History Matters: Historical Breaches May Undermine Assumption Of Executory Contracts

One of the primary fights underlying assumption of an unexpired lease or executory contract has long been over whether any debtor breaches under the agreement are "curable." Before the 2005 amendments to the Bankruptcy Code, courts were split over whether historic nonmonetary breaches (such as a failure to maintain cash reserves or prescribed hours of operation) undermined a debtor's ability to assume the lease or contract. By the 2005 amendments, however, Congress apparently took the position that—at least for contracts other than nonresidential real property leases—historic nonmonetary breaches do in fact generally preclude assumption of an executory contract or unexpired lease. A recent case from the Fifth Circuit Court of Appeals implicitly confirms that interpretation.

Nonmonetary Breaches Before the 2005 Amendments

Section 365(a) of the Bankruptcy Code generally permits a debtor to assume an executory contract or unexpired lease. If the contract or lease is subject to prepetition defaults, section 365(b)(1) requires the debtor to first "cure" those defaults. A breach caused by a failure to pay money is "cured" by paying the unpaid amount owed. A breach of nonmonetary covenants, however, may not be as simple. Some terms require performance at a specific time period or interval, so performance at some point in the future may not remedy the past breach. When dealing with these nonmonetary provisions, courts generally hold that the default is not curable as a matter of law. For example, courts have prohibited assumption where breaches related to, among other things, requirements to maintain continuous operations, promises not to use leased equipment for work with parties other than the lessor, promises not to place licensed software on third-party computers, and obligations to consummate a transaction by a specified closing date. The cure requirements under section 365(b)(1) are somewhat moderated by section 365(b)(2), which enumerates a series of exceptions to the requirement for curing prepetition defaults. Prior to the 2005 amendments to the Bankruptcy Code, section 365(b)(2) provided:

Paragraph (1) of this subsection [requiring cure of any defaults] does not apply to a default that is a breach of a provision relating to— (A) the insolvency or financial condition of the debtor at any time before the closing of the case; (B) the commencement of a case under this title; (C) the appointment of or taking possession by a trustee in a case...