In the Absence of Default, Landlord Not Entitled to Attorneys’ Fees as Cure Costs Upon Lease Assumption and Assignment

The recent spate of major retail bankruptcy filings — Sports Authority, Radio Shack, Wet Seal, PacSun and Aeropostale, to name a few — have thrust landlords into the middle of unfamiliar and complex chapter 11 restructurings and asset sales. Whether the tenants in such cases intend to internally reorganize or liquidate their assets through one or more sales, they often seek to either assume or assume and assign their most attractive leases. To do so, however, the tenant must satisfy all requirements for assumption, including those articulated in § 365(b)(1) of the Bankruptcy Code, which provides, in pertinent part, that “[i]f 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 ... the trustee ... (A) cures ... such default; (B) compensates ... 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.”

Frequently, disputes arise over the proper amount of the so-called “cure costs” a debtor must pay to enable it to assume or assume and assign a contract or lease. Among other things, landlords and contract counterparties will frequently add their attorneys’ fees to such cure costs and oppose a debtor’s attempt at assumption or assumption and assignment unless they are paid. In In re FKA FC LLC, 545 B.R. 567 (Bankr. W.D. Mich. 2016), the U.S. Bankruptcy Court for the Western District of Michigan squarely addressed whether and to what extent a landlord is entitled to payment of its attorneys’ fees as cure costs in connection with a debtor’s attempt to assume and assign a lease.

In FKA FC, the debtors — sellers of religious books, music, movies and other supplies, with more than 250 retail locations — moved for the approval of a sale of substantially all of their assets and the assumption and assignment of numerous contracts and leases, including a shopping center lease with one of their landlords, Los Banos Gravel Co. Inc. In their assumption-and-assignment notice, the debtors indicated that the cure cost associated with the assumption and assignment of the Los Banos lease was $0. Los Banos filed a limited and protective objection, contending that the cure claim should include certain year-end tax adjustments and CAM reconciliations, but acknowledging that “‘[t]he Debtor is not in default under the terms of the lease at this time.’” The bankruptcy court ultimately denied the debtors’ motion.

Thereafter, the debtors filed a liquidating plan that similarly contemplated the sale of substantially all of their assets and the assumption and assignment of numerous contracts and leases. In its second assumption-and-assignment notice, the debtors again indicated that the cure cost associated with the assumption and assignment of the Los Banos lease was $0. Los Banos filed an objection because the cure amount did not include its attorneys’ fees incurred in connection with its first objection. During additional briefing, Los Banos identified several purported defaults under its lease and referred to a provision in its lease purportedly entitling it to the recovery of attorneys’ fees. After an evidentiary hearing, the bankruptcy court approved the debtors’ assumption and assignment of the Los Banos lease and concluded that the cure amount was $0.

The bankruptcy court determined that § 365(b)(1) did not provide an independent basis for the recovery of a landlord’s attorneys’ fees upon assumption, but rather the landlord must first satisfy the following criteria: “(i) a default has occurred, (ii) the agreement must specifically entitle the non-debtor party to reimbursement of attorneys’ fees, (iii) applicable non-bankruptcy law must recognize a right to attorneys’ fees, and (iv) the attorneys’ fees must be reasonable.” The bankruptcy court concluded that the debtors were not in default under the lease and, “[f]or this reason alone, Los Banos is not entitled to its attorneys’ fees” as a cure cost. In so holding, the bankruptcy court rejected, among other contentions, Los Banos’s assertion that the debtors’ bankruptcy filing alone constituted a default under the express terms of the lease — recognizing that a purported default in a contract or lease based on a bankruptcy filing is an unenforceable ipso facto clause.

The bankruptcy court further concluded that even if a default was not required, Los Banos still would not have been entitled to the recovery of its attorneys’ fees because neither the express terms of its lease nor applicable nonbankruptcy law provided such a right. According to the bankruptcy court, the lease provision addressing the right to attorneys’ fees was not broad enough under the circumstances because it applied to defaults “related to reentry, repossession, and/or reletting of the premises.” Further, the bankruptcy court rejected Los Banos’s reliance on a Texas state law[1] providing that “‘[a] person may recover reasonable attorney’s fees from an individual or corporation, in addition to the amount of a valid claim and costs, if the claim is for ... an oral or written contract.’” The bankruptcy court reasoned that this provision was not applicable because a valid claim was a prerequisite to the recovery of attorneys’ fees, and because there was no default under the lease, Los Banos did not hold such a claim.

Based on FKA FC, counterparties to contracts and landlords must be cognizant that even if their contracts and leases contain rock-solid attorneys’ fee provisions, it is unlikely they will be able to recover their attorneys’ fees as cure costs when a debtor seeks to assume or assume and assign a contract or lease under which it is not in default. As the bankruptcy court noted in FKA FC, under these circumstances, the counterparty to a contract or lease “must, like the majority of other parties in interest in this case, bear its own costs of representation.”