Curing Defaults - Prompt Cure May Not Be as Prompt as You Think
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.
Cure Required for a Contract to Be Assumed
A. §365 of the Code. Section 365(b)(1) provides:
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—11 U.S.C. §365(b)(1) (emphasis added).(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.
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.3
(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.4 However, it should be noted that a cure of any default before assuming the lease is governed by appropriate state law.5 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.6 In another case, In re Coors of North Mississippi Inc.,7 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.8 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."9
In another case, the district court determined that a proposal to cure the arrearage over a seven-month period did not constitute "prompt cure."10 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.11
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 In the Matter of Old World Skating Center Inc., 100 B.R. 147 (Bankr. D. Conn. 1989) (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, In re Berkshire Chemical Haulers, 20 B.R. 454, 458-59 (Bankr. D. Mass. 1982) (payments of default amounts over 18 months held not to constitute adequate assurance of prompt cure under §365(b)(1)); see, also, In re Future Growth Enterprises, 61 B.R. 469 (Bankr. E.D. Pa. 1986); In re Skylark Travel Inc., 120 B.R. 352 (Bankr. S.D.N.Y. 1990).
(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.12 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."13 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.14 Courts have been more uneven in their treatment of contracts outside the real estate context. In one case, In the Matter of Luce,15 the court held that, "a promise or similar lesser assurance will not be an adequate cure of a monetary default."16 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.17
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.18 At least one circuit court has determined that determination of cure amounts is governed by Rules 6006 and 9014 of the FRBP.19 Technically, the setting of cure claim amounts is "not otherwise governed by" the Bankruptcy Rules unless filed under the auspices of Rule 9014.20 Further, "determining the amount necessary to cure existing defaults is necessarily related to the assumption or rejection of executory contracts."21 Accordingly, the O'Brien court determined that an issue concerning cure amounts is to be resolved by motion practice.22
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.23
In one case, In the Matter of Madison Hotel Association,24 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.25
Another court has held that a chapter 11 plan's cure of a default pursuant to 11 U.S.C. §1124(b)(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 11 U.S.C. §1129. Since 11 U.S.C. §1124 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 In re Valente v. Savings Bank of Rockville, 34 B.R. 362 (D.C. Conn. 1983), the court recognized the right of a chapter 11 debtor to cure a default in its reorganization plan pursuant to 11 U.S.C. §1123(a)(5)(G) 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, Demeris v. Federal Land Bank, 89 B.R. 48 (D. S.D. 1987) 853 F.2d 605 (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 11 U.S.C. §1123(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,26 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 11 U.S.C. §1124(2)(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.27
Finally, in In re Entz-White Lumber & Supply Inc., 850 F.2d 1338 (9th Cir. 1996), the court ruled that the cure of a default by a chapter 11 debtor under 11 U.S.C. §§1123(a)(5)(G) 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.
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.
1 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. Return to article
3 See In re J.W. Fortune Inc., 173 F.3d 424, (4th Cir. Va. 1999). See, also, Adventure 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). Return to article
9 61 Am. Bankr. L.J. at 76. See, also, In re Masterworks Inc., 100 B.R. 149 (Bankr. D. Conn. 1989) (debtor permitted to cure royalty payment defaults any time prior to confirmation). Return to article
13 In re Bronx Westchester Mack Corp., 4 B.R. 730, 734-35 (Bankr. S.D.N.Y. 1980). See, also, "Contractual Cure in Bankruptcy," supra note at 71. Return to article
14 See, e.g., In re Anderson, 36 B.R. 120 (Bankr. D. Hawaii 1983); In re Berkshire Chemical Haulers Inc., 20 B.R. 454. (D. Mass. 1982). See, also, "Contractual Cure in Bankruptcy," supra at 71. Return to article
15 See, e.g., G.M.A.C. v. Lawrence, 11 B.R. 44 (Bankr. N.D. Ga. 1981) (chapter 13 case where creditor consented to attempt monthly cure). Return to article
19 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." Return to article
23 See, e.g., In re Orlando Tennis World Dev. Co., 34 B.R. 558 (Bankr. M.D. Fla. 1983); In 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). See "Contractual Cure in Bankruptcy," supra note 8 at 79. Return to article
25 See, also, "Contractual Cure in Bankruptcy," supra note 8 at 80. See, also, In re Kuljas Seafood Co., 73 B.R. 659 (Bankr. S.D. Miss. 1986), citing In re Jones, 32 B.R. 951 (Bankr. D. Utah 1983). Return to article