults. However, Section 365(b)(1)(A) was also amended to protect real property leases, allowing the trustee or debtor-in-possession to assume a lease despite an uncured nonmonetary default if the trustee or debtor-in-possession cannot cure the default "by performing nonmonetary acts at or after the time of assumption."11 Therefore, the trustee or debtor-in-possession must cure all monetary defaults, including all rent arrears and actual pecuniary losses, along with any curable nonmonetary defaults. However, a nonmonetary default that cannot be cured does not prevent assumption of a lease.
[d]—Actual Pecuniary Loss
Actual pecuniary loss may include late charges, damages incurred in reliance on the default provisions in an agreement and actual expenses involved in retaking and reletting, as provided in the lease.12 As discussed below, actual pecuniary loss may also include the landlord's attorneys' fees, third-party damages, and interest on delinquent rent.
[e]—Can the Landlord Recover Attorneys' Fees?
The landlord's ability to recover attorneys' fees, especially those incurred in connection with the bankruptcy, is an issue that may arise with respect to lease assumption. (The issue also arises in connection with computing the landlord's damages if the lease is rejected and in determining the liability of a trustee or debtor-in-possession for rent during the post-petition/pre-rejection period if attorneys' fees are incurred by the landlord in connection with a default by the debtor or trustee that occurs during that period.13 ) Although some bankruptcy courts have refused to authorize attorneys' fees as a matter of principle, the statute requires cure of the tenant's defaults as a condition to assumption (or adequate assurance) and makes no exception for attorneys' fees. Accordingly, if the debtor's lease provides for recovery of attorneys' fees, the landlord should be able to include its attorneys' fees in the computation of its pecuniary loss.14
Would a provision specifically permitting a landlord to recover attorneys' fees incurred in connection with a bankruptcy case be enforceable? The "ipso facto" provisions of the Bankruptcy Code invalidate any lease provision that would prohibit an assignment of a lease in a bankruptcy proceeding, or cause a termination or modification of a lease by reason of a tenant's bankruptcy.15 These provisions have been broadly interpreted, and it is arguable that a provision specifically requiring payment of attorneys' fees in a bankruptcy proceeding would not be enforceable as a "modification" of the lease triggered by the bankruptcy filing. One possible solution for a landlord may be to draft broad attorneys' fees and indemnity clause covering, among other things, attorneys' fees incurred by landlords in connection with all collection and bankruptcy proceedings.
According to at least two courts, reasonable attorneys' fees incurred as a result of a debtor's default may constitute actual pecuniary loss.16 However, other courts have held that if a contract or lease does not provide for attorneys' fees to be paid upon default, the non-debtor party is not entitled to recover such fees since there is no independent right in favor of the non-debtor to recover attorneys' fees.17
[f]—Third-Party Damages
When a debtor turned over premises to a third-party prepetition and before the lease had expired, the trustee could assume the lease provided that he reimbursed the third party for funds advanced to cure the debtor's defaults.18
[g]—Interest on Delinquent Rent
If a contract or lease does not provide for payment of interest on delinquent rent, then the debtor need not pay such interest in order to cure.19 If, however, state law requires interest on delinquent rent, then the debtor must pay such interest in order to satisfy the requirement of compensating the landlord for "actual pecuniary loss."20 In a 1998 Illinois case, the bankruptcy court held that interest on prepetition lease charges continued to run at the 18% rate set forth in the lease and had to be paid as a condition of assumption.21
After the 2005 amendments, debtors/trustees must "cure" defaults under a "continuous operation" clause, although the statute makes clear that an unexpired lease may be assumed even if nonmonetary defaults exist that are impossible to cure.22
[h]—The Concept of Adequate Assurance
The Bankruptcy Code provides that landlords are entitled to "adequate assurance of future performance" by a tenant upon assumption by the tenant of its interest in a lease.23 The Bankruptcy Code does not define "adequate assurance."24 One standard adopted by some bankruptcy courts is that: (1) the debtor must show a firm commitment to make all payments, and have a reasonably demonstrable capacity to do so (e.g., evidence of profitability), and (2) the plan or reorganization must have a foundation that is not speculative.25 The debtor's or trustee's investment of a substantial amount of money...
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