Spanish Peaks: What Happens When Leases Collide with a Bankruptcy Sale?

July 5, 2018

Nicholas A. Binder
Michigan State University College of Law; East Lansing, Mich.

 

Editor’s Note: The following article, “Spanish Peaks’ Reinvigoration of the Precision Industries Debate: Rejection in the Context of a § 363 Sale Free and Clear of Commercial Leasehold Interests” won the prize for third place in the Tenth Annual ABI Bankruptcy Law Student Writing Competition. Mr. Binder is a third year student at Michigan State University College of Law in East Lansing, Michigan. In the summer of 2017, he served as a Judicial Extern in Judge David McKeague's chambers at the United States Court of Appeals for the Sixth Circuit and as a Research Extern at the Michigan Court of Appeals. This summer, Nicholas will be a summer associate at Kirkland & Ellis in Chicago. Thank you to Jenner & Block for sponsoring this prize.

In the summer of 2017, the Ninth Circuit addressed whether §§ 363 and 365 of the Bankruptcy Code conflict when a trustee proposes a § 363 sale free and clear of an unexpired commercial lease without first rejecting it.[1] Section 363(f) of the Code allows the trustee to sell property of the estate free and clear of interests if certain conditions are met.[2] Section 365(h) allows the trustee to reject an unexpired lease on a debtor-lessor’s real property.[3] However, the Code does not define “rejection.[4] If the trustee rejects an unexpired lease, then the lessee may retain its appurtenant possessory rights in the property for the balance of the lease term.[5] Intuitively, an attempt to sell free and clear of an unexpired lease seems like rejection.[6] But courts reject common intuition when they decide how the Code contemplates rejection.[7]

Historically, the majority of courts that have addressed the matter have interpreted §§ 363 and 365 to conflict when a trustee attempts to sell property of the estate free and clear of a lease without explicitly rejecting it first.[8] In these cases, the majority of courts give more credence to § 365(h) than § 363(f).[9] Courts justify allowing § 365(h) to trump § 363(f) for three reasons. First, courts look to a maxim of statutory interpretation in which specific language prevails over general language when statutory provisions conflict.[10] Under this logic, § 365(h) governs because it is more specific than § 363(f).[11] Second, courts interpret legislative history to indicate that Congress intended greater protection for tenants in the event of a landlord’s bankruptcy.[12] Third, courts express concern for the nugatory impact on § 365(h) protections if a sale under § 363(f) could wipe them out.[13] Interestingly, the only two circuit courts that have addressed whether the sections conflict held that they did not.[14]

In 2003, the Seventh Circuit was the first circuit court to address this issue in Precision Industries Inc. v. Qualitech Steel SBQ LLC.[15] The Seventh Circuit concluded that the provisions in § 365(h) do not trump the provisions in § 363(f).[16] The court distinguished between a situation in which the trustee rejects the lease, implicating § 365, and a situation in which the trustee sells the property, implicating § 363.[17] After Precision Industries, many commentators chimed in on the § 363 vs. § 365 conundrum. Academics typically analyzed the sections in light of their legislative history and purpose and proposed new statutory language.[18] One academic outspokenly criticized the Seventh Circuit’s holding and reasoning.[19] Practitioners provided numerous practice recommendations in light of the Seventh Circuit’s decision.[20] Fourteen years later, the Ninth Circuit faced the same question in In the Matter of Spanish Peaks Holdings II LLC.[21] The court in Spanish Peaks found no conflict because the trustee did not reject the lease before the sale and thus did not trigger § 365.[22]

However, §§ 363(f) and 365(h), despite not being cross-referenced in the Code, in fact govern in tandem without conflict even if the court construes a proposed sale free and clear as a rejection.[23] The situation in which a trustee rejects a lease and subsequently proposes a § 363 sale should be treated the same as the situation in which a trustee proposes a sale in the absence of an affirmative rejection. Dishi & Sons v. Bay Condos LLC demonstrated that reconciling §§ 363 and 365 is not an insurmountable task.[24] Regardless of what approach courts take, there are definitive courses of action that practitioners must take.

 

Construing Rejection Constructively

When a trustee proposes a § 363 sale, courts should construe it as a rejection.[25] While the constructive rejection would trigger § 365 rights, the court should subject these rights to all relevant provisions in the Code.[26] In the case of a sale, § 363 is the relevant provision and must be given full effect.[27] Congress may have intended to protect lessees when it provided them with the right to retain their possessory interest via § 365(h);[28] however, Congress did not intend to give lessees more protection than that afforded outside of bankruptcy.[29]

Because the Code does not define “rejection,”[30] courts should define it based on its plain meaning,[31] in a manner that best adheres to congressional intent.[32] Furthermore, the Code’s provisions should be interpreted in a way that avoids conflict and gives each provision full effect.[33]

The Code does not automatically deem a trustee’s failure to assume an unexpired commercial lease a rejection.[34] Unlike with an unexpired residential real property lease in chapter 7, if the trustee does nothing, the unexpired lease of commercial real estate is not rejected.[35] The trustee must affirmatively act[36] when proposing a § 363 sale; no sale takes place without the trustee’s action.[37] The Seventh Circuit in Precision Industries called this affirmative act “repudiation” rather than “rejection.”[38] Yet this reasoning fails analysis, and Michael Baxter’s proclamation that a proposed sale is tantamount to rejection is true, [39] even if it amounts to a distinction without a difference.

The Merriam-Webster dictionary defines rejection as “to refuse to accept.”[40] Black’s Law Dictionary defines “assume or reject” as “to make an election under the Bankruptcy Code concerning an executory contract or an unexpired lease.”[41] A trustee’s proposal to sell property free and clear of a lease is a clear indication that the trustee has elected to not assume the lease.[42] This action by the trustee should be constructively considered a rejection under the plain meaning of the word in § 365(h).[43] Furthermore, nothing in § 365(h) indicates that Congress intended to prevent constructive rejections.[44] Nevertheless, whether a proposed free-and-clear sale is in fact a rejection is a moot point because the Spanish Peaks, Precision Industries and Dishi & Sons courts share the same analytical framework. Courts, by interpreting a proposed § 363 sale as distinct from rejection, merely circumvent the need to interpret the perceived conflict between §§ 363 and 365.[45] Such maneuvering is unnecessary if courts construe a proposed sale as a rejection and give both provisions full effect, as the court in Dishi & Sons did.

 

Dishi & Sons Framework

The Dishi & Sons court faced a factual scenario in which the trustee both rejected an unexpired lease and proposed a free-and-clear sale.[46] The court had no choice but to resolve the seemingly conflicting provisions.[47] The Dishi & Sons court reconciled the provisions by interpreting the Code straightforwardly and provided a framework that harmonizes §§ 363(f) and 365(h).[48]

Under the framework, the lessee’s appurtenant rights survive rejection pursuant to § 365(h) and must be considered in a free-and-clear sale pursuant to § 363(f).[49] The framework is logical and preserves the trustee’s ability to maximize the value of the estate. Section 365(h) permits the lessee to retain its appurtenant rights when the trustee rejects the lease.[50] The trustee may then extinguish these appurtenant rights in a § 363(f) sale if one of the § 363(f) conditions is satisfied.[51] Section 365(h) does not mandate the survival of a lessee’s rights when § 363(f) authorizes a free-and-clear sale.[52] There is nothing in § 365(h) that would prohibit a trustee from extinguishing the lessee’s rights if another provision in the Code provided the trustee with such power.[53] Nor does anything in § 365(h) give the lessee rights above the trustee.[54] Simply, the trustee can extinguish a lessee’s appurtenant rights because § 363(f) provides the power.[55]

Ultimately, the district court in Dishi & Sons affirmed the bankruptcy court’s decision to preserve the lessee’s rights.[56] However, the court declined to do so pursuant to § 365(h).[57] It found that the lessee was entitled to retain its appurtenant rights because its lease was rejected pursuant to § 365(h),[58] but it subjected those rights to extinguishment in a § 363(f) sale.[59] Since none of five § 363(f) provisions were met and the lessee sought adequate protection under § 363(e) in the alternative, the Dishi & Sons court permitted the lessee’s continued possession.[60]

The Dishi & Sons framework harmonizes §§ 363(f) and 365(h) by permitting the lessee to retain its appurtenant possessory rights in the event of a rejection subject to extinguishment in a free-and-clear sale.[61] The framework also honors the lessee’s right to seek adequate protection, which must be granted.[62] However, under this framework, the court has discretion within its equitable powers to determine what constitutes necessary adequate protection.[63]

 

Practitioner Points

Regardless, practitioners must act appropriately to ensure that their clients’ interests are being protected. By exercising appropriate business and professional judgment,[64] the trustee decides which, if any, executory contracts and unexpired leases to assume or reject.[65] The trustee also determines which, if any, property to use, sell or lease[66] in order to maximize the value of the estate, which fulfills the trustee’s fiduciary obligation.[67]

In the event of a landlord debtor, the trustee should sell property of the estate without the burden of an uneconomical commercial lease.[68] The trustee must be aware of whether the relevant jurisdiction perceives a conflict between §§ 363 and 365 and how the court will resolve any perceived conflict. If the court in the relevant jurisdiction adheres to the majority viewpoint, then all the trustee can do is argue that the Dishi & Sons framework should be applied because it gives effect to all provisions within the Code.

Regardless, the trustee should be careful to not reject an unexpired lease and motion for a free-and-clear sale pursuant to § 363(f).[69] The trustee need not be so cautious if the court applies the Dishi & Sons framework. However, in the absence of an objection from the lessee, a court that construes a proposed free-and-clear sale as being distinct from rejection will permit the termination of the lessee’s interest if at least one of the § 363(f) provisions is met.[70] Additionally, the court may construe a failure to object as consent, thus satisfying § 363(f)(2).[71]

A lessee may take several steps to protect its interest.[72] The court in Spanish Peaks determined that the trustee could sell the property free and clear of the lease pursuant to § 363(f)(1) because a foreclosure sale under applicable state law would terminate the lease.[73] The bankruptcy court in Precision Industries also permitted a sale free and clear of the lessee’s leasehold interest.[74] The applicable priority statute and foreclosure law allowed for the termination of the lease because it was unrecorded and subordinated by two prior mortgages.[75] Therefore, a lessee should preserve its possessory rights in the event a mortgagee forecloses on its landlord.[76]

In order to preserve its possessory rights, a lessee must first record its lease at the time the lessee enters into it, which ensures that the law recognizes it and protects it from a subsequent bona fide purchaser.[77] The lessee in Precision Industries did not record its lease, which was therefore an unrecognized interest under applicable state law.[78] However, even if the lessee in Precision Industries had properly recorded its lease, its interest would be subordinate to the existing mortgages.[79] In addition to recording its lease, a lessee should seek a Subordination, Nondisturbance and Attornment Agreement (SNDA) with any existing mortgagees.[80] An SNDA protects the lessee because it ensures that creditors do not disturb the lessee’s property rights upon the occurrence of conditions beyond the lessee’s control, such as a landlord’s default and foreclosure.[81] In an economically favorable lease agreement, a lender would not likely object because the value of the property is enhanced.[82] A lessee that records its lease and obtains an SNDA protects its possessory rights from being extinguished pursuant to § 363(f)(1) when a foreclosure sale would otherwise extinguish them.[83]

Second, the lessee must object to the sale and argue that the trustee’s proposed sale is, in effect, a rejection, to which the lessee asserts its appurtenant rights pursuant to § 365(h).[84] In doing so, the lessee forces the trustee to declare whether or not it is assuming or rejecting the lease.[85] A lessee that asserts its § 365(h) rights to continued possession forces the court to consider whether §§ 363 and 365 conflict.[86] However, the point is moot under the Dishi & Sons framework because it would allow a § 363 sale to extinguish § 365 possessory rights as if those rights had been assumed.[87]

Third, the lessee must object to the sale and argue that none of the five § 363(f) provisions are satisfied.[88] The lessee in Precision Industries did not object when the trustee proposed the § 363 sale.[89] Sure, the court may still determine that a § 363(f) provision is met, but a court that perceives a lessee’s failure to object as consent will certainly allow the extinguishment of a lessee’s rights under § 363(f)(2).[90] A lessee may not sit on its rights and expect the court to protect them.[91]

Fourth, even if the court authorizes a § 363 sale, a lessee should actively seek adequate protection in order to protect its interest in continued possession.[92] The court must provide some form of protection to an entity that seeks adequate protection and has a valid interest in the property to be sold.[93] The court may provide adequate protection in the form of a prohibition or conditions on the sale.[94] Adequate protection may take the form of continued possession if required to realize the indubitable equivalent of the leasehold interest.[95] Adequate protection may also take the form of cash remuneration to the extent that the seeking entity’s interest is reduced.[96] Courts use their discretion in determining what constitutes adequate protection, which is an equitable remedy.[97] The lessee in Precision Industries did not seek adequate protection.[98] The lessee in Dishi & Sons actively sought and received adequate protection in the form of continued possession.[99] An excellent example of a lessee successfully asserting its rights is found in In re Revel AC Inc., [100] in which the lessee objected, arguing that § 365 gave it the right to retain its possessory interest, that the trustee could not satisfy any of the five § 363(f) conditions, and in the alternative that it was entitled to adequate protection.[101]

Whether the trustee explicitly rejects the lease or proposes a § 363 sale, the lessee must act with vigilance.[102] The lessee, with a perfected leasehold interest and SNDA agreement, must object and assert its § 365(h) possessory rights.[103] In addition, a diligent lessee may protect its possessory interest without using § 365(h) by arguing that none of the five § 363(f) provisions are met and by seeking adequate protection.[104] The court will reward a diligent lessee with a valid possessory interest, especially when the court’s equitable powers under § 363(e) are preserved and it need not creatively construe rejection.[105]

 

Conclusion

In sum, for simplicity sake, courts should deem a trustee’s proposal of a § 363 sale a rejection that implicates § 365(h) rights, which may be extinguished if the conditions for a § 363 sale are met and adequate protection is not warranted or sought. Practitioners must be vigilant and follow appropriate steps to protect the interests of their clients.

 

[1] In the Matter of Spanish Peaks Holdings II, No. 15-35572, 2017 WL 4156370, at *5 (9th Cir. Sept. 12, 2017).

[2] 11 U.S.C. § 363(f) (2012). Under § 363(f), the trustee may sell property of the estate free and clear of a leasehold interest if “applicable nonbankruptcy law permits [the sale];... the entity consents;... such interest is in bona fide dispute; or [the lessee] could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.” Id.

[3] Id. § 365(h).

[4] See Collier on Bankruptcy  365.10 (Alan N. Resnick & Henry J. Sommer eds., 16th ed.).

[5] 11 U.S.C. § 365(h)(1)(A)(ii) (2012).

[6] See Spanish Peaks, 2017 WL 4156370, at *5.

[7] Id. (declaring that a “sale of property free and clear of a lease may be an effective rejection of the lease in some everyday sense, but it is not the same thing as the ‘rejection’ contemplated by [§] 365”).

[8] Id. at *4.

[9] Id.

[10] In re Churchill Props. III Ltd. P’ship, 197 B.R. 283, 288 (Bankr. N.D. Ill. 1996).

[11] Spanish Peaks, 2017 WL 4156370, at *4.

[12] See In re Taylor, 198 B.R. 142, 165-66 (Bankr. D.S.C. 1996).

[13] In re Churchill Props., 197 B.R. at 288 (basing its conclusion on fact that “Code is not meant to be read in a vacuum”). The court applied § 365(h) despite a free-and-clear sale in which § 363(f)(1) was satisfied and permitted the lessee to retain possession. Id.

[14] See Precision Indus. Inc. v. Qualitech Steel SBQ LLC, 327 F.3d 537, 548 (7th Cir. 2003); Spanish Peaks, 2017 WL 4156370, at *5 (holding there was no conflict between the provisions on the facts of the particular case).

[15] 327 F.3d at 548.

[16] Id. at 547.

[17] Id.

[18] See, e.g., Robert M. Zinman, Precision in Statutory Drafting: The Qualitech Quagmire and Sad History of 365(h) of the Bankruptcy Code, 38 J. Marshall L. Rev. 97, 167-69 (2004); Daniel J. Ferretti, Eviction Without Rejection — The Tenant’s Bankruptcy Dilemma: Bankruptcy Code Sections 363(f) and 365(h)(1)(A) and the Divergent Interpretations of Precision Industries, Inc. v. Qualitech Steel SBQ, LLC and In re Haskell, 39 Cumberland L. Rev 707, 715 (2009).

[19] See Michael St. Patrick Baxter, Section 363 Sales Free and Clear of Interests: Why the Seventh Circuit Erred in Precision Industries v. Qualitech Steel, 59 Bus. Law. 475, 477 (2004) (stating that the “Seventh Circuit rendered a substantively flawed decision”).

[20] See, e.g., Joshua Stein, “Did the Sky Fall on Leasehold Mortgagees? Ground Lease Financing After Qualitech,” 25 Practical Real Est. Law. 7, 8 (2009); Patrick A. Jackson & Ian J. Bambrick, “Debunking the Perceived Conflict Between §§ 365(h) and 363(f),” Am. Bankr. Inst. J., Oct. 2014, at 91-92.

[21] 2017 WL 4156370 at *5.

[22] Id.

[23] See Dishi & Sons v. Bay Condos LLC, 510 B.R. 696, 699 (S.D.N.Y. 2014) (providing consistent framework for handling proposed free-and-clear sale after a rejection triggered § 365 rights).

[24] Id.

[25] Baxter, supra n. 19. Baxter made this proposition in order to argue that § 365(h) rights should be retained in spite of free-and-clear sales. Id. at 482, 486.

[26] United States v. Menasche, 348 U.S. 528, 538-39 (1955) (stating that courts must “give effect, if possible, to every clause and word of a statute”).

[27] See 11 U.S.C. § 363 (2012); Dishi & Sons 510 B.R. at 698.

[28] In re Taylor, 198 B.R. 142, 165-66 (Bankr. D.S.C. 1996).

[29] See James H. Millar, “Fixing the Qualitech Problem by Revising § 365,” 6 Am. Bankr. Inst. J. 36, 82 (2012); In re MMH Auto. Grp. LLC, 385 B.R. 347, 366 (Bankr. S.D. Fla. 2008) (holding that lessor’s “bankruptcy did not confer any greater legal rights on [the lessee] under the [lease] or applicable non-bankruptcy law”). The MMH court also articulated that § “365(h) preserves certain tenant rights; it does not enhance them.” Id.

[30] See Precision Indus. Inc. v. Qualitech Steel SBQ LLC, 327 F.3d 537, 544 (7th Cir. 2003).

[31] Moskal v. United States, 498 U.S. 103, 108 (1990) (stating that court looks to language of a statute in order to determine its scope, and court gives words of the statute their ordinary meaning); Precision Indus., 327 F.3d at 544 (articulating that court construes words in a statute “according to their ordinary, common meaning”).

[32] United States v. Am. Trucking Ass’ns, 310 U.S. 534, 542 (1940) (stating that function of courts is “to construe [statutory] language so as to give effect to the intent of Congress”).

[33] Watt v. Alaska, 451 U.S. 259, 267 (1981) (stating that court must “read the statutes to give effect to each if [the court] can do so while preserving their sense and purpose”); Corley v. United States, 556 U.S. 303, 314 (2009) (stating that a statute “should be construed so that effect is given to all its provisions, so that no part will be inoperative or superfluous”).

[34] See Christopher C. Genovese, “Precision Industries v. Qualitech Steel: Easing the Tension Between Sections 363 and 365 of the Bankruptcy Code?,” Real Prop. Prob. & Tr. J. 627, 717 (2004).

[35] 11 U.S.C. § 365(d)(1) (2012) (stating that in chapter 7, trustee’s failure to assume or reject unexpired residential lease within 60 days amounts to rejection).

[36] See Zinman, supra n. 18 at 118.

[37] See 11 U.S.C. § 363 (2012) (permitting trustee to engage in affirmative use, sale or lease of property).

[38] Precision Indus. Inc. v. Qualitech Steel SBQ LLC, 327 F.3d 537, 547 (7th Cir. 2003).

[39] See Baxter, supra n. 19 at 486 (proclaiming that the Seventh Circuit’s reasoning was flawed).

[40] Reject, Merriam-Webster Dictionary, available at https://www.merriam-webster.com/dictionary/rejecting (last visited Feb. 7, 2018).

[41] Assume or Reject, Black's Law Dictionary (10th ed. 2014).

[42] Baxter, supra n. 19 at 486. Baxter’s pronounced that the “plain meaning of ‘reject’ in § 365 should include a sale free and clear of the leasehold interest if the effect of the sale is to repudiate the lease.” Id.

[43] Id.

[44] See id. (stating that the “plain language of § 365(h) does not manifest an intent to exclude deemed or implied rejections, and there is no compelling reason why this artificial distinction should be made”).

[45] See, e.g., In the Matter of Spanish Peaks Holdings II, No. 15-35572, 2017 WL 4156370, at *5 (9th Cir. Sept. 12, 2017). The Ninth Circuit’s decision to interpret the meaning of a § 365(h) rejection differently than the plain meaning of the word ensured the preservation of its equitable powers.

[46] Dishi & Sons v. Bay Condos LLC, 510 B.R. 696, 699 (S.D.N.Y. 2014).

[47] Id. at 704.

[48] See id. at 699-702; see also Jackson & Bambrick, supra n. 20 at 92 (asserting that Dishi & Sons court’s ability to reconcile the provisions demonstrated that conflict between §§ 363 and 365 was merely perceived).

[49] Dishi & Sons, 510 B.R. at 699.

[50] Id. at 698-99.

[51] Id. at 699.

[52] Id.

[53] Id. at 707 (stating that “nothing in § 365(h) — which simply preserves the lessee’s appurtenant rights in the event of rejection — precludes the trustee from terminating such rights if so empowered under another provision of the Code”).

[54] Id. at 698. The court reiterated that § 365(h) “does not grant the lessee special rights; it protects the lessee’s existing appurtenant rights in the event that the trustee exercises its rejection power. § 363(f), in turn, authorizes the trustee to sell property free and clear of any interest, including the lessee’s appurtenant rights, but only if one of its five grounds permits extinguishment of such rights.” Id. at 707.

[55] Id. See also In re MMH Auto. Grp. LLC, 385 B.R. 347, 366 (Bankr. S.D. Fla. 2008) (stating that “[t]here is nothing in [§] 365(h) that prohibits a debtor/landlord from selling property in which there is a tenant in possession, whether that tenant is in possession by virtue of a lease that has been assumed or a lease that has been rejected”).

[56] Dishi & Sons, 510 B.R. at 707.

[57] Id.

[58] Id. at 708.

[59] Id.

[60] Id. at 710, 711-12. Furthermore, the court refused to allow a foreclosure sale to satisfy § 363(f)(1). Id. at 710.

[61] See id. at 698 (stating that § 365(h) “is applicable to § 363(f) sales, [but] it does not give the lessee absolute rights that take precedence over the trustee’s right to sell free and clear of interests”).

[62] 11 U.S.C. § 363(e) (2012) (stating that “[o]n request of an entity that has an interest in the property ... the court ... shall prohibit or condition [the] sale ... as necessary to provide adequate protection of such interest”) (emphasis added).

[63] See, e.g., Dishi & Sons, 510 B.R. at 712. The court determined that continued possession was necessary to adequately protect the lessee’s interest. Id.

[64] 11 U.S.C. § 704 (2012) (outlining duties of chapter 7 trustee); id., § 1106(a) (stating duties of chapter 11 trustee). Handbook for Chapter 7 Trustees, U.S. Dept’ Just., available at https://www.justice.gov/ust/handbook-chapter-7-trustees (last visited Jan. 27, 2018) (providing that “goal of the United States Trustee is to establish a system that allows for the complete, economical, equitable and expeditious administration of chapter 7 cases, while allowing the trustee to exercise appropriate business and professional judgment in performing the trustee's fiduciary duty”).

[65] See generally 11 U.S.C. § 365 (2012) (stating what trustee may do regarding executory contracts and unexpired leases).

[66] See generally id., § 363 (stating what trustee may do regarding use, sale or lease of property).

[67] Commodity Futures Trading Comm’n v. Weintraub, 471 U.S. 343, 352 (1985).

[68] See, e.g., Precision Indus. Inc. v. Qualitech Steel SBQ LLC, 327 F.3d 537, 540-41 (7th Cir. 2003) (stating that lessee’s rent was a nominal $1 per year); In the Matter of Spanish Peaks Holdings II, No. 15-35572, 2017 WL 4156370, at *1, 2 (9th Cir. Sept. 12, 2017) (highlighting that the leases were well below fair market value).

[69] See Precision Indus., 327 F.3d at 547 (determining that rejection amounts to repudiation); Spanish Peaks, 2017 WL 4156370, at *5-6 (determining that proposed sale in absence of rejection does not activate lessee’s § 365(h) rights).

[70] See Precision Indus., 327 F.3d at 541 (mentioning that Precision never objected to the Sale Order).

[71] Some courts have held that failure to object amounts to consent to the sale. See, e.g., FutureSource LLC v. Reuters Ltd., 312 F.3d 281, 285 (7th Cir. 2002); In re James, 203 B.R. 449, 453 (Bankr. W.D. Mo. 1997); In re Shary, 152 B.R. 724, 725-26 (Bankr. N.D. Ohio 1993).

[72] See, e.g., In re Revel AC Inc., 802 F. 3d 558, 562 (3d Cir. 2015).

[73] Spanish Peaks, 2017 WL 4156370, at * 6.

[74] Precision Indus. Inc. v. Qualitech Steel SBQ LLC, 2001 WL 699881, at *10 (S.D. Ind. Apr. 24, 2001), rev’d, 327 F.3d 537 (7th Cir. 2003).

[75] Id.

[76] See 11 U.S.C. § 363(f)(1) (2012) (allowing trustee to sell property free and clear of any interest if permitted under applicable nonbankruptcy law).

[77] See Stein, supra n. 20.

[78] Precision Indus., 2001 WL 699881, at *10.

[79] Id.

[80] See James H. Millar, “Fixing the Qualitech Problem by Revising § 365,” 6 Am. Bankr. Inst. J. 36, 37 (2012). Millar recommends obtaining an SDNA as a diligent step that a lessee can take to secure its interest prior to the landlord filing bankruptcy. Id. “An SNDA typically includes three distinct concepts: (1) the lessee subordinates its leasehold to the lender’s lien; (2) so long as the lessee performs its obligations under the lease, it can remain in possession notwithstanding foreclosure; and (3) the lessee acknowledges its obligations to the new landlord after foreclosure.” Id. at 37, n.14 (citing Thomas C. Homburger & Lawrence A. Eiben, “Who’s on First — Protecting the Commercial Mortgage Lender,” 36 Real Prop. Prob. & Tr. J. 411, 415-21 (2001)).

[81] Douglas J. Sanderson, “Subordination, Non-Disturbance and Attornment Agreements: Meeting the Legitimate Goals of Landlords, Tenants and Lenders; Negotiation Techniques,” McCandlish & Lillard, P.C., 1, 1, available at https://mccandlishlawyers.com/wp-content/uploads/2013/12/SNDAMaterialsRev11-27.pdf (last visited Jan. 22, 2018).

[82] See id. at 2-3.

[83] See Millar, supra n. 80 (recommending steps lessee should take to protect itself).

[84] See In re Revel AC Inc., 802 F. 3d 558, 562 (3d Cir. 2015) (stating that lessee made it clear that it did not intend to avert sale, but rather to prevent trustee from selling property free and clear of its lease). The lessee argued that § 365 gave it the right to retain its possessory interest. Id.

[85] C.f. In the Matter of Spanish Peaks Holdings II, No. 15-35572, 2017 WL 4156370, at *5-6 (9th Cir. Sept. 12, 2017) (determining proposed sale did not amount to rejection).

[86] C.f. id. The court in Spanish Peaks was able to avoid this analysis and deem that a proposed sale only triggered § 363 and not § 365.

[87] Dishi & Sons v. Bay Condos LLC, 510 B.R. 696, 698 (S.D.N.Y. 2014).

[88] See In re Revel AC Inc., 802 F. 3d 558, 562 (3d Cir. 2015). In Revel, the lessee successfully argued in the alternative that “even if § 365(h) did not secure its interest, § 363(f) ... was of no use to [the trustee], as it could [not] satisfy any of the five alternative conditions necessary to trigger a sale under its strictures.” Id.

[89] Precision Indus. Inc. v. Qualitech Steel SBQ LLC, 327 F.3d 537, 541 (7th Cir. 2003).

[90] See supra n. 71.

[91] See Stein, supra n. 20 at 9.

[92] See 11 U.S.C. § 363(e) (2012).

[93] See id. When the lessee requests adequate protection, the court “shall” provide it. Id.

[94] Id. (stating that court “shall prohibit or condition [the] sale ...  as is necessary to provide adequate protection” to an entity that has an interest in the property).

[95] See id. § 361(3).

[96] Id. § 361(1).

[97] See Amy S. Ashworth, Adequate Protection — The Equitable Yardstick of Chapter 11, 22 U. Va. L. Rev. 455, 460 (1988).

[98] Precision Indus. Inc. v. Qualitech Steel SBQ LLC, 327 F.3d 537, 548 (7th Cir. 2003).

[99] Dishi & Sons v. Bay Condos LLC, 510 B.R. 696, 712 (S.D.N.Y. 2014). The court determined that continued possession was necessary to adequately protect the lessee’s interest. Id.

[100] 802 F.3d 558, 562 (3d Cir. 2015).

[101] Id.

[102] Genovese, supra n. 35 at 649 (concluding that “lessees must remain vigilant when their lessors file for bankruptcy or risk losing their leasehold interest to a sale free and clear”).

[103] See, e.g., In re Revel AC Inc., 802 F. 3d 558, 562 (3d Cir. 2015). The lessee in Revel effectively provides the model for all lessees in the same situation. See id.

[104] See Jackson & Bambrick, supra n. 20. According to Jackson and Bambrick, a diligent lessee is one who perfects its leasehold (by recording it) and requests adequate protection in a bankruptcy proceeding. Id.

[105] Stein, supra n. 20 (asserting that “there was no reason for Qualitech to create the frenzy that it did, because the case stood for nothing more than the principle that a tenant must pay attention and object early and often and request protection of its interest in a landlord’s bankruptcy”). Stein contends that the reaction to Precision Industries was overblown because a diligent lessee can take steps for protection. Id.

 

 

This article was originally published in the July 2018 edition of the Asset Sales Committee Newsletter. Participation in ABI's committees is one of the many benefits of becoming a member.  Committees provide networking and leadership opportunities.  For additional information on how you could become involved in ABI and our Committees please visit membership.abi.org.

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