Recent issues of Bankruptcy Basics have covered a debtor-tenant’s options for its leases in a retail bankruptcy case, the timing of that process, and the debtor’s requirement to timely perform its leasehold obligations pending its decision. In this issue, we’ll discuss the debtor’s requirement to cure lease defaults if it wants to assume (retain) or assume and assign a lease.
Pre-Petition vs. Post-Petition Lease Obligations
The Bankruptcy Code treats a debtor-tenant’s real property lease obligations very differently depending on whether they arose prior to or after the bankruptcy filing. As soon as a tenant files for bankruptcy, they must timely perform their go-forward lease obligations. The landlord, however, can’t attempt to collect pre-petition arrears due to the automatic stay, which protects the debtor’s property from its creditors.
If the debtor rejects a lease, the landlord is left with a “claim” against the debtor, which may not be worth much, as general unsecured creditors often share pro rata in assets at the end of the case. The good news for landlords, though, is that if the debtor wants to assume or assume and assign a lease, it must pay the arrears in full unless the landlord agrees otherwise.
Bankruptcy Code Requirements for Cure of Lease Defaults
Bankruptcy Code Section 365 provides that a debtor may assume a real property lease if it cures defaults under the lease or provides adequate assurance that it will promptly cure the defaults. Practically speaking, cure almost always takes place at the time of assumption. The most common pre-petition lease defaults are monetary, but nonmonetary lease defaults, such as performing deferred maintenance obligations or required renovations, must generally be cured as well. Defaults based on the debtor’s breach of an operating covenant under the lease will be deemed cured by performance in accordance with the lease at and after assumption.
The debtor must also compensate the landlord for any “actual pecuniary loss” resulting from defaults. In addition to any unpaid rent, under this concept landlords generally assert attorneys’ fees and any claims by third-party service providers that the landlord paid but were the responsibility of the tenant. The debtor must also provide adequate assurance of future performance—a showing they (or the assignee) will be able to perform under the lease going forward—which will be covered in the next Bankruptcy Basics issue.
The statutory requirements of “cure” and “adequate assurance of future performance” are often simply the starting point in negotiations, as the landlord may need to compromise its rights in order to assure that the lease is assumed rather than rejected.
How Landlords Can Protect Themselves
To put themselves in the best position for a potential cure of defaults, landlords should document all lease defaults, both monetary and nonmonetary, and provide notice to the tenant as required under the lease. Another pre-bankruptcy measure is to negotiate attorneys’ fees clauses that will entitle the landlord to assert as much as possible in the event of a lease assumption.
When the tenant is in bankruptcy, landlords must keep a close eye on the setting of a “bar date,” which is the deadline by which pre-petition claims must be filed. Another filing to look out for is a notice of proposed cure amounts, which a debtor often files as part of a reorganization or sale process when it seeks to assume or assume and assign leases that include an objection deadline. If a landlord does not meet both deadlines, it risks waiving payment of its cure amount in a lease assumption or assumption and assignment. Experienced counsel will be able to guide the landlord through these steps to ensure it preserves all of its rights and asserts all amounts the landlord is entitled to under bankruptcy law and the lease.
The next issue of Bankruptcy Basics for Retail Landlords will detail the concept of adequate assurance of future performance, another requirement for a debtor seeking to assume or assume and assign a real property lease.