Daily Development for
Monday, April 15, 1996

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law

The editor wishes all DIRT readers a "Happy Tax Day" - might as well laugh - crying does no good.

The following case may mean very little, but it contains some very malicious seeds.

BANKRUPTCY; LEASES; ASSIGNMENT: Neither bankrupt debtors nor their lease assignees have a duty to cure nonmonetary defaults. Ford Motor v. Claremont Acquisition Corp, Inc., 186 B.R. 977 (C.D. Cal. 1995)(dicta).

This startling holding is an interpretation of the new provisions added to Section 365 of the 1994 Bankruptcy Reform Act. The facts of the case involve automobile franchises, rather than a lease, but the court clearly understands that it is interpreting language that would be applicable equally to nonresidential leases.

Debtor held certain automobile franchises. The franchise arrangements required that the debtor continuously operate the dealer locations, and that failure to operate for seven consecutive days would constitute grounds for termination. The debtor ceased operations on November 7, but did not file a bankruptcy petition until November 20. The facts are unclear as to whether the franchisors actually terminated the leases prior to bankruptcy. [If they did - the opinion is even more frightening and virtually nonsensical - so the editor assumes that the court viewed the leases as not having been actually terminated.]

Following the bankruptcy, the debtor attempted to assign the franchises to another dealer (The proposed assignee was the famous Cal Worthington, who would "stand upon his head till his ears were turning red [or do other ignominious things] to make a deal.") Most of the opinion is taken up with a discussion of whether the franchisors could validly object to the assignment to Worthington.

Perhaps caught up in the discussion of the acceptability of Worthington as an assignee, the court tends to give short shrift to the franchisors' other argument - that there was no right to assign because the breach of the continuous operation clause could not be cured.

In a few pages at the end of the opinion, the court analyzes new language added to 11 U.S.C. Sec. 365(b) (2) (D), which provides that:

"Paragraph 1 of this subsection [imposing the requirement of curing defaults prior to assumption and assignment] does not apply to a default that is a breach of a provision relating to -- . . .

(D) the satisfaction of any penalty rate or provision relating to a default arising from any failure by the debtor to perform nonmonetary obligations under the executory contract or unexpired lease."

In a nutshell, the court reads this language as providing that neither the bankruptcy estate has no obligation to cure a nonmonetary default in connection with an assignment of an unexpired lease.

Consequently, in this case, the franchisee could assign the franchise notwithstanding the prior breach of the continuous operation clause. The court states its ruling curtly and clearly:

"The most natural reading of this language supports the interpretation given it by the bankruptcy court - that a trustee or debtor in possession is not required to cure nonmenotary defaults in order to assume and assign executory contracts and leases."

The court discounts the legislative history propounded by the franchisors to the effect that the purpose of the bankruptcy amendment was to avoid forcing the estate to deal with penalty interest or other penalty provisions that might otherwise arise upon default.

Comment: If the court means to say that nonmonetary defaults need not be cured at all, even by the assignee, then this is indeed a distortion of the overall policy of this section of the Act.

Perhaps the court is saying only that the estate need not cure nonmonetary defaults, but that the assignee would still have the duty to cure such defaults, assuming that they persisted following the assignment, then perhaps the case does not set such a difficult standard. For instance, in the case at hand, one would assume that the proposed assignee would have a duty to continuously operate from the moment the assignment became valid.

On the other hand, if the court is holding that leases that have been terminated due to nonmonetary defaults can be revived after their termination, assumed and assigned, if the lessee goes bankrupt then the court indeed is standing the law on its head. As there is no concept of "preference periods" for lease termination, the court's ruling might permit the revival of leases terminated a substantial time prior to the filing of the petition. For this reason, the editor assumes that the court can't possibly mean that a terminated lease "revives," but only that if the landlord has not promptly terminated as a consequence of a nonmonetary default, the landlord must accept an assignment of the lease even though the nonmonetary default remains uncured (or, as in this case, uncureable.)

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. This item, however, has not been. It is an April Fool story. But no one ever reads this fine print anyway. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last five years, these Reports annually have been collated, updated, indexed and bound into the annual Survey of Developments in Real Estate Law, volumes 1-5, published by the ABA Press. The Annual Survey volumes are available for sale to the public. Contact Laprica Mims at the ABA. (312) 988 5260.

Items reported here and in the ABA publications are for general information (and, in this case disinformation) purposes only and should not be relied upon in the course of representation or in the forming of decisions in legal matters. Accuracy of data and opinions expressed are the sole responsibility of the DIRT editor and are in no sense the publication of the ABA.