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Landlords of nonresidential real property know that navigating the rubric of a Chapter 11 bankruptcy can be expensive and frustrating and seem downright unfair. Not only do Chapter 11 debtors have the ability to delay their decision to assume or reject an unexpired lease up to 210 days (including the statutory maximum 90-day extension period), but a landlord could have its lease assigned to a third party not of its choosing. Section 365 of the Bankruptcy Code allows a Chapter 11 debtor in possession (or a bankruptcy trustee under any chapter) to assume a nonresidential real property lease and assign it to a third party. In general, the debtor must cure the defaults under the lease and provide “adequate assurance of future performance” to assume the lease, i.e., continue to perform in accordance with the lease terms upon exit from bankruptcy. 11 U.S.C. 365(b). (This article does not address certain unique and additional requirements relating to shopping center leases.) If the debtor is going to assign the unexpired lease, the debtor must provide adequate assurance of future performance by the assignee. Assigned tenant may be entitled to a long lease Usually, despite the fact that the relationship between the assignee and the landlord is by force of law and court order, the standard for a debtor to accomplish an assignment is relatively low, even if the landlord does not consent. In most cases, as long as a cure of any lease defaults are made by the assignor, and the assignor can show that the proposed new tenant can demonstrate its ability to perform, the bankruptcy court will approve the assumption and assignment of the lease. Even worse, this new relationship that must be borne by the landlord may be long-lived, depending on the term of the lease and its renewal options. Is there a way for a landlord to limit the duration of this union resulting from a most unholy matrimony? How about all of the debtor’s prepetition defaults, which cannot simply go away by payment of money (i.e., historical nonmonetary defaults)-don’t those matter any more? What is the effect, if any, before and after the assumption of a lease in bankruptcy, of the debtor’s prepetition sins committed against the landlord? (Indeed, before the recent change in the bankruptcy laws, some debtors obtained orders from judges finding that an assumption of a lease or executory contract under Bankruptcy Code � 365 cures all prior defaults.) These types of questions and conflicting case law discussed below caused Congress to revise Bankruptcy Code � 365 in its Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). Prior to BAPCPA, which generally became effective for cases filed on and after Oct. 17, 2005, there was a split of authority on whether and what types of nonmonetary defaults needed to be cured prior to an assumption of an unexpired lease or executory contract. Certain courts held that Bankruptcy Code � 365(b)(2)(D) excused debtors and trustees from any requirement to cure historical nonmonetary defaults; i.e., those that would now be impossible to cure. See, e.g., In re BankVest Capital Corp., 360 F.3d 291 (1st Cir. 2004); In re Walden Ridge Dev. LLC, 292 B.R. 58, 66-67, n.2 (Bankr. D.N.J. 2003); In re GP Express Airlines Inc., 200 B.R. 222, 233-234 (Bankr. D. Neb. 1996). Other courts held that the debtor was not excused from the requirement to cure all defaults-monetary or nonmonetary-unless those defaults related to the satisfaction of a penalty rate or payment of a penalty. See, e.g., In re Claremont Acquisition Corp. Inc., 113 F.3d 1029 (9th Cir. 1997); In re Williams, 299 B.R. 684, 686 (Bankr. S.D. Ga. 2003). In Claremont Acquisition-a watershed case for nonbankrupt parties to executory contracts-the 9th U.S. Circuit Court of Appeals held that the debtor’s failure to operate a car dealership (a material breach of the franchise agreement) was not a default of a contractual provision relating to the satisfaction of a penalty rate or a payment of a penalty and, thus, the debtor’s obligation to cure such a default was not excused. Therefore, the debtor was not able to assume and assign its franchise agreements due to this nonmonetary default. Unexpired lease provision was substantially revised Congress chose to overrule Claremont Acquisition Corp., and � 365(b)(1)(A) was substantially revised as follows: “(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 the pecuniary losses resulting from such default shall be compensated in accordance with the provisions of this paragraph.” 11 U.S.C. 365(b)(1)(A) (italics denote addition by BAPCPA). Amended � 365 clarified some unsettled issues Despite the somewhat convoluted nature of the amendment on a first reading, the BAPCPA amendment to � 365 did clarify some unsettled issues. In short, in connection with the assumption and assignment of an unexpired lease or executory contract, a debtor or trustee no longer needs to worry about trying to cure historical nonmonetary defaults (although pecuniary losses from such defaults must be “cured”). Curiously-and contrary to the many “pro-landlord” changes to the Bankruptcy Code- BAPCPA made it significantly easier for a real property lease to be assumed and assigned by a bankruptcy trustee or debtor. Unlike the situation under pre-BAPCPA law, when an assumption may have meant that all prior defaults were cured, the statute now expressly states that, with limited exceptions, nonmonetary defaults are not deemed cured due to the trustee’s (or debtor in possession’s) assumption of the lease. The statutory exception to this new rule is for defaults due to a “failure to operate,” which are now deemed cured upon assumption of a lease under � 365(b)(1)(A). This exception was Congress’ attempt to rid the statute of any ambiguity and overrule Claremont. (Had Claremont been decided today, the franchise agreements would have been successfully assumed and assigned, and the “failure to operate” defaults would be deemed cured). Landlords can make some use of new provisions To revisit our questions above, however, how can a landlord take advantage of the new provisions? Is there way to plan for-and benefit from-uncured nonmonetary defaults in the event of a bankruptcy case? In a recent case, a landlord’s lease had a renewal option. The renewal option, however, would terminate under certain circumstances, including the occurrence of at least three noticed defaults within the 12 months prior to the deadline to exercise the renewal option. Because at least three such defaults occurred prepetition (although the last day to exercise the renewal option occurred post-petition), the landlord took the position that the renewal option was extinguished, and curing the monetary defaults under the lease did not cure the historical nonmonetary default under the renewal-option provisions. (The case settled before the court ruled.) If there was any doubt before BAPCPA, the new law would assist the landlord in arguing that the cure in connection with an assumption under Bankruptcy Code � 365 does not cure the noticed defaults and would not revive that extinguished right to renew. This would give the landlord leverage in its negotiations with both the assignor and assignee. Of course, the lack of a renewal option in a lease would make an assumption or assignment to a third-party much less attractive, thereby reducing the likelihood that a landlord would be compelled to accept a tenant against its will. Therefore, to protect a landlord of nonresidential real property, counsel should draft a lease to give effect to nonmonetary defaults that may give the landlord some additional leverage in a bankruptcy case. For example, using a similar provision to that illustrated above, a lease could provide that a renewal option (or other right) would expire if within 12 months prior to the date the landlord seeks to assign the lease (whether or not in the context of a � 365 assignment), the tenant had three or more noticed defaults (whether monetary or nonmonetary). With diligence on behalf of the landlord, this may provide much needed ammunition in connection with unwelcomed efforts to assign a lease in a bankruptcy case. Craig M. Rankin and Daniel H. Reiss are partners at Los Angeles-based Levene, Neale, Bender, Rankin & Brill, a bankruptcy boutique. The firm represented the landlord whose lease terms were discussed toward the end of this article.

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