Law, Not Lease, Defines Default
In a victory for landlords dealing with a tenant in bankruptcy, Ansell.Law attorney Anthony D’Artiglio recently secured a ruling in a reported decision that broadly defined the “defaults” tenants must cure in order to assume a lease. The decision in In re Old Market Group Holdings Corp. clarifies that a “default” as set forth in the Bankruptcy Code is given its ordinary meaning, regardless of any narrower definition of default contained in the lease.
The firm represented 400 Walnut Avenue, LLC (“Walnut”), which owned a product distribution center leased by the debtor, Fairway Group Holdings (“Fairway”), a regional grocery store chain. Fairway filed for Chapter 11 bankruptcy protection and sold most of its assets under the confirmed plan of reorganization. This included assigning its lease of Walnut’s property to another supermarket chain according to Section 365 of the Bankruptcy Code. Section 365 permits a debtor-lessee under an unexpired lease to assume (and subsequently assign) that lease if the debtor believes that assumption is in the estate’s best interest. If there is an existing default under the lease, Section 365(b)(1) requires that the debtor cure any such defaults as a prerequisite to assumption, among other obligations of the debtor.
The dispute concerned Fairway’s responsibility, under Section 365(b), to cure defaults under its lease — specifically, its failure to make required repairs — when it assigned that lease. Fairway claimed that it had no obligation to make those repairs as its failure to do so was not a “default” as defined in the lease because Walnut allegedly did not demand that Fairway make those repairs before Fairway filed for Bankruptcy. As such, Fairway asserted that it could not be liable for the cost to make repairs to the property because no “default” — as defined by the Lease — occurred prior to Bankruptcy.
“Any Failure To Perform” = Default
In response, Walnut argued that any notice provision in the lease was irrelevant because a “default” under an assumed lease is given its ordinary meaning pursuant to Section 365, not the terms of the lease, and the outstanding repairs constituted a default as that term is plainly understood — a failure to perform a defined obligation. Accordingly, Fairway should be responsible for the cost of any repairs.
The bankruptcy court rejected Fairway’s position and agreed with the argument put forth by D’Artiglio on behalf of Walnut. The court ruled that: “Both the text and the purposes of [Section 365(b)(1)] compel the conclusion that the statutory term ‘default’ means any failure to perform under the assumed contract or lease, regardless of the definition of default contained in that contract or lease.”
The court went on to note that “Consideration of the purposes of Section 365(b)(1) reinforces the conclusion that the statutory term ‘default’ should be construed to include any failure to perform contractually required obligations.” Citing prior decisions, the court further stated that “The case law is consistent with this plain-meaning reading of the statute. When debtors seek to assume leases or contracts under which they have failed to make required repairs, courts routinely require the debtor to make those repairs — that is, to cure the defaults — as a condition to assumption.”
The interpretation of “default” articulated by the court applies to assumed executory contracts and assumed unexpired leases. The ruling Ansell’s lawyer obtained means that debtors will likely need to cure any failure, shortcoming, or unfulfilled obligation under a lease or contract — whether material or not, whether a “default” as defined in the agreement or not — before they can assume or assign such agreements. This further protects parties, including lessors, whose interests may be adversely affected by an uncured contract breach by a debtor.
If you have any questions about this case or its impact, please contact Anthony D’Artiglio.
