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Confusion About Section 365(b)(2)(D)

By Amy L. Boyd and Mark Shinderman
December 01, 2003

It is generally understood that bankruptcy law requires debtors to cure all contractual defaults before assuming any executory contract because debtors would receive a windfall without such requirement: They could assume (and compel performance on) contracts that they had breached without paying any resulting damages claim. If such a result were permitted under the Code, failing companies would have even less incentive to continue performing on contracts pre-petition because they could presumably seek to assume those contracts in bankruptcy without penalty. For this reason, Bankruptcy Code ' 365(b)(1) expressly provides that a debtor may only assume an executory contract if the debtor first:

  • cures, or provides adequate assurance that it will promptly cure any defaults under the contract;
  • compensates, or provides adequate assurance that it will promptly compensate, a party for any actual pecuniary loss resulting from such default; and
  • provides adequate assurance of future performance under the contract. 11 U.S.C. ' (b)(1).

Despite this well-understood and widely applied Code provision, the Bankruptcy Reform Act of 1994 modified Section 365 in such a way as to potentially eliminate the long-standing obligation to cure certain defaults in connection with the assumption of executory contracts. Specifically, Section 365(b)(2)(D) now provides that:

The requirements of Section 365(b)(1) do not apply to a default that is a breach of a provision relating to the satisfaction of any penalty rate or provision relating to a default arising from any failure by the debtor to perform nonmonetary obligations under the executory contract or unexpired lease relating to a default arising from any failure by the debtor to perform nonmonetary obligations under the executory contract or unexpired lease. 11 U.S.C. ' 365(b)(2)(D) (emphasis added).

Courts disagree as to the interpretation of this provision. Some read it in the conjunctive, as excusing the debtor's obligation to cure any penalty rate or penalty provision arising from a nonmonetary default. Others read it in the disjunctive, as excusing the debtor's obligation to cure either penalty rates or contractual provisions relating to nonmonetary defaults. If this latter interpretation is adopted, then Section 365(b)(2)(D) carves out a significant (and, from the debtor's perspective, extremely favorable) exception to Section 365's requirements for contract assumption — that is, it alleviates the debtor's burden of curing nonmonetary defaults when, for example, the time for performance under the contract has passed.

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