More Time to Make the Donuts: Court Holds Debtor-Franchisee Is Not Bound By the Deadline to Assume or Reject Nonresidential Real Property Leases

Print This Post Print This Post

Contributed by Doron P. Kenter.

Though the Bankruptcy Code is not entirely clear what constitutes an executory contract, section 365(d)(2) of the Bankruptcy Code provides that chapter 11 debtors generally have until plan confirmation to decide whether to assume or reject any such contracts.  However, in section 365(d)(4), a provision well-known to retail debtors, the Bankruptcy Code carves out nonresidential real property leases, providing that debtors have only 120 days (or up to 210 days, with the court’s permission) to determine whether to assume or reject such leases.  But what of nonresidential real property leases that are so interrelated with “ordinary” executory contracts that they constitute one integrated agreement?  Does the lease trump the contract? Or, does the debtor earn extra time to assume or reject the lease because of the symbiosis between the lease and the contract?

The Bankruptcy Court for the Eastern District of New York recently faced this very question, holding that franchisor-landlords necessarily lose the protections of section 365(d)(4) where they are parties to executory contracts that are entirely integrated with the underlying lease, and that debtors are accordingly not bound by the 120/210 day time limit for assumption or rejection of any such leases.

In In re FPSDA I, LLC, the debtors operated quick serve restaurant franchises (including Dunkin’ Donuts franchises), several of which were located on premises owned by Dunkin’ Brands.  For those stores, Dunkin’ Brands served as both the landlord and the franchisor for the franchises operating on those premises.  Each of the relationships between Dunkin’ Brands and the various franchisee-tenants was governed by both a lease and a franchise agreement, each of which contained various cross-default provisions.  The debtors initially had sought and obtained a 90-day extension of time within which they could assume or reject those leases.  Near the expiration of the 210 days prescribed by section 365(d)(4), the debtors filed a motion seeking either (i) a determination that the leases need not be assumed or rejected within the 210 day period or (ii) authorization to assume the leases without having to cure defaults under the franchise agreements.

First turning to the nature of the agreements, all parties agreed that because of the cross-defaults and other provisions in each Dunkin’ Brands lease and franchise agreement, each pair constituted one integrated agreement.  In other words, the two agreements were so “economically interrelated and interdependent” as to preclude either agreement from operating independently of the other.

The court then addressed the debtors’ suggestions that if they were required to assume the leases prior to confirmation, that they should only be required to cure any defaults under the lease and not those defaults arising under the franchise agreements, which they would not have had to assume at that point absent the deadline for assumption of the leases.  The court, relying on In re Szenda, 406 B.R. 574 (Bankr. D. Mass. 2009) and other established precedent, concluded that where a nonresidential real property lease is integrated with another executory contract, the debtor cannot assume the lease obligation without also curing the defaults under the related contract.

Turning to the central issue before it, the court then held that integrated agreement comprised of a nonresidential real property lease and another executory contract need not be assumed or rejected within the period prescribed by section 365(d)(4).  Looking to a similar situation in In re Harrison, 117 B.R. 570 (Bankr. C.D. Cal. 1990), the court noted that the Bankruptcy Code was designed “to allow the debtor an opportunity to effectuate a reorganization and to obtain some recovery for the benefit of all of the debtors’ [sic] creditors.”  If the deadlines imposed by section 365(d)(4) were to apply to the interrelated franchise agreements, there would be a loss of value to the debtor’s estate as a result of this premature deadline.  Instead, the court concluded that the debtors should be afforded the opportunity to develop a plan of reorganization, which would necessarily be contingent on the franchise agreements, which agreements, in turn, constituted the debtors’ most valuable assets and the core value provided in any reorganization.

Second, the bankruptcy court observed that if section 365(d)(4) were to apply to the franchise-lease agreement, the franchisor-landlord would be provided with a “superior power to determine the course and outcome of such debtor’s bankruptcy case th[a]n intended,” allowing the landlord to pressure the debtor to assume or reject the franchise agreement simply because it would refuse to extend the time to assume or reject the lease.  Accordingly, the bankruptcy court was unwilling to grant the landlord such great power over the outcome of the bankruptcy case by virtue of the portion of its relationship with the franchisee that was governed by the real property lease.

Lastly, the court noted that an assumption of the lease would necessarily require the debtor to cure all defaults under the franchise agreement, turning the franchisor-landlord’s unsecured claims into postpetition administrative expenses, thereby moving the franchisor ahead of all similarly situated unsecured creditors.  Because of the great power and advantages that would be afforded to such a landlord-franchisor, the bankruptcy court suggested that the decision whether to assume or reject such a “double agreement” should be made “with great consideration and with as much time as permitted under the Bankruptcy Code.”  Accordingly, the court held that section 365(d)(4) was inapplicable to the leases and franchise agreements and that the debtors were accordingly not compelled to assume or reject those agreements until plan confirmation.

As a result of the bankruptcy court’s decision, the landlord-franchisor’s bargained-for protections and advantages (i.e., the cross-defaults in the franchise agreements and in the leases) ultimately caused the landlord to lose rights and protections otherwise afforded to it under the Bankruptcy Code.  Do the bankruptcy court’s equitable considerations justify the outcome?  Is there a way to contract for the protections of integrated lease-franchise agreements while retaining one’s status as a nonresidential landlord upon the franchisee’s commencement of a bankruptcy case?  Let’s discuss over Dunkin’ Donuts coffee and crullers.