Landlords Given Reasons To Sweat: "Teeny Tiny" Non-Monetary Defaults And Assumption Requirements

• Jurisdiction: United States,Federal,California
• Law Firm: Kelley Drye & Warren LLP
• Subject Matter: Real Estate and Construction, Insolvency/Bankruptcy/Re-structuring, Insolvency/Bankruptcy, Real Estate, Landlord & Tenant - Leases
• Author: Robert L. LeHane and Philip Weintraub
• Published date: 27 March 2023

The good news for party-goers and tenants: Thanks to a recent decision from the Ninth Circuit Court of Appeals, a popular nightclub in historic downtown Los Angeles will remain open notwithstanding the concerted multi-year effort by a stubborn landlord to reject the nightclub's lease. The silver lining for stubborn landlords: The Ninth Circuit overturned a troubling Central District of California ruling that if existing defaults are not "material," your debtor/tenant does not have to cure them or provide adequate assurance to assume your lease in their bankruptcy. The district court in In re Hawkeye Entertainment LLC, affirming a bankruptcy court ruling, held that the cure and adequate assurance protections of ' 365(b) of the Bankruptcy Code only apply if the breach of the lease by the tenant is of sufficient materiality to warrant the termination of the lease under state law. On this key issue, the Ninth Circuit reversed.¹

After its landlord initiated an eviction action, Hawkeye Entertainment LLC - whose primary asset is a lease for several floors of the Pacific Stock Exchange Building, which it subleases to an affiliate that operates a successful nightclub and entertainment venue - filed for chapter 11 protection. Shortly after filing, Hawkeye moved to assume the lease and sublease under ' 365.

Section 365(a) empowers a debtor to assume an unexpired lease, binding the landlord to the existing lease terms after the debtor emerges from bankruptcy. This can be a powerful tool, especially if the lease is below market, as it was in the Hawkeye case. However, existing defaults under the unexpired lease prevent assumption unless the tenant/debtor complies with ' 365(b), which requires, among other things, that the debtor cure defaults and provide adequate assurance of future performance. In the absence of a default (or if the only defaults are those carved out in ' 365(b)(2)), a landlord has no real recourse to prevent assumption unless the debtor/tenant is also seeking to assign the lease under ' 365(f).

Hawkeye's landlord objected to the assumption motion, citing myriad lease defaults that, absent cure, would ordinarily prevent nonconsensual assumption. Specifically, the landlord alleged the following defaults, which were ultimately reviewed on appeal: (1) late April 2020 rent payment; (2) violation of the "use of premises" provision by allowing religious services; (3) refusal to sign an estoppel certificate; (4) violation of a conditional-use alcohol...