Fifth Circuit Holds That Assumption of a Real Property Lease Is Effective Upon Entry of an Agreed Order

The Big Easy.  A city overflowing with art, food, fun, and pride.  A place where you can experience the immensity and power of a hurricane (both the rum-based libation and the coastal weather event).  And home to one of the most popular travel destinations in the United States—the French Quarter.  In this installment of the Weil Bankruptcy Blog, we take you to Bourbon Street and review a decision of the Fifth Circuit Court of Appeals resolving a dispute between two companies regarding (fittingly) the assumption of a lease for a saloon on Bourbon Street.  In In re Bourbon Saloon, Inc., the Fifth Circuit considered the bankruptcy court’s authority to approve a debtor’s assumption of a lease that is subject to ongoing defaults by entering an agreed order, the language that must be included in such an order, and the timing of the assumption effected thereby. 
In 1997, Bourbon Saloon, Inc. entered into a 20-year lease with Absinthe Bar, LLC.  More than a decade later, after numerous defaults under the maintenance provisions of the lease, Absinthe Bar commenced eviction proceedings.  Shortly thereafter, Bourbon Saloon filed for bankruptcy protection and moved to assume the lease pursuant to section 365(b)(1) of the Bankruptcy Code.  Absinthe Bar objected, citing the continuing defaults.  The parties agreed to continue the motion to assume until after confirmation of Bourbon Saloon’s chapter 11 plan, which occurred nearly one year later.
Eventually, the parties negotiated an agreed order authorizing assumption of the lease.  The order provided, among other things, that (i) Bourbon Saloon had cured all monetary defaults; (ii) Bourbon Saloon had about seven months to cure all nonmonetary defaults; (iii) Absinthe Bar had been provided adequate assurance that such nonmonetary defaults would be cured; and (iv) the bankruptcy court retained jurisdiction to enforce the order.  After Bourbon Saloon failed to cure the outstanding defaults in accordance with the terms of the agreed order, Absinthe Bar filed a motion with the bankruptcy court to declare the lease rejected.  The bankruptcy court denied the motion, holding that the lease had been assumed pursuant to the agreed order and that Bourbon Saloon had substantially performed its obligations thereunder.  Absinthe Bar then appealed to the district court, which affirmed each of the bankruptcy court’s rulings.
Section 365(b)(1) of the Bankruptcy Code allows a debtor to assume a lease that is in default if the debtor (i) cures the default(s) (or provides adequate assurance that such defaults will be cured), (ii) compensates the lessor for losses resulting from such default(s) (or provides adequate assurance that it will do so), and (iii) provides the lessor with adequate assurance of future performance under the lease.  On appeal before the Fifth Circuit, Absinthe Bar argued that entry of the agreed order did not result in assumption of the lease because the order failed to address the requirements of sections 365(b)(1)(B) and (C)—whether Bourbon Saloon had provided adequate assurance of both its future performance under the lease and that Absinthe Bar would be compensated for its losses resulting from Bourbon Saloon’s defaults.
Although the Fifth Circuit agreed that all three requirements of section 365(b)(1) must be satisfied before a debtor is authorized to assume a lease that is in default, the court stated that assumption is often effected through court-approved agreed orders.  Moreover, the court explained that neither the Bankruptcy Code nor any prior decision required such an order to expressly address each of the elements of section 365(b)(1).  In fact, the court noted the only relevant case cited by Absinthe Bar involved a decision enforcing the assumption of a lease pursuant to an agreed order that failed to explicitly address the debtor’s obligation to cure prepetition defaults.  The court also reasoned that Absinthe Bar could have required all three conditions of section 365(b) to be satisfied prior to entering into the agreed order, but it failed to do so.  Accordingly, the Fifth Circuit rejected the notion that an agreed order must explicitly address each element of section 365(b)(1) in order to effectuate the assumption of a defaulted lease.
Absinthe Bar next argued that Bourbon Saloon’s failure to cure certain defaults by the deadline provided in the order prevented assumption of the lease.  In its analysis, the court applied general principles of contract interpretation and explained that interpreting the agreed order required consideration of both the express terms of the agreement and the surrounding circumstances.  In particular, the court focused on the following language:  “IT IS ORDERED that the Reorganized Debtor’s assumption of the Lease of the premises at 400 Bourbon is approved, subject to the terms of this Order, which provide Absinthe Bar with adequate assurance of cure as required by Section 365 of the Bankruptcy Code.”  The court rejected Absinthe Bar’s contention that the deadline imposed by the order to cure the defaults was a condition precedent to the assumption of the lease.  Instead, as the Fifth Circuit explained in its holding, “assumption occurred at the time the parties entered into the agreed order and…the remaining provisions of the order were conditions which Bourbon Saloon became legally obligated to meet under the supervision of the bankruptcy court.”
The decision serves as yet another of our frequent reminders about the importance of precision in drafting.  Absinthe Bar could have spelled out in the agreed order what the consequences would be of Bourbon Saloon’s failure to cure, but it did not do so.  It also could have provided that the lease would not be deemed assumed unless and until the nonmonetary defaults were cured, but it did not do so.  Having failed to take these measures, Absinthe Bar was left to pursue whatever remedies it had in state court.
Patrick Thompson is an Associate at Weil Gotshal & Manges, LLP in Houston.