Chapter 9 - § 9.10 • LEASES

• Jurisdiction: Colorado

§ 9.10 • LEASES

§ 9.10.1—Pre-bankruptcy Considerations

Issues in Negotiating the Lease

The Bankruptcy Code requires that a debtor assume or reject the entirety of a lease agreement. Accordingly, when drafting a lease on behalf of a landlord, be sure to integrate all critical provisions into a single document, and include a non-severability provision setting forth the parties' intent that each part of the agreement is dependent upon each of the other parts. The danger in a bankruptcy setting is that if critical parts of an integrated transaction are set forth in separate documents, a court may determine that each document is a separate contract, and a debtor could assume the favorable lease provisions but reject the more burdensome portions of the agreement.

The Bankruptcy Code only permits a debtor to assume an unexpired lease. If a lease terminates according to its terms prior to the filing of the bankruptcy petition, the debtor cannot then assume it. Accordingly, when drafting a lease on behalf of a landlord, consider including language to create automatic termination, not just automatic default upon the occurrence of certain events of default. This allows for the argument that the lease terminated before bankruptcy and, therefore, cannot be assumed. This is especially important for ipso facto provisions based upon insolvency or the tenant's financial condition. These provisions are unenforceable after bankruptcy, but probably effective to give rise to a termination before the bankruptcy petition if all conditions of termination have occurred before the petition and no redemption or renewal provisions or protections of state law apply.

Finally, ascertain whether the lease is a "true lease" or a disguised security agreement. The distinction between these property interests is critical if the owner/tenant files for bankruptcy. In determining whether a transaction is a "true lease" or a disguised security agreement, bankruptcy courts look to the substance as opposed to the form of the transaction. If the transaction could be deemed a disguised security agreement, the lessor should obtain security for damages for breach of the agreement and promptly perfect its security interests. Otherwise, the lessor runs the risk of losing the protections granted to a landlord and a secured creditor under the Bankruptcy Code and having only an unsecured claim against the bankruptcy estate.

§ 9.10.2—A Lease May Only Be Assumed With Court Approval And The Entire Agreement Must Be Assumed With All Defaults Cured

In this district, court approval is always required to assume a lease; the debtor's conduct or oral assurances will not constitute implicit assumption, even when there has been no default under the lease. In re Swiss Hot Dog Co., 72 B.R. 569 (D. Colo. 1987).

The decision whether to assume or reject is subject only to the "business judgment" test (NLRB v. Bildisco & Bildisco, 465 U.S. 513 (1984)), under which a bankruptcy court will defer to the debtor's business judgment as to whether the assumption or rejection of the lease is in the best interests of the estate.

A debtor cannot partially assume a lease; the lease must be assumed in its entirety or not at all. In re Case, 91 B.R. 102 (Bankr. D. Colo. 1988). Where, however, the court finds that a single document contains undertakings beyond the central agreement, some courts have allowed the debtor to assume the basic undertakings and reject the related agreements, such as purchase options or commission agreements. For instance, in In re Gardinier, Inc., 831 F.2d 974 (11th Cir. 1987), a debtor/seller assumed a $5 million real estate sales contract, but rejected the portion of the contract requiring payment of a 10 percent commission to the broker, because the court found the purchase-and-sale agreement was intended to be a separate contract from the commission agreement although they were contained in the same document. The broker was left with an unsecured claim in the estate for damages for breach of the commission agreement.

Generally, all defaults, including pre-petition defaults, must be cured for the debtor to assume the lease. 11 U.S.C. § 365(b)(1)(A) and (2). In this important respect, parties to leases are better situated than under-secured lenders.

The debtor is not, however, required to cure defaults known as ipso facto defaults in a lease. Specifically, the Bankruptcy Code excuses the cure of defaults based upon (1) the insolvency or financial condition of the debtor, (2) the commencement of a bankruptcy case, and (3) the appointment of a trustee in a bankruptcy case or the appointment of a custodian or receiver prior to the filing of a bankruptcy case. Additionally, nonmonetary defaults under an unexpired lease of real property that are inherently incurable at the time of assumption, such as use of the property for an unauthorized purpose, do not have to be cured. 11 U.S.C. § 365(b)(1)(A).

Prior to assumption, the Bankruptcy Code requires that the debtor compensate for any actual pecuniary loss caused by the debtor's default. In re Grayhall Resources, Inc., 63 B.R. 382 (Bankr. D. Colo. 1986). Despite the broad language of 11 U.S.C. § 365(b)(1)(B) requiring a debtor to "compensate [the other party to the lease] for any actual pecuniary loss to such party resulting from such default," the court will not require the tenant/debtor-in-possession to pay the landlord's post-petition attorney fees as a condition of assuming the lease. In re Shangra-La, Inc., ...