Curing Defaults - Prompt Cure May Not Be as Prompt as You Think

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Apr 2003

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Most bankruptcy practitioners are all too familiar with the language of §365 of
the Code and the concept that in order for an executory contract to be assumed,
defaults must be cured.<a href="#2" name="2a">2</a> However, many may be surprised to learn that the
"prompt" cure called for in §365(a)(1)(A) and (B) of the Code
may not necessarily require all defaults to be cured "promptly"
prior to assumption.

Overall, the cases
interpreting what constitutes a prompt cure of defaults prior to assumption
are sparse and incredibly
factually dependent. However, an examination of the case law may be useful for
an appreciation of the range of results available that may provide more
creativity to debtors' attorneys in fashioning cure arrangements or, in
the alternative, provide ammunition to counsel objecting to proposed cure
arrangements.

<h3>Cure Required for a Contract to Be Assumed</h3>

A. §365 of the Code. Section 365(b)(1) provides:

<blockquote>
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—

<blockquote>
(A)
cures, or provides adequate assurance that the trustee will promptly cure, such default;

(B)
compensates, or provides adequate assurance that the trustee will promptly
compensate, a party other than the debtor
to such contract or lease, for any actual pecuniary loss to such party
resulting from such default; and

(C) provides adequate
assurance of future performance under such contract or lease.
</blockquote>
</blockquote>

<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §365(b)(1)</a> (emphasis added).

It
is not clear what exactly constitutes "prompt" cure of such default
for the purposes of §365(b)(1)(A). Further, it is also not clear what
constitutes "adequate assurance" of such a prompt cure for the
purposes of §365(b)(1)(B). Congress did not define the term
"prompt," and the meaning of this provision has been left to
subsequent case law development. Cases have largely been determined upon the
unique facts, making the formation of clear law difficult.

(i)
Section 365(b)(1)(A) vs. §365(b) (1)(B).
The primary difference between §365(b)(1)(A) and §365(b)(1)(B) is
that §365(b)(1)(A) mandates the cure of a "default which occurred
pursuant to the contract or lease," while §365(b)(1)(B) mandates
compensation for any actual pecuniary loss arising from any such defaults.
Thus, §365(b)(1)(A) speaks to the underlying default itself, and
§365(b)(1)(B) speaks to the consequences of such default.<a href="#3" name="3a">3</a>

(ii)
Section 365(b)(1)(A)—Actual Defaults.
What satisfies the requirements of §365(b)(1)(A) depends on the facts or
circumstances of each case.<a href="#4" name="4a">4</a> However, it should be noted that a cure of any
default before assuming the lease is governed by appropriate state law.<a href="#5" name="5a">5</a> In one
case, the debtor's proposal to pay the balance over two years was
determined to be "prompt" because it was reasonable in light of the
fact that the lease had approximately 22 years remaining in its term.<a href="#6" name="6a">6</a> In
another case, In re Coors of North Mississippi Inc.,<a href="#7" name="7a">7</a> the court permitted a cure to take place over a
three-year period. In the Coors

case, the debtor was a beer distributor and owed the manufacturer of Coors
approximately $110,000 at the time the petition was filed. Coors required the
debtor to make all future purchases in cash and, in addition, to pay a $0.50
per case surcharge to reduce the arrearage. The distributor had reduced the
pre-petition debt to approximately $60,000 by the time it proposed to assume
the distributor agreement and assign it to another beer distributor. The court
permitted a three-year cure period based on its assessment of the
debtor's assignee's inequitably imposing the surcharge for the new
sales agreement to its distributors.<a href="#8" name="8a">8</a> The Coors court clearly was influenced by the fact that the
manufacturer had already unilaterally extracted repayment of nearly half its
pre-petitioned debt prior to assumption. However, the decision in Coors essentially rewrote the distributor agreement under
the pretext of "cure."<a href="#9" name="9a">9</a>

In
another case, the district court determined that a proposal to cure the
arrearage over a seven-month period did not constitute "prompt
cure."<a href="#10" name="10a">10</a> One court noted that it possessed broad powers to require
"timely and substantial guaranties of cure and future performance in the
context of any order on the assumption of a contract.<a href="#11" name="11a">11</a>

With
respect to adequate assurance of a prompt cure, adequate assurance requires a
foundation that is non-speculative and sufficiently substantive so as to assure
the parties that it will receive the amount of the loss. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… the Matter
of Old World Skating Center Inc., 100 B.R. 147
(Bankr. D. Conn. 1989)</a> (the curing of an arrearage over a
three-year period where the record would not support any finding by the court
that the promise would constitute adequate assurance was not approved by the
court. See, also, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Berkshire Chemical Haulers, 20 B.R. 454,
458-59 (Bankr. D. Mass. 1982)</a> (payments of default amounts over
18 months held not to constitute adequate assurance of prompt cure under
§365(b)(1)); see, also, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6…
re Future Growth Enterprises, 61 B.R. 469
(Bankr. E.D. Pa. 1986)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
re Skylark Travel Inc., 120 B.R. 352 (Bankr.
S.D.N.Y. 1990)</a>.

(iii)
Section 365(b)(1)(B)—Pecuniary Loss.
With respect to adequate assurance that the trustee/debtor will
"promptly" compensate for actual pecuniary loss arising from a
default, the term "adequate assurance" is borrowed from the Uniform
Commercial Code provisions dealing with the anticipatory repudiation of contracts.<a href="#12" name="12a">12</a>
Bankruptcy courts have attempted to provide several definitions of the term:
"Such assurance must be in the form of cash or cash collateral that is
non-speculative, positive and sufficiently substantial so as to assure the
non-breaching party that it will realize the amount of the default."<a href="#13" name="13a">13</a> It
has become increasingly clear that in the case of real estate leases or real
estate sales contracts, courts will almost universally require that the
pecuniary default be cured at or prior to the time the contract is assumed.<a href="#14" name="14a">14</a>
Courts have been more uneven in their treatment of contracts outside the real
estate context. In one case, In the Matter of Luce,<a href="#15" name="15a">15</a> the court held that, "a promise or similar
lesser assurance will not be an adequate cure of a monetary default."<a href="#16" name="16a">16</a>

However, each case is so factually dependent, taking such judicial statements
out of context can be unwise. Specifically, after making the preceding
statement, the Luce court
permitted the debtor to assign a franchise agreement to a third party who did
not assume any of the debtor's obligations, and who failed to furnish any
collateral money or other property to ensure that the promise of the infusion
of capital into the debtor's business would occur. It was from this
capital infusion that the franchisor was to be paid for inventory sold to the
debtor on credit. Fortunately for the franchisor, the district court in Luce reversed.<a href="#17" name="17a">17</a>

B.
Procedure for Cure. Interestingly, the
Federal Rules of Bankruptcy Procedure (FRBP) do not explicitly prescribe a
procedure for establishing cure claim amounts payable upon the assumption of
executory contracts. Additionally, case law concerning this issue is lacking.<a href="#18" name="18a">18</a>
At least one circuit court has determined that determination of cure amounts is
governed by <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=F…
6006 and 9014 of the FRBP</a>.<a href="#19" name="19a">19</a> Technically, the setting of cure claim
amounts is "not otherwise governed by" the Bankruptcy Rules unless
filed under the auspices of Rule 9014.<a href="#20" name="20a">20</a> Further, "determining the
amount necessary to cure existing defaults is necessarily related to the
assumption or rejection of executory contracts."<a href="#21" name="21a">21</a> Accordingly, the O'Brien court determined that an issue concerning cure
amounts is to be resolved by motion practice.<a href="#22" name="22a">22</a>

C.
Curing Defaults in the Context of a Chapter 11 Reorganization Plan. Section 1123(a)(5)(G) provides that a chapter 11
plan can provide for a cure of default. In the business reorganization context,
the dispute over application of cure provisions usually revolves around the
debtor's attempt in the plan to decelerate an accelerated mortgage, note,
deed of trust or other debt instrument by paying all delinquent installments
and promising to make all future payments under the note as if no acceleration
had occurred. The parties then turn to the applicability of Code §1124(2),
dealing with impairment. If the deceleration does not impair the secured
creditor's contractual rights, the plan may be confirmed notwithstanding
that creditor's objection.<a href="#23" name="23a">23</a>

In
one case, In the Matter of Madison Hotel Association,<a href="#24" name="24a">24</a> the Seventh Circuit reversed the lower
court's finding of impairment and allowed confirmation of a
reorganization plan that purported to cure default to the mortgagee's
note. Madison Hotel and other
similar cases stand for the proposition that a creditor may not be able to rely
on default and acceleration on the bankruptcy context to rid itself of
long-term debt obligations written at low rates of interest.<a href="#25" name="25a">25</a>

Another
court has held that a chapter 11 plan's cure of a default pursuant to <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §1124(b)(A)</a> must be completed by the effective date of the
debtor's reorganization plan in order to avoid impairment of the
creditor's claim for purposes of the plan's confirmation under <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §1129</a>. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
11 U.S.C. §1124</a> requires that a chapter 11 debtor's
reorganization plan makes provision for cure of any arrearage to a creditor on
or before the effective date of such a plan without otherwise altering the
legal rights of the creditor, in order that the creditor's claim may be
deemed unimpaired for purposes of acceptance of the plan, a plan that provided
that any arrearages would be cured "prior to the confirmation
date," which the plan defined as the date on which payments under the
plan would commence by order of the bankruptcy court at or after the
confirmation of a plan, did not meet the requirements.

Additionally,
in <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=3…
re Valente v. Savings Bank of Rockville, 34
B.R. 362 (D.C. Conn. 1983)</a>, the court recognized the right of a
chapter 11 debtor to cure a default in its reorganization plan pursuant to <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §1123(a)(5)(G)</a> by repaying arrearages on a mortgage debt over a
12-month period expiring subsequent to a property sale date set presumably
under state law by the court. The court appears to have held that a chapter 11
debtor seeking to cure a default in its reorganization plan cannot do so by making
debt payments subsequent to the applicable statutory redemption period under
state law.

In
another case, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…
v. Federal Land Bank, 89 B.R. 48 (D. S.D. 1987)</a>
<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…
F.2d 605</a> (8th Cir.), the court held that the chapter 11 debtor's
proposal in the debtor's reorganization plan to redeem real property, as
to which a mortgage had been foreclosed due to the debtor's default by
paying on the mortgage over a period of time terminating subsequent to the
applicable statutory redemption period, is not within the debtor's
authority to cure a default granted by <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §1123(a)</a> (5)(G). Noting that it was well-established that
bankruptcy courts cannot create property rights that did not exist under state
law, the court stated that redemption by confirmation of a chapter 11 plan,
which would have had the effect of extending the applicable redemption, must
fail.

In
In re Durant Realty,<a href="#26" name="26a">26</a> the court held
that a chapter 11 debtor seeking to cure a default in its reorganization plan
must do so within the time period during which its creditor can enforce a lien
against the debtor under state law. The Durant court, citing <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §1124(2)(A)</a>, held that if the cure in satisfaction of a
pre-petition matured secured lien could be delayed by a debtor in pre-petition
default, such delay must be so brief as to be deemed inconsequential, meaning
not more than the time it would take the creditor to enforce its lien against
the debtor under available state remedies.<a href="#27" name="27a">27</a>

Finally,
in <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…
re Entz-White Lumber & Supply Inc., 850
F.2d 1338 (9th Cir. 1996)</a>, the court ruled that the cure of a
default by a chapter 11 debtor under <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §§1123(a)(5)(G)</a> and 1124(2)(A) entitled the debtor to
avoid all consequences of the default in its reorganization plans, including
higher debt interest rates imposed as default penalties. The court observed
that the relevant case law construing the cure provisions of the Code did not
treat acceleration as the only possible consequence of default that could be
nullified by the debtor's cure.

<h3>Conclusion</h3>

While
each case tends to turn upon its own unique facts and upon the views and
philosophies of the particular trier of fact making it difficult to come up
with any bright lines and rules, it is important to determine whether the cure
proposed by the debtor/trustee is (1) for defaults under §365(b)(1)(A),
(2) to compensate or provide adequate assurance that the debtor/trustee will
promptly compensate for pecuniary losses arising out of the defaults as
provided for in §365(b)(1)(B), or (3) defaults and pecuniary losses
generated by existing defaults that are attempting to be cured pursuant to a
reorganization plan pursuant to §1123(a) (5)(G). While the cases are not
voluminous, they can provide some assistance in creating a proposal for cure or
support for an objection to a proposed cure arrangement.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Ms.
Brighton is a partner in Nixon Peabody LLP's Manchester, N.H., office in
the Bankruptcy Group, where she practices primarily in the area of bankruptcy,
workouts and secured lending. She is certified in business bankruptcy by the
American Board of Certification. <a href="#1a">Return to article</a>

<a name="2">2</a> See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §365(b)</a>. <a href="#2a">Return to article</a>

<a name="3">3</a> See

<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
re J.W. Fortune Inc., 173 F.3d 424, (4th Cir.
Va. 1999)</a>. See, also, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
Resources Inc. v. Holland, 137 F.3d 786, 798
(4th Cir.) (noting that the debtor must compensate all non-debtor parties for
actual pecuniary losses that have resulted from the default); cert.
denied, 525 U.S. 962, 119 S. Ct. 404, 142 L.
Ed. 2d 328 (1998)</a>. <a href="#3a">Return to article</a>

<a name="4">4</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Valley View Shopping Center, 260 B.R. 10
(Bankr. D. Kan. 2001)</a>. <a href="#4a">Return to article</a>

<a name="5">5</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
re J.W. Fortune Inc., 173 F.3d at 425</a>.
See, also, In re Shangrala Inc., No.
98-1497 slip op. at *9 (4th Cir. January 1999). <a href="#5a">Return to article</a>

<a name="6">6</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Valley View Shopping Center, 256 B. R. at 10</a>.

See, also, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
re Embers 86th Street Inc., 184 B.R. 892, 900
(Bankr. S.D.N.Y. 1995)</a>. <a href="#6a">Return to article</a>

<a name="7">7</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
B.R. 918 (M.D. Miss. 1983)</a>. <a href="#7a">Return to article</a>

<a name="8">8</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
B.R. 918</a>. See, also, 61 Epling, "Contractual Cure in Bankruptcy," 61. Am. Bankr. L.J. 71, 76 (1987). <a href="#8a">Return to article</a>

<a name="9">9</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6…
Am. Bankr. L.J. at 76</a>. See, also, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
re Masterworks Inc., 100 B.R. 149 (Bankr. D.
Conn. 1989)</a> (debtor permitted to cure royalty payment defaults
any time prior to confirmation). <a href="#9a">Return to article</a>

<a name="10">10</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
v. Kramer Suburban Car Wash Enter. Inc., 1992
W.L. 62144 (D. Md. 1992)</a>. <a href="#10a">Return to article</a>

<a name="11">11</a> See
<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Travelot Co., 286 B.R. 447, 462 (S.D. Ga.
2002)</a>. <a href="#11a">Return to article</a>

<a name="12">12</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
Commercial Code §2-608 (1972)</a>. See, also, Epling, "Contractual Cure in
Bankruptcy," <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…; note 8 at 71</a>. <a href="#12a">Return to article</a>

<a name="13">13</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=4…
re Bronx Westchester Mack Corp., 4 B.R. 730,
734-35 (Bankr. S.D.N.Y. 1980)</a>. See, also, "Contractual Cure in Bankruptcy," <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=4…; note at 71. <a href="#13a">Return to article</a>

<a name="14">14</a> See,
e.g., <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=3…
re Anderson, 36 B.R. 120 (Bankr. D. Hawaii
1983)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… re Berkshire
Chemical Haulers Inc., 20 B.R. 454. (D. Mass.
1982)</a>. See, also, "Contractual Cure in Bankruptcy," <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…; at 71</a>. <a href="#14a">Return to article</a>

<a href="15">15</a> See,
e.g., <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1….
v. Lawrence, 11 B.R. 44 (Bankr. N.D. Ga. 1981)</a>
(chapter 13 case where creditor consented to attempt monthly cure). <a href="#15a">Return to article</a>

<a name="16">16</a> In
Matter Luce Indus. Inc., 7 Bankr. Ct. Dec.
(CRR) 78, 80 (Bankr. S.D.N.Y. 1980), rev'd., <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
B.R. 529 (S.D.N.Y. 1981)</a>. <a href="#16a">Return to article</a>

<a name="17">17</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
B.R. at 531</a>. See, also, "Contractual Cure in Bankruptcy," <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…; note 8 at 71</a>. <a href="#17a">Return to article</a>

<a name="18">18</a> See,
e.g., <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
re O'Brien Environment Energy Inc., 188
F.3d 116 at 123 (3rd Cir. 1999)</a>. <a href="#18a">Return to article</a>

<a name="19">19</a> Specifically,
Rule 6006(a) states that "A proceeding to assume, reject or assign an
executory contract or unexpired lease, other than as part of a plan, is
governed by Rule 9014." Bankruptcy Rule 9014 states in pertinent part the
following: "In a contested matter in a case under the Code not otherwise
governed by these rules, relief shall be requested by motion and reasonable
notice and opportunity for a hearing shall be afforded the party against whom
relief is sought." <a href="#19a">Return to article</a>

<a name="20">20</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
Environmental, 188 F.3d at 123</a>. <a href="#20a">Return to article</a>

<a name="21">21</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…; <a href="#21a">Return to article</a>

<a name="22">22</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…; <a href="#22a">Return to article</a>

<a name="23">23</a> See,
e.g., <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=3…
re Orlando Tennis World Dev. Co., 34 B.R. 558
(Bankr. M.D. Fla. 1983)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=3…
re Valente, 34 B.R. 804 (Bankr. D. Conn. 1982),

rev'd. sub. nom, Valente v. Savings Bank of Rockville, 34 B.R. 362, 364 (D. Conn. 1983)</a>. See "Contractual Cure in Bankruptcy," <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…; note 8 at 79</a>. <a href="#23a">Return to article</a>

<a name="24">24</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=7…
F.2d 410, 419 (1984)</a>. <a href="#24a">Return to article</a>

<a name="25">25</a> See,
also, "Contractual Cure in
Bankruptcy," supra note 8
at 80. See, also, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=7…
re Kuljas Seafood Co., 73 B.R. 659 (Bankr. S.D.
Miss. 1986)</a>, citing <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=3…
re Jones, 32 B.R. 951 (Bankr. D. Utah 1983)</a>. <a href="#25a">Return to article</a>

<a name="26">26</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=3…
B.R. 211 (Bankr. S.D. Fla. 1987)</a>. <a href="#26a">Return to article</a>

<a name="27">27</a> See,
generally, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=9…
ALR Fed. 847 (1990)</a>. <a href="#27a">Return to article</a>

Journal Authors

Jo Ann J. Brighton

Journal Date

Tuesday, April 1, 2003 - 12:00

Bankruptcy Rule

2003