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In what has become a perennial issue, the new 108th Congress may find itself addressing the issue of bankruptcy reform. The previous legislation was killed over an amendment to deny a discharge for fines imposed on anti-abortion protesters. The chairman of the House Judiciary Committee has announced that he intends to reintroduce last year’s bill without the abortion provision. [FOOTNOTE 1] Last year, both houses of Congress agreed that � 365(d)(4) of the Bankruptcy Code should be revised to bar a debtor from extending its time to assume or reject a non-residential real property lease beyond 210 days after the commencement of a debtor’s voluntary case without a landlord’s consent. On its face, such a restriction would severely undermine the viability of large Chapter 11 cases in which a debtor has numerous lease locations. Fortunately, the system appears to have sufficient flexibility to adjust to such a change. Presently, � 365(d)(4) of the Bankruptcy Code requires a debtor to assume or reject a non-residential real property lease within the first 60 days of a Chapter 11 case, but further grants a court the right to extend such 60-day period. As recognized by Congress and in case law, such extensions are granted routinely. [FOOTNOTE 2]Congress’ decision in a proposed, revised � 365(d)(4) to limit a court’s ability to grant such repeated extensions is reflective of the real estate lobby’s repeated success in obtaining improvements in the position of its constituency. For example, prior to the amendment of the Bankruptcy Code in 1984, a Chapter 11 debtor did not have to decide whether to assume or reject a commercial lease until confirmation of a plan, unless a landlord was successful in obtaining an order of the court shortening such time. [FOOTNOTE 3]Similarly, in 1988, the “landlords’ lobby was successful in obtaining a special provision in the code requiring the estate to pay the rent reserved in the lease, rather than [only the] fair rental value,” [FOOTNOTE 4]prior to a lease’s assumption. A debtor’s need to extend its time to assume or reject a lease arises from at least two basic factors. First, in order to assume a lease, � 365(b)(1) of the Bankruptcy Code requires a debtor to cure or provide adequate assurance that it will promptly cure past defaults, and demonstrate adequate assurance of future performance. Second, in the 2nd U.S. Circuit Court of Appeals and 4th Circuit, future rent owing under a lease becomes an administrative expense with a priority over all pre-petition unsecured claims upon a lease’s assumption. Thus, if no Chapter 11 plan is confirmed, the future rent owing under a lease nevertheless must be paid. [FOOTNOTE 5]In addition, such a claim is not limited by the one year/15 percent cap on lease rejection damage claims imposed by � 502(b)(6) of the Bankruptcy Code [FOOTNOTE 6]and there is no duty to mitigate damages under New York law. [FOOTNOTE 7] Such requirements obviously are in conflict with the scarcity of funds and uncertainty which remains until a debtor has confirmed a Chapter 11 plan. However, the likely legislation would not allow for the postponing of a lease’s assumption, until such uncertainty disappears. The new legislation, therefore, would create major tensions in the operation of a Chapter 11 case. For example, how can a Chapter 11 debtor, whose future is still uncertain, raise funds to cure pre-petition arrearages? How can such a debtor provide adequate assurance of future performance? How can other creditors be protected from the devastating effect of the subsequent failure of a debtor and resulting need to pay the future rent owing under an assumed lease in full? No simple answers to these questions exist, but existing case law provides sufficient flexibility to meaningfully address these problems, if the judiciary so chooses. One way in which the effects of a revised � 365(d)(4) could be partially harmonized with the demands of Chapter 11 realities is by a modification of related case law. For example, in Klein Sleepit was recognized that the Bankruptcy Code was ambiguous with respect to whether future rent under an assumed lease was entitled to an administrative expense priority. [FOOTNOTE 8] The 2nd Circuit in Klein Sleepalso observed that the potential harsh effects of its holding could be ameliorated by delaying the decision on a lease’s assumption until the confirmation of a plan. Given this recognition of the Bankruptcy Code’s ambiguity and the court’s understanding that interpretations of � 365 entail a balancing of landlord and tenant interests, the 2nd Circuit might be willing to reconsider its holding in Klein Sleepin recognition of the changed circumstances created by a revised � 365(d)(4). Another way to protect a debtor’s estate from the potentially devastating effects of a revised � 365 is to create a new non-debtor entity to whom the lease may be assigned. The use of such an entity, such as a bankruptcy remote corporation, already is utilized outside of Chapter 11 to protect real estate lenders in the creation of collateralized mortgage obligations. [FOOTNOTE 9]There is no reason why such a mechanism cannot be utilized in addressing the problems that arise within a Chapter 11 case, so that a landlord may receive its statutory protections without crippling a Chapter 11 reorganization. It is not necessary that a landlord be granted absolute security in the debtor’s assumption of a lease. Adequate assurance of future performance “falls considerably short of an absolute guaranty.” [FOOTNOTE 10]However, “more than … speculative plans are needed.” [FOOTNOTE 11] Similarly, the actions needed to satisfy � 365(b)(1)’s requirement for “promptly” curing a default will vary with “the facts and circumstances of each case.” [FOOTNOTE 12]For example, if a debtor’s business is seasonal, the needed cure amount (with the consent of the debtor-in-possession lender) could be paid during the periods of high revenue. Such an approach would harmonize proposed revisions to � 365 with the recognized policy of not using � 365 as a means of providing windfalls to landlords. [FOOTNOTE 13] During the course of a Chapter 11 case, the requisite adequate assurance can be provided by granting a landlord a super-priority claim for any month a debtor is actually occupying the premises. Such a priority would exceed the basic administrative priority afforded a landlord by � 365(d)(3) of the Bankruptcy Code. Of course, that priority is likely to be subordinate to the claim of a debtor-in-possession lender, unless the lender consents to the subordination of its claim. A lease assumption order also could provide that as part of the confirmation of a plan, the newly created bankruptcy remote entity be collapsed back into the reorganized debtor. If no plan is confirmed, a landlord may be granted the absolute right to a return of the lease. Such a right would be of significant value in the case of a below-market lease. However, no claim for future rent against a debtor’s estate would exist, because the lease would have been assigned to a non-debtor entity. Another means of harmonizing the requirements of a revised � 365(d)(4) with the operation of a Chapter 11 case would be to allow the effective date of the assumption of a lease to occur at some date in the future, such as the effective date of a Chapter 11 plan. Case law already provides that the time limit established under � 365(d)(4) is tolled once a motion to assume a lease is filed. [FOOTNOTE 14]By delaying the effective date of a lease’s assumption the problems resulting from a premature assumption of a lease would be significantly lessened. In addition, in order to provide greater protection to a landlord, such an assumption order could provide that cure payments commence at the time of the order’s entry, rather than the effective date of the lease’s assumption. There are no theoretical limits to the protections which may be appropriate. Instead, there are the basic principles that a landlord receive the added protections provided by the assumption of a lease and that a debtor’s estate and its creditors not be unfairly prejudiced by the added burdens and leverage that a revised � 365(d)(4) would grant to a landlord. CONCLUSION Any proposed legislation would not alter � 365′s basic purpose of balancing debtor and landlord interests in furtherance of the overall goal of promoting Chapter 11 reorganizations. [FOOTNOTE 15] A lease assumption order, which can be tailored to the facts of a case, provides a ready mechanism for striking the proper balance between the interests of a landlord and a debtor. Leonard H. Gerson is a bankruptcy attorney at Angel & Frankel ( www.angelfrankel.com). If you are interested in submitting an article to law.com, please click herefor our submission guidelines. ::::FOOTNOTES:::: FN 1Legislative Update, ABI Network Update, Dec. 19, 2002. FN 2 In re The Circle K. Corp., 127 F.3d 904, 909 n. 5 (9th Cir. 1997), cert. denied, 522 U.S. 1148 (1998). FN 3 In re The Circle K. Corp., 190 B.R. 370, 375 (BAP 9th Cir. 1995). FN 4 In re Monarch Capital Corp., 163 B.R. 899, 908 n. 2 (Bankr. D. Mass. 1994). FN 5 In re Klein Sleep Products Inc., 78 F 3d 18 (2nd Cir. 1996); In re Merry-Go-Round Enterprises Inc., 180 F.3d 149, 155-156 (4th Cir. 1999). FN 6 Klein Sleep, at 28, Merry-Go-Round Enterprises, at 161. FN 7 In re Andover Togs Inc., 231B.R. 521, 542-543 (Bankr. S.D.N.Y. 1999); but see, In re Highland Superstores Inc., 154 F.3d 573, 579 (6th Cir. 1998). FN 8 Klein Sleep, at 26-27. FN 9 See, e.g., Kaster, “Bankruptcy Remote LLCs: Are They Really?” N.Y.L.J., March 25, 2002 at S1. FN 10 In re Prime Motor Inns Inc.166 B.R. 993, 997. (Bankr. S.D. Fla. 1994). FN 11 In re Washington Capital Aviation & Leasing, 156 B.R. 167, 173 (E.D. Va. 1993). FN 12 In re PRK Enteprises Inc., 235 B.R. 597, 601 (E.D. Tex. 1999). FN 13 Prime Motors Inc., at 997. FN 14 See, e.g., In re Victoria Station Inc., 840 F.2d 682 (9th Cir. 1988). FN 15 In re Embers 86th Street Inc.,184 B.R. 892, 896 (Bankr. S.D.N.Y. 1995).

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