Cite as: Keith M. Lundin, Lundin On Chapter 13, § 102.2, at ¶ ____, LundinOnChapter13.com (last visited __________).
Section 365(b) applies in Chapter 13 cases: to assume an executory contract or unexpired lease, the debtor must cure any default or provide adequate assurance that any default will be promptly cured; and the debtor must provide adequate assurance of future performance under the contract or lease.1 If the agreement is a true contract or lease,2 the debtor cannot satisfy § 365 by treating the agreement as a secured claim—cram down under § 1325(a)(5)3 does not promptly cure default or otherwise satisfy the assumption requirements of § 365(b)(1).4
In Chapter 13 cases filed after October 22, 1994, § 365(b)(2)(D) has been “clarified” to provide that an executory contract or unexpired lease in default can be cured at the “nondefault rate” under the contract.5 The 1994 amendment eliminated the lessor’s argument that the debtor must pay default penalties or penalty rates to assume an executory contract or lease.
Although § 365(b)(2)(D) was reworded to preclude recovery of contract penalty rates as an element of curing default, there is a potentially conflicting provision of the 1994 amendments. Discussed in detail elsewhere,6 the Bankruptcy Reform Act of 1994 amended § 1322(e) to provide:
Notwithstanding subsection (b)(2) of this section and sections 506(b) and 1325(a)(5) of this title, if it is proposed in a plan to cure a default, the amount necessary to cure the default shall be determined in accordance with the underlying agreement and applicable nonbankruptcy law.7
The legislative history states that § 1322(e) was intended to overrule the Supreme Court’s decision in Rake v. Wade.8 Rake required the payment of interest on arrearages when a Chapter 13 debtor cured defaults on a home mortgage under § 1322(b)(5).
However, the generic reference to “a plan to cure a default” in § 1322(e) could be interpreted to include the curing of defaults with respect to executory contracts or unexpired leases under § 365(b). If so (mis)read, new § 1322(e) would determine “the amount necessary to cure the default . . . in accordance with the underlying agreement and applicable nonbankruptcy law.” There is no protection from contractual penalty rates in § 1322(e) analogous to new § 365(b)(2)(D). Section 365(b)(2)(D) is certainly more specific to contracts and leases than is § 1322(e).
Section 1322(b)(2)—cross-referenced in § 1322(e)—deals with the modification of claims, not with executory contracts or unexpired leases. Courts that reach the legislative history will not apply § 1322(e) when § 365(b)(2)(D) is in play.
Default under a contract or lease usually consists of the failure to make prepetition payments. Curing default typically means making up the missed payments over some specified time or by some fixed deadline.
The debtor must “promptly” cure any prepetition default.9 “Promptly” is not defined by the Code. Promptly in § 365(b)(1)(A) is probably a shorter period of time than the “reasonable time” to cure defaults in a long-term debt under § 1322(b)(5).10
In some jurisdictions, promptly means curing lease defaults at confirmation; elsewhere, the debtor is permitted several months after confirmation, depending on the circumstances of the debtor and the contract.11 It has been held that neither three years12 nor two years13 is a prompt cure for a residential lease.14 The assumption of an unexpired subsidized lease was rejected under § 365(b)(1) when the arrearage the debtor proposed to cure was $1,000 less than the amount claimed by the landlord, and the cure period of 48 to 60 months was neither prompt nor assured.15 One court held that a Chapter 13 debtor must cure default under an apartment lease “prior to the renewal date of the lease,” with a “rule of thumb” that debtors who cannot pay arrearages in six months probably should not be allowed to assume.16 This same court offered the following elaborate definition for “adequate assurance” of future performance of a rent-to-own contract for personal property:
In order to assume a rent-to-own contract, a chapter 13 debtor must provide adequate assurance of: (1) cure of any default; (2) compensation for pecuniary loss resulting from the default; and, (3) future performance under the contract. . . . [T]he debtor must earn sufficient disposable income to allow the payment of the arrearage and other costs within a time period specified, while continuing to make regular plan payments. . . . [T]he debtor must make current contract payments as they become due. . . . [T]he merchant must be given a quick and relatively inexpensive avenue for obtaining relief from the stay if the debtor either defaults on any of the current payments or cure payments.17
Along these same lines, another bankruptcy court rejected the 12-month cure of a car lease, holding that six months was the presumptive maximum permissible period to cure a lease arrearage in a consumer case.18 This court noted that prompt cure under § 365(b)(1) is a “far shorter period of time” than the cure contemplated by § 1322(b)(5).19 The court offered the following factors to determine whether a Chapter 13 debtor’s proposed cure is prompt enough:
the nature of the leased property;
the provisions of the lease;
the amount of the arrearage under the lease;
the remaining term of the lease; and
the provisions of the debtors proposed plan.20
The Chapter 13 plan should be precise in its provision for curing the default in an executory contract or lease. For example, it has been held that the plan fails to cure the default when the budget includes an estimated monthly expense for health insurance premiums, but the debtor did not provide a payment for health insurance in the plan.21 To ensure clarity, the plan provision for assumption of a contract should include two separate payments: the ongoing periodic payment required by the contract or lease and a separate payment toward the arrearage.
Curing default does not require the debtor to satisfy contract provisions that would be unenforceable under state or federal law. For example, in Brattleboro Housing Authority v. Parker (In re Parker),22 the debtor proposed to assume a public housing lease that contained a provision for recovery of attorney fees, repair costs and utility charges. The debtor successfully challenged the amount necessary to cure default by proving that recovery of these items was inconsistent with HUD regulations.
Not all prepetition defaults will be monetary. Debtors sometimes come into Chapter 13 in default of nonmonetary provisions, for example, a lease requirement to keep an apartment clean or a prohibition against making a lot of noise at 3 a.m. Chapter 13 can be a mechanism for the debtor to preserve a favorable lease or executory contract notwithstanding a nonmonetary default.23
The plain wording of the 1994 amendment to § 365(b)(2)(D) permits assumption of an executory contract or unexpired lease without curing default with respect to a “provision relating to . . . any failure by the debtor to perform nonmonetary obligations.”24 Some courts, including the U.S. Court of Appeals for the Ninth Circuit, have tortured § 365(b)(2)(D) to conclude that only “penalty rates” and “penalty provisions” relating to nonmonetary defaults are excused by the 1994 amendment.25 Applying the Ninth Circuit’s view, one bankruptcy court held that a Chapter 13 debtor could not cure default in a provision of a truck lease that prohibited use of the truck for work with any company other than the lessor when it was a “historical fact” that the debtor used the truck for other work before the petition.26 Courts in the Eastern and Western Districts of Pennsylvania have reported decisions holding that Chapter 13 debtors cannot cure “material” breaches of nonmonetary obligations in public housing contracts.27 These cases should be contrasted with decisions that permit Chapter 13 debtors to cure default under §§ 1322(b)(3) and 1322(b)(5) with respect to nonmonetary provisions of mortgages such as a due-on-sale clause.28 Once assumed, nonmonetary obligations in a contract or lease are binding on the debtor, and any post-assumption misbehavior is a new default with full contractual consequences.
Section 365(g)(2)(A) applies in Chapter 13 cases with serious consequences for debtors who improvidently assume a lease or executory contract. Rejection of a previously assumed lease or executory contract constitutes a postpetition breach.29 In In re Hall,30 the bankruptcy court applied § 365(g) to conclude that a housing authority was entitled to an administrative expense for postpetition rent that accrued when the Chapter 13 debtor assumed the lease through the confirmed plan, defaulted and then moved out after confirmation.31 The potential to generate an enormous administrative expense that can destroy the Chapter 13 plan is especially great with respect to car leases that typically contain especially onerous liquidated damages clauses. If the debtor assumes a car lease early in the Chapter 13 case and later abandons or rejects the lease, contract damages may be an administrative expense that must be paid in full through the plan.32 No reported decision discusses the possibility that rejection of an assumed lease or contract gives rise to a postpetition claim under § 1305 in a Chapter 13 case.33 The implications are obvious: Chapter 13 debtors must be counseled not to assume contracts or leases carelessly.
Neither § 1322(b)(7) nor § 365 permits a Chapter 13 debtor to finance the residual purchase price in a lease of personal property.34 When the debtor reaches the end of the lease term and desires to exercise the purchase option, the debtor is bound by the contract to pay the purchase option price consistent with the contract. If the contract requires a lump-sum payment, the debtor cannot spread that payment over a period of months through the plan, except with the lessor’s consent.
Satisfying the requirement in § 365(b)(1)(C) that the debtor provide adequate assurance of future performance is typically accomplished in a Chapter 13 case by providing for the regular contract payments through the plan. If the contract is a budget item such as apartment rent, the ongoing payment may be found in the budget rather than in the plan, but assumption of the lease should be a specific provision of the plan. If the budget is reasonable and the plan is feasible, adequate assurance of future performance is present. One court has defined adequate assurance of future performance of a residential lease to require somewhat more of the debtor:
[A]dequate assurance of future performance requirement will be met if a debtor’s proposal contains three basic safeguards. First of all, the debtor must earn sufficient disposable income to allow him to pay the arrearage and costs within the time period specified. . . . Second, the debtor must make current rent payments as they fall due. Third, the lessor must be given a quick and relatively inexpensive avenue for obtaining relief from the stay if the debtor either defaults on any of the current rent payments or any prompt cure payment.35
1 11 U.S.C. §§ 365(b), 1322(b)(7). Prior to the 1984 amendments to § 1322(b)(7), there was some dispute whether § 365 applied to assumption or rejection of an executory contract in a Chapter 13 case. See Benevides v. Alexander, 670 F.2d 885 (9th Cir. 1982) (Chapter 13 does not subject the rejection of an executory contract to the bankruptcy court’s discretionary approval. Section 365 does not apply because § 1322(b)(7) provides that rejection operates apart from § 365.). Contra In re Meehan, 46 B.R. 96 (Bankr. E.D.N.Y. 1985), aff’d sub nom. Bregman v. Meehan, 59 B.R. 380 (E.D.N.Y. 1986) (Section 1322(b)(7) must be read in pari materia with § 365. Debtor’s rejection of contract for sale of house involves consideration of § 365 standards. Court applies business judgment test and does not allow debtor to reject contract after state court ordered specific performance.). The 1984 amendments to § 1322(b)(7) probably overrule Benevides.
2 See § 175.1 [ Fake Leases and Rental Agreements ] § 102.8 Fake Leases and Rental Agreements.
3 See § 101.1 [ General Rules ] § 74.1 General Rules before BAPCPA.
4 In re Farrell, 79 B.R. 300 (Bankr. S.D. Ohio 1987).
5 See 11 U.S.C. § 365(b)(2)(D), as amended by Bankruptcy Reform Act of 1994, Pub. L. No. 103-394, § 219, 108 Stat. 4106 (1994); 140 Cong. Rec. H10,769 (section-by-section analysis by Congressman Brooks) (“[S]ection 365(b) is clarified to provide that when sought by a debtor, a lease can be cured at a nondefault rate (i.e., it would not need to pay penalty rates).”).
6 See § 135.1 [ Section 1322(e): Contracts after October 22, 1994 ] § 83.2 Section 1322(e): Contracts after October 22, 1994.
7 11 U.S.C. § 1322(e), as amended by Bankruptcy Reform Act of 1994, Pub. L. No. 103-394, § 305, 108 Stat. 4106 (1994).
8 508 U.S. 464, 113 S. Ct. 2187, 124 L. Ed. 2d 424 (1993). See 140 Cong. Rec. H10,770 (section-by-section analysis by Congressman Brooks).
9 11 U.S.C. § 365(b)(1)(A).
10 See § 133.1 [ Reasonable Time to Cure Defaults ] § 82.4 Reasonable Time to Cure Defaults.
11 See In re Trusty, 189 B.R. 977, 983–84 (Bankr. N.D. Ala. 1995) (“This Court has held that ‘prompt,’ as it related to curing defaults in residential leases, is six months or the time remaining on the unexpired lease, whichever is less. . . . That formula presupposes however that a contract, unlike rent-to-own agreements, has a definite term. In ‘rent-to-own time’ there is no definable term of the agreement or specific end to the contract. . . . Where promptness cannot be determined in relation to a contract term, promptness may be defined as a portion of the time a debtor proposes to pay other debts and other creditors. In these three cases where the range of time of payment is from 54 to 60 months, a 12 month period to cure a rent-to-own arrearage and to pay pecuniary losses, is most certainly prompt.”).
12 In re DiCamillo, 206 B.R. 64, 72 (Bankr. D.N.J. 1997) (Thirty-six-month cure of residential lease arrearages is not “prompt.” “The term ‘promptly’ . . . suggests a shorter period of time than the ‘reasonable time’ to cure defaults in a long-term debt under § 1322(b)(5). . . . Whether a cure is prompt must be determined on the facts and circumstances of each case. The courts have consistently held that a proposed cure over a period of two years or more was not ‘prompt’ for purposes of § 365(b)(1). . . . The three-year ‘cure’ of rental arrearages proposed by the debtor here cannot constitute adequate assurance that the debtor will promptly cure his default.”).
13 In re Yokley, 99 B.R. 394 (Bankr. M.D. Tenn. 1989) (Section 365 requires a Chapter 13 debtor to “promptly” cure any default in an assumed lease. Debtor’s proposal to cure defaults in an unexpired apartment lease over two years is not “promptly” enough.).
14 See also In re Flugel, 197 B.R. 92, 96–97 (Bankr. S.D. Cal. 1996) (“Debtors are behind in the rent in the amount of $14,961. Additionally, [the landlord] has incurred attorneys fees in the estimated amount of $1,500–2,000. . . . [T]he Debtors propose to make current rent payments and cure their arrearage by making additional monthly payments of $125.00. . . . [T]he Debtors [sic] cure would take just over 119 months, or nearly ten years. Under section 365(b)(1) the Debtors must cure the pre- and post-petition arrearage ‘promptly’ if the plan is to be confirmed. . . . Ten years under the Debtors’ plan is certainly not prompt.”).
15 In re Liggins, 145 B.R. 227 (Bankr. E.D. Va. 1992).
16 In re Morgan, 181 B.R. 579, 585–88 (Bankr. N.D. Ala. 1994) (“[T]he right to cure does not extend beyond the term of the lease. . . . In order to assume a residential lease, . . . the debtor must pay the rent arrearage in full. . . . [T]he debtor must pay any accrued costs of collection provided for under the lease in full. . . . [T]he debtor must propose to pay the rent arrearage and lessor’s collection costs promptly. . . . [A]ny rent arrearage and the lessor’s collection costs must be paid prior to the renewal date of the lease. . . . As a rule of thumb, this Court adopts a time period of six months, absent evidence that a different period should be required. If the debtor cannot pay the arrearage and costs in six months, then it may be that curing the lease is not in the debtor’s best interest.”). Accord In re Reed, 226 B.R. 1 (Bankr. W.D. Ky. 1998); In re Trusty, 189 B.R. 977 (Bankr. N.D. Ala. 1995).
17 In re Trusty, 189 B.R. 977, 982 (Bankr. N.D. Ala. 1995).
18 In re Reed, 226 B.R. 1 (Bankr. W.D. Ky. 1998).
19 226 B.R. at 2.
20 226 B.R. at 2.
21 Aetna Cas. & Sur. Co. v. Gamel, 45 B.R. 345 (N.D.N.Y. 1984).
22 269 B.R. 522 (D. Vt. 2001).
23 See In re Cottle, 189 B.R. 591, 599 (Bankr. E.D. Pa. 1995) (Debtor offered adequate assurance to public housing authority with respect to prepetition default of failing to use utility allowance to pay utility bills by “assuring that she will pay her postpetition electric and utility bills as they come due.” Court suggested that a portion of the utility allowance be placed in escrow each month with the Philadelphia Housing Authority as further assurance.); Madisonview Towers v. Yardley (In re Yardley), 77 B.R. 643 (Bankr. M.D. Tenn. 1987) (Chapter 13 debtor is permitted to cure nonmonetary defaults and assume residential lease. Debtor cured default involving altercation with security guard by paying a criminal fine imposed by state court. Debtor gave adequate assurance of future performance by agreeing not to carry a pocketknife and promising to be good.).
24 11 U.S.C. § 365(b)(2)(D), as amended by Bankruptcy Reform Act of 1994, Pub. L. No. 103-394, § 219, 108 Stat. 4106 (1994). See, e.g., In re Bankvest Capital Corp., 270 B.R. 541 (Bankr. D. Mass. 2001) (A nonmonetary default need not be cured by a Chapter 11 debtor prior to assumption of an executory contract.), aff’d, 290 B.R. 443 (B.A.P. 1st Cir. 2003), aff’d, 360 F.3d 291 (1st Cir. 2004).
25 See, e.g., Claremont Acquisition Corp. v. General Motors Corp. (In re Claremont Acquisition Corp.), 113 F.3d 1029 (9th Cir. 1997) (Chapter 11 debtor’s failure to operate a car dealership was not excused by § 365(b)(2)(D).).
26 In re Williams, 299 B.R. 684 (Bankr. S.D. Ga. 2003) (Adopting Worthington v. General Motors Corp. (In re Claremont Acquisition Corp., Inc.), 113 F.3d 1029 (9th Cir. 1997), Chapter 13 debtor cannot assume truck lease because debtor cannot cure default of provision with respect to prohibited uses of the truck.).
27 See Beckett v. Coastesville Hous. Assocs., No. CIV.A. 00-5337, 2001 WL 767601, *1–*6 (E.D. Pa. July 5, 2001) (Chapter 13 debtor cannot cure “material” prepetition breach of nonmonetary obligation to keep a federally subsidized leasehold clean. Before petition, state court entered judgment for possession to landlord based on debtor’s breach of lease requirement to maintain premises in “clean, orderly and safe condition.” Plan proposed to assume the lease and cure the default “by proposing to thereafter maintain her premises in a clean, safe and orderly fashion.” “Congress intended section 365 to apply both to monetary and non-monetary defaults. Nevertheless, . . . bankruptcy law is not intended to be used to escape the implications of state court judgments. . . . [M]aterial breaches of a non-monetary nature are not curable under § 365. . . . [B]ecause the state court has already found Beckett’s non-monetary breach to be material, her default is incurable under section 365 so that although section 365 applies, Beckett cannot meet the requirements of § 365(b)(1)(A).”); In re Gilmore, 261 B.R. 175, 180–81 (Bankr. W.D. Pa. 2001) (Arguably in dicta, “[Housing Authority of the City of Pittsburgh] contends that Debtor cannot use chapter 13 to cure non-monetary defaults or provide adequate assurance of future performance. There is case law to the contrary and I agree, generally, that certain non-monetary breaches can be cured. . . . I do not agree with [In re Yardley, 77 B.R. 643 (Bankr. M.D. Tenn. 1987)] . . . that satisfaction of criminal penalties (i.e., time served and payment of a fine) cures the civil consequences of breach of a lease. The civil consequence of the breach alleged in this case is the order for possession issued by the District Justice but, as explained above, the record before me contains no facts supporting that order for possession on non-monetary grounds. I agree that a debtor may provide adequate assurance that he will not commit future non-monetary lease violations in a variety of ways, depending upon the facts in the case. In this case, Debtor’s history of over three years’ tenancy without violating the lease and his promise to keep his unit free of controlled substances and users thereof, coupled with an order granting relief from stay to HACP prospectively to litigate future alleged non-monetary violations in the state court is adequate protection. However, I see no basis upon which Debtor can ‘cure’ a criminal conviction, and if that conviction is the ground for an order of possession based on non-monetary lease defaults, the eviction may proceed.”).
28 See § 132.1 [ Nonmonetary Defaults ] § 82.3 Nonmonetary Defaults.
29 11 U.S.C. § 365(g)(2)(A).
30 202 B.R. 929 (Bankr. W.D. Tenn. 1996).
31 Accord In re Masek, 301 B.R. 336 (Bankr. D. Neb. 2003) (Chapter 13 debtors are cautioned that lease payments become an administrative priority claim if the debtor assumes the lease and then defaults after assumption.); In re Pearson, 90 B.R. 638 (Bankr. D.N.J. 1988).
32 See 11 U.S.C. § 1322(a)(2), discussed in §§ 98.1 [ Plan Must Provide Full Payment ] § 73.1 Plan Must Provide Full Payment, 291.1 [ Treatment of Priority Claims ] § 136.1 Treatment of Priority Claims and 296.1 [ Leases and Executory Contracts ] § 136.10 Leases and Executory Contracts before BAPCPA.
33 See § 302.1 [ Postpetition Claims ] § 137.1 Postpetition Claims before BAPCPA.
34 In re Pittman, 289 B.R. 448, 451–52 (Bankr. M.D. Fla. 2003) (Debtor cannot confirm plan that treats purchase option in car lease as a secured claim to be paid in installments. Debtor exercised purchase option under car lease before the Chapter 13 petition. Plan treated the purchase price as a secured claim payable over 36 months with interest. Debtor filed a secured claim on behalf of car lessor. “Section 1322(b)(7) permits a Chapter 13 debtor to assume an unexpired lease, subject to the provisions of § 365. However, a debtor who assumes an unexpired lease pursuant to § 1322(b)(7) and subject to § 365 may not vary the terms thereof. . . . [Section] 1322(b)(7) does not permit a Chapter 13 debtor to finance the residual purchase price of a leased vehicle over the life of a Chapter 13 plan. . . . [T]he lease unambiguously requires Debtor to make a lump sum payment in order to exercise the purchase option.”); In re Weske, 203 B.R. 694, 696 (Bankr. E.D. Wis. 1996) (Section 1322(b)(7) cross-references § 365 and prohibits financing the residual purchase price on a car lease over the life of the Chapter 13 plan; rather, “the debtor is bound by the contract and must pay the residual purchase price in full in a lump sum.”); In re Ramirez-Arellano, 113 B.R. 796 (Bankr. S.D. Fla. 1990) (Chapter 13 plan cannot be modified under § 1329 to make use of § 1322(b)(2) or 1325(a)(5) to “cram down” the purchase price option at the end of an automobile lease when the debtors were paying the automobile lease directly and GMAC refuses to finance the residual purchase price.); In re Jackson, 105 B.R. 418 (Bankr. S.D. Ohio 1989); Blackburn v. Security Pac. Credit Corp. (In re Blackburn), 88 B.R. 273 (Bankr. S.D. Cal. 1988). See In re Wallace, 122 B.R. 222 (Bankr. D.N.J. 1990) (Filing of a Chapter 13 petition does not itself constitute the exercise of a purchase option contained in a lease. On lessor’s motion to compel debtors to assume or reject, court granted debtors 15 days to file a motion to assume or reject the lease, including a plan provision for exercise of the purchase option.).
35 In re Morgan, 181 B.R. 579, 588 (Bankr. N.D. Ala. 1994).