October 2, 2020

Leases and Executory Contracts.

The Act also vests receivers with significant new powers relating to existing leases and executory contracts which provides another possible benefit for lenders from a receivership.  A receiver may “adopt or reject an executory contract,” which includes leases under the definition of “executory contract” in Section 33-2601(4), with court approval.   The court may require the receiver to agree to “terms appropriate under the circumstances” with the counterparty to the contract as a condition to the adoption of the agreement.  A.R.S. §33-2616(A). 

Ipso facto provisions (terms that purport to terminate or void the contract upon the appointment of a receiver or the insolvency of the owner) do not affect the receiver’s ability to adopt the agreement. A.R.S. §33-2616(C).

Significantly, the Arizona legislature did not incorporate a provision in UCRERA §17(b) that requires a receiver to seek court approval to adopt or reject a contract “within a reasonable time”.  Therefore, there is no statutory time frame in which the receiver must decide to adopt a contract in the Act.  Any lender which requests the receiver’s appointment certainly will want to see contracts adopted or rejected prior to any sale so it is able to ensure any potential buyers what they will be receiving and, thereby, maximize the potential sale price.

A receiver may assign a contract if the owner had a right to assign it on the date the receiver was appointed.  A.R.S. §33-2616(E).   Contracts such as a personal services agreement, for example an agreement to paint a portrait, are not assignable under prevailing law and, thus, may not be assigned by a receiver.

If a receiver rejects a contract, it constitutes a breach of the agreement as of the time of the receiver’s appointment and she is no longer entitled to possession or use of any property covered by that agreement and the counterparty has a claim for damages. A.R.S. §33-2616(C).   

Of great significance are the limitations on the right of a receiver to reject leases where the owner is a landlord of real property and the tenants occupy the property as their primary residences.   A receiver may not reject a tenant’s lease of a residence if:

(1)       The receiver was appointed by a person other than the holder of a deed of trust on that property; OR

(2)       The receiver was appointed by a lender holding a deed of trust on the property and either:

  1. ALL of the following are true
    • The lease is superior to the lender’s lien;
    • The tenant has an enforceable non disturbance agreement with the lender;
    • The lender has consented to the lease; OR
  2. On the date the owner entered into the lease its terms were commercially reasonable and the tenant did not actually know or have reason to know that the lease violated the terms of the deed of trust. 

A.R.S. §33-2616(G). 

Therefore, a receiver may reject leases in an apartment building or other residential property under Section 33-2616(G)(2)(b) only if the terms of those leases were significantly below market on the date they were signed or the tenants had constructive knowledge that the leases violated the terms of the deed of trust. 

Significantly, similar limitations do not exist on a receiver’s power to reject leases of commercial real estate.  Accordingly, a receiver over a strip mall or office building may reject any leases of spaces in such a property which are under market rent on the date of the proceeding even if the leases were commercially reasonable on the date they were signed.   This promises be a substantial benefit to a lender where the commercial property is encumbered by long term below market leases.    Tenants who believe they have locked in the benefits of long term commercial leases may be forced to renegotiate with the receiver or make plans to move.

Any person looking to the comments to UCRERA §17 for guidance in interpreting its analog in the Act must do so with great care.   The actual language in subsection (G) of Section 33-2616 differs significantly from the terms of §17(h) of UCRERA which appears to provide far broader restrictions on the rejection power than exist in the Act.  The author has not been able to find any explanation in the legislative history for these differences.

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