Second Circuit holding: Assumption of Ground Lease doesn’t require cure payment to contractor

The appeal to the Second Circuit was made in connection with the bankruptcy filing of George Washington Bridge Bus Station Development Venture LLC (the “Debtor”), the redeveloper of the bus station owned by the Port Authority of New York and New Jersey (the “Port Authority”) located at the Manhattan end of the George Washington Bridge. The Debtor and Port Authority entered into a  contract in July 2011, agreeing that the Debtor was to manage and oversee the redevelopment project in exchange for a 99-year ground lease to operate and maintain the retail mall that was to be built on the redeveloped site (the “Ground Lease”). The Ground Lease provided that the Debtor was to hire contractors and subcontractors, including a general contractor, to work on the project.

In June 2013, the Debtor and Tutor Perini Building Corp. (“Tutor Perini”) entered into a construction contract (the “Construction Contract”) for Tutor Perini to act as general contractor of the project. However, after many years of disputes and arbitration with Tutor Perini regarding contested bills and missed deadlines on the redevelopment project, the Debtor filed for bankruptcy in October 2019. In its bankruptcy case, the Debtor sought to sell substantially all of its assets, including its rights in the Ground Lease.

Tutor Perini objected to the sale on the basis that the Debtor had failed to cure its approximately $113 million claim under the Construction Contract. Tutor Perini claimed the amount due under the Construction Contract constituted a default under the Ground Lease, and thus under § 365 of the Bankruptcy Code, the Debtor was unable to assign the Ground Lease until Tutor Perini’s “cure claim” was paid in full. The Debtor argued that Tutor Perini was not a party to the Ground Lease, and therefore was not owed any cure claim amount under Bankruptcy Code § 365(b)(1)(A).

The Second Circuit heard the case on appeal from the U.S. District Court for the Southern District of New York, which had affirmed the bankruptcy court’s ruling that Tutor Perini was neither entitled to a cure claim under the Ground Lease nor was it a third party beneficiary of the Ground Lease. The Second Circuit considered both issues.

First, the court determined whether the Debtor was required to “cure” Tutor Perini’s claim under the Construction Contract prior to assuming and assigning the Ground Lease. Under § 365(b)(1)(A) of the Bankruptcy Code, a debtor must cure any defaults prior to assuming an executory contract. These cure claims are provided administrative priority in the bankruptcy – resulting in their payment prior to all other claims against the debtor.

Tutor Perini argued that although it was not a party to the Ground Lease, it was entitled to assert a cure claim under § 365(b)(1)(A), as the text of the statute does not limit who may bring a cure claim. The court disagreed with this reading of the statute, holding that to “receive priority under § 365(b)(1)(A), a creditor asserting a default must have some right to pursue a breach of contract claim under the executory contract or unexpired lease a debtor assumes under § 365(a).” The court believed that allowing non-parties to seek payment under a contract would result in creditors receiving an “unjustified windfall” as non-parties to a contract have no “relevant bargain with the debtor and owes the debtor no performance under that contract.”

The court also addressed Tutor Perini’s argument that it was a third party beneficiary of the Ground Lease, and therefore entitled to assert a cure claim. The court considered whether Tutor Perini qualified as an intended third party beneficiary under New York state law, on the basis that the Ground Lease states that the Debtor was required to make payments to the contractors and subcontracts hired by the Debtor to complete the project. The court found that this obligation in the Ground Lease simply allocated payment responsibilities to the Debtor, instead of the Port Authority, rather than creating a promise by the Debtor to perform any obligation for the benefit of any contractor, including Tutor Perini. Further, the Ground Lease specified certain third party beneficiaries, but did not list Tutor Perini as one of these beneficiaries. These facts taken together indicated that Tutor Perini was not a third party beneficiary under the Ground Lease, and therefore not entitled to any cure payment on that basis.

The Second Circuit’s ruling makes clear that only parties who have a direct contractual relationship with the debtor through the executory contract to be assumed are entitled to cure payments under Bankruptcy Code § 365(b)(1)(A). Entities whose damages are incidental to the assumed contract will only be treated as a general unsecured creditor. This is particularly important in the New York real estate market where project developments are often structured as ground leases, and both developers and contractors should be aware of the potential negative treatment available for unpaid claims of contractors notwithstanding the ability to assume and assign the ground lease.

Authored by John Beck and Katherine Lynn.