After prevailing against the landlord following a five-day trial before the Bankruptcy Court in the Central District of California and thereafter prevailing in the appeal filed by the landlord to the U.S. District Court, Leech Tishman Business Restructuring & Insolvency Group Partner and Co-Chair Sandford L. Frey, Employment & Labor Partner and Chair Philip A. Toomey, and Employment & Labor Partner Fadi K. Rasheed recently received a favorable decision from the Ninth Circuit Court of Appeals, which affirmed the decision of the Bankruptcy Judge and U.S. District Court Judge, ruling that the operator of a prominent Los Angeles-area music event venue can keep its space in downtown Los Angeles’ Pacific Stock Exchange building, dismissing the landlord’s attempt to prove defaults and terminate its lease. The decision is the latest ruling in a dispute that traces back to 2014.
In a published opinion on September 23, 2022, the Ninth Circuit Court of Appeals settled a legal issue that has significant consequences beyond this particular case. The Ninth Circuit Court of Appeals determined that the debtor in possession’s burden to provide adequate assurance of future performance is not dependent on whether the default was “material” under California law such that it warranted forfeiture of the entire lease. In other words, the debtor in possession must provide adequate assurance of future performance under Bankruptcy Code § 365(b)(1) even if a default is cured as of the time of assumption and even if the default is non-material and would not warrant forfeiture or termination of the lease under California law; and the Ninth Circuit Court of Appeals further found that the Bankruptcy Court erred in holding that Section 365(b)(1) was not triggered because the alleged defaults were non-material.
However, the Ninth Circuit Court of Appeals nevertheless affirmed the Bankruptcy Court’s decision regardless of its failure to consider adequate assurance on the basis of the secondary argument that if error occurred, it was harmless error. The Bankruptcy Code does not specify what constitutes “adequate assurance of future performance.” Instead, courts apply this requirement “based upon the facts and circumstances of each case.” The Ninth Circuit Court of Appeals reasoned that adequate assurances under Section 365(b)(1)(C) are only appropriate and necessary where the counterparty has reasonable grounds for insecurity with respect to the debtor’s ability to fully perform its obligations under the contract. Here, the Court of Appeals found that the record established that the Bankruptcy Court determined that any default was cured as of the time of assumption, and that many of the alleged defaults were either not defaults in the first place or were only minor deviations from the contract terms. Thus, the Court of Appeals found that any adequate assurance responsive to the nature of the alleged defaults in this case would be little more than simple promises not to deviate from the contract terms again. Significantly, the Court of Appeals pointed out that although Section 365 provides protection for a landlord from having to be saddled with a debtor that may continue to default and return to bankruptcy, it does not allow a landlord to improve its position by escaping the bargain it made in pursuit of an opportunity to rent the premises to others at a higher amount. The Court of Appeals further determined that requiring further assurances would serve only to assist the landlord in its attempts to avoid continuance of an under-market lease, and that this is not a right or benefit afforded under section 365. Therefore, the Court of Appeals ruled that the Bankruptcy Court’s failure to analyze whether the debtor in possession satisfied section 365(b)(1)’s curative requirements before granting its assumption motion was harmless error, and it affirmed the decision of the Bankruptcy Court in favor of Leech Tishman’s client.
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