The following is a case update written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, CD CA, ret.), analyzing a recent decision of interest:

The United States District Court for the Southern District of New York (the “Court”) recently affirmed a bankruptcy court decision which held that a third party had no rights to assert a “cure claim” under the provisions of Bankruptcy Code section 365(b)(1), which allows a debtor to assume an executory contract upon a “prompt cure” of any defaults which existed at the time of assumption. The counterparty had agreed to waive the cure in order for the debtor to assume the contract without it. In re George Washington Bridge Bus Station Development Venture, LLC, 2021 WL 3403590 (S.D. NY, August 4, 2021).

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FACTS

George Washington Bridge Bus Station Development Venture LLC, debtor, is the developer on an approximately $183 million project to renovate and improve a Port Authority bus station at the end of the George Washington Bridge. In 2011 the debtor and the Port Authority formed a public-private venture to improve the bus terminal and build a large retail mall. This venture was memorialized by a ground lease which obligated the debtor to arrange for the necessary renovations on the bus station. In turn, the Port Authority promised a monetary contribution toward the costs of construction and, as landlord, allowed the debtor the rights to operate and manage the retail center for 99 years. Under the ground lease, the debtor would retain a general contractor for the construction work and would be responsible for paying the contractor. The Port Authority would not be responsible for any costs of construction.

In 2013 the debtor and Tutor Perini Building Corp. (the “Contractor”) entered into a construction contract. During the course of the construction, disputes and delays arose between the debtor and the Contractor which ended up in counterclaims in an arbitration proceeding, with the Contractor asserting it was owed $133 million in damages. Although the project opened in 2017, the cost overruns caused the debtor to file a chapter 11 proceeding in 2019. The debtor’s proposed plan for reorganization was based on a sale of its assets, the most valuable of which was the ground lease. The desire to sell the ground lease triggered the need to assume it under section 365(a), then assign it to the buyer. Normally assumption would require the debtor to cure defaults under the lease (section 365(b)(1)(A)), which in this instance was the necessity for the debtor to pay the $113 million claimed due to the Contractor. However, after negotiations, the Port Authority agreed to waive its cure claim and allow the sale. The debtor and the Port Authority jointly asked the bankruptcy court to approve their settlement under Bankruptcy Rule 9019.

The Contractor filed the only objection to the compromise, asserting that the settlement could not prevent it from asserting its own right to a cure claim. It asserted two theories as to why it was entitled to demand that the debtor cure its alleged default: (1) it was a third-party beneficiary of the ground lease with rights to enforce it; and (2) if not a third-party beneficiary, the statute itself did not limit what parties could assert a cure claim and its economic interest in the cure gave it standing to do so.

The bankruptcy court rejected those arguments and approved the assumption without the cure. The Contractor appealed that ruling to the Court, which affirmed.

REASONING

The Court addressed the Contractor’s theories separately. First, it ruled that it was not a third-party beneficiary, based on the language in the ground lease. To be a third-party beneficiary under New York law a binding contract must have been “intended for the third party’s benefit” and that benefit must be “sufficiently immediate to indicate the assumption by the contracting party of a duty to compensate the third party if the benefit is lost.” Looking at the language in the ground lease, the Court concluded that the parties did not intend it to confer an enforceable benefit on the Contractor because, among other things, it did not name the Contractor nor a general contractor in the abstract, whereas it did specifically name other parties (such as subtenants) as such beneficiaries. Also, the ground lease had specific provisions that the Port Authority would have no obligations or liabilities in connection with performance of the construction project, which reinforced that the Contractor had no enforceable rights.

On the second assertion—that because of its economic interest the Contractor was allowed to assert the cure claim because section 365(b)(1)(A) contained no express limitation on who could bring the claim—the Court ruled that a coherent statutory scheme demanded that only the party entitled to the cure should have a right to demand it. Of importance to the Court was the fact that the cure provisions gave the counterparty to an executory contract a priority right to payment not accorded to other unsecured creditors. It found that this specific exception to the order of priority makes sense, because the contract sought to be assumed would be a valuable asset of the estate. To get the full value of that asset, the debtor must pay for it—i.e., cure the priority claim. Therefore, only the counterparty is entitled to that priority payment, not some other party with an economic interest in the outcome.

AUTHOR’S COMMENTS

This has to be the right decision. The third-party beneficiary argument turned on state law and interpretation of the contract and the parties’ intent, which are well explained by the Court. The limitation on section 365(b)(1)(A)’s impact has broader significance. The Court correctly observed that the counterparty’s right to cure upon assumption of an executory contract is a priority of payment issue, moving that creditor ahead of many others in a bankruptcy proceeding. That priority is properly based on the need to preserve the valuable asset for the estate, a right which must be paid for promptly. To allow others to achieve that same priority status is inconsistent with the distribution scheme. Section 365(b)(1) should be read narrowly, as the Court here did.

These materials were authored by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, a member of the ad hoc group, with editorial assistance by Meredith Jury, (bankruptcy judge, C.D. Cal. (Ret.)), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.