January 23, 2018
With increasing frequency, we find landlords facing lease issues in bankruptcy as a result of mall closings, strip mall vacancies, and what appears to be a movement away from brick and mortar in some retail industries.
Executory contracts are governed by section 365 of the Bankruptcy Code. Section 365(d)(3) requires that a debtor under a non-residential real property lease must continue to fully and timely perform its obligations from the petition date through the date on which the lease is assumed or rejected.
Section 365 also provides that a debtor, in its business judgment, may assume or reject a non-residential real property lease. By assuming a lease, the debtor’s estate accepts all obligations under the lease. The debtor’s estate is also required to cure all defaults under the lease.
The code provides that a debtor must assume or reject a non-residential real property lease within 120 days after the Petition Date, or the lease will be deemed rejected. Section 365(d)(4)(B)(i) permits the court to extend the 120-day period for 90 days on the motion of the debtor or lessor for “cause.” An extension beyond 90 days will only be permitted by “prior written consent of the lessor.”
Section 365(b)(1) of the Code sets forth the requirements, which a debtor must satisfy to assume a lease of unexpired real property. This Section provides that:
If there has been a default on an . . . unexpired lease of the debtor, the [debtor in possession] may not assume such . . . lease unless, at the time of assumption of such . . . lease, the [debtor in possession]
(A) cures, or provides adequate assurance that the [debtor in possession] will promptly cure, such default…;
The Bankruptcy Code fails to specifically define the terms "cure" or "prompt cure" and does not specify timing requirements or restrictions. A number of courts and legal authorities have held that a "prompt cure" of a monetary default is one made at or about the time of a contract’s or lease’s assumption. Upon assumption, the bankruptcy estate becomes bound by the contract, and all amounts thereafter owed by the debtor under the contract will constitute administrative expense claims, which means the claim shall be paid in full.
The mechanics for the assumption of a lease is accomplished by motion of the debtor, subject to objection by other creditors and court approval. The debtor has the burden of persuasion that the lease is (1) subject to assumption and (2) all the requirements of § 365 have been met. Generally, if any dispute exists, courts then require the non-debtor party to prove any defaults, which then shifts the burden back to the debtor to prove adequate "cure" of those defaults.
If a client advises you that a tenant filed bankruptcy it is important to begin a dialogue with debtor’s counsel. The Code does not provide a great deal of time for the debtor to decide what to do with a non-residential lease, and the decision to assume or reject will have significant consequences. Providing your client with an understanding of the benefits and risks associated with the leased space during and after the bankruptcy proceeding is essential.