If there has ever been a breach of a lease of real property — even if it was cured or was not material — the landlord is still entitled to “adequate protection” or one of the other assurances laid out in Section 365(b)(1), according to the Ninth Circuit.
However, “adequate assurance” may not be required if the breach has been cured or if the debtor has agreed to comply with the lease by having assumed the lease, Circuit Judge Danielle J. Forrest said.
The Monetary and Nonmonetary Breaches of Lease
The debtor leased several floors of an office building in a large city. In her September 23 opinion, Judge Forrest said the lease was below-market.
The landlord and the tenant were not on good terms. Before the tenant’s bankruptcy, the landlord asked the tenant to sign an estoppel certificate to assist in refinancing. The tenant refused and instead said there were problems with the premises and that the tenant had claims against the landlord.
After the squabble about the estoppel certificate, and also before bankruptcy, the landlord notified the tenant about several alleged, non-monetary breaches of the lease. When the landlord threatened to terminate the lease, the tenant filed a chapter 11 petition.
In bankruptcy, the tenant paid a month’s rent into an escrow account, claiming a right to a Covid rent moratorium under local law. The bankruptcy court concluded that the moratorium did not apply. The tenant-debtor paid the rent late and subsequently paid a late fee charged by the landlord.
Soon after filing, the tenant moved to assume the lease. After a year’s discovery, the bankruptcy judge held a trial and allowed the tenant to assume the lease. Judge Forrest quoted the bankruptcy judge as finding that many of the alleged breaches “appeared manufactured, and minor, and made-up, sometimes.”
The landlord nonetheless sought “adequate protection” under Section 365(b)(1) because there had been a breach of lease. The bankruptcy judge decided that the landlord was not entitled to “adequate protection” because the breaches were cured or were not material and would not result in forfeiture of the lease under California law.
The district court affirmed. The landlord appealed to the circuit and won a pyrrhic victory. Although the landlord was entitled to the protections of Section 365(b)(1), the error was harmless because any monetary breach had been cured, and the debtor’s promise to abide by the lease covered everything else.
The Verb Tense in Section 365(b)(1) Is Pivotal
Judge Forrest paraphrased Section 365(b)(1) as saying that a debtor may assume an unexpired lease if (1) it cures or provides adequate assurance of curing a default, (2) provides compensation for actual pecuniary loss, and (3) provides “adequate assurance of future performance.”
However, the prelude in Section 365(b)(1) requires the three protections “[i]f there has been a default.” When there has been no default, “section 365(b)(1)’s requirements — cure, compensation and adequate assurance of future performance — are not triggered,” Judge Forrest said.
The tenant-debtor contended that no protection under Section 365(b)(1) was required because the bankruptcy court had found “no ongoing default at the time of assumption and . . . that any default that had occurred was immaterial under California law.”
Judge Forrest nixed the contention by reference to the “plain terms of the statute” and the use of the “present-perfect tense,” i.e., if “there has been a default.” Citing the Collier treatise, she said that the “assertion that section 365(b)(1) can provide no relief for a landlord where a default already has been cured is simply incorrect both as a matter of interpretation and common sense.”
Judge Forrest held that the absence of an “active default . . . did not render section 365(b)(1)’s curative requirements inapplicable.”
Next, Judge Forrest dealt with the idea that the lack of a material default would render the section inapplicable. She found “no basis for this interpretation” and held that “the bankruptcy court erred in narrowly interpreting ‘default’ to refer only to defaults that are sufficiently material to warrant forfeiture of the lease under California law.”
Judge Forrest concluded the opinion by addressing “whether the bankruptcy court’s failure to analyze section 365(b)(1)’s curative requirements was reversible error” under F.R.C.P. 61, made applicable by Bankruptcy Rule 9005.
The only issue was the landlord’s claimed right to “adequate protection of future performance” under Section 365(b)(1)(C), because any existing breaches had been cured or had been found by the bankruptcy judge to be “only minor deviations from the contract terms.”
“Thus,” Judge Forrest said, “any adequate assurance responsive to the alleged defaults would be little more than simple promises not to deviate from the contract terms again.” She went on to say that the landlord “has not explained how any additional assurance of future performance would have substantively impacted its right to full performance of the lease terms.”
Judge Forrest held that any error by the bankruptcy court was “harmless.” Alluding to the below-market nature of the lease, she said that the landlord “made the deal” and “is not entitled to use section 365(b)(1) as a means to get out of a bad deal so that it can make a better one.”
If there has ever been a breach of a lease of real property — even if it was cured or was not material — the landlord is still entitled to “adequate protection” or one of the other assurances laid out in Section 365(b)(1), according to the Ninth Circuit.
However, “adequate assurance” may not be required if the breach has been cured or if the debtor has agreed to comply with the lease by having assumed the lease, Circuit Judge Danielle J. Forrest said.