Introduction: The Context in which the Following Assumption and Assignment Issues Arise
The following materials address certain issues that may arise in a bankruptcy proceeding of a tenant/debtor who elects to assume and assign its commercial real estate lease. In general terms, the legal context for those issues is (all references to Sections and Subsections herein, except where otherwise noted, are to 11 U.S.C.):
1. Unlike a sale of property, a bankrupt tenant’s occupancy of the premises, or the continued existence of a lease, continues a relationship that may have a substantial impact on the financeability and synergies of the shopping center or office complex. The landlord and the tenant may negotiate amendments to the lease subject to Court approval.
2. For the period from the date the tenant files the bankruptcy petition until the date the tenant assumes or rejects the lease (a) the tenant must timely perform all of its obligations under the lease (except the ipso facto ones), and (b) the landlord’s claims therefor have priority over general unsecured creditors. Subsection 365(d)(3).
3. If the lease is in default at the time the tenant files its bankruptcy petition, then, as more fully discussed in part below, the tenant cannot assume the lease unless, subject to certain exceptions, the tenant:
(A) cures, or provides adequate assurance that the trustee will promptly cure, such default; . . .
(B) compensates, or provides adequate assurance that the trustee will promptly compensate [the landlord] . . . for any actual pecuniary loss to [the landlord] . . . resulting from such default; and
(C) provides adequate assurance of future performance under such contract or lease.
Subsection 365(b)(1).
4. Once the tenant assumes the lease, the amounts thereafter due thereunder are subject to priority as, or in a manner similar to, administrative expenses.
5. If the tenant assumes, and later rejects, the lease, the landlord is entitled to priority, as an administrative expense, of the following until the bankruptcy estate is closed:
(7) with respect to a nonresidential real property lease previously assumed under section 365, and subsequently rejected, a sum equal to all monetary obligations due, excluding those arising from or relating to a failure to operate or a penalty provision, for the period of 2 years following the later of the rejection date or the date of actual turnover of the premises, without reduction or setoff for any reason whatsoever except for sums actually received or to be received from an entity other than the debtor, and the claim for remaining sums due for the balance of the term of the lease shall be a claim under section 502(b)(6); Subsection 503(b)(7).
6. If the tenant initially rejects the lease, that rejection is treated as a breach, for which the landlord has only an unsecured, non-priority claim for damages. Furthermore, that claim is limited to:
(A) the rent reserved by such lease, without acceleration, for the greater of one year, or 15 percent, not to exceed three years, of the remaining term of such lease, following the earlier of--
(i) the date of the filing of the petition; and
(ii) the date on which such lessor repossessed or the lessee surrendered, the leased property; plus
(B) any unpaid rent due under such lease, without acceleration, on the earlier of such dates;
Subsection 502(b)(6). Furthermore, the tenant may try to limit the landlord’s claim even more by seeking to have its rejection retroactive to the later of (a) the date the tenant vacated the premises, or (b) the date the tenant filed the bankruptcy petition. Lastly, although there is a split of authority, the better-reasoned cases hold that (a) if a lease is rejected, the foregoing cap on the landlord’s damages applies to only the landlord’s claims to rent and other damages caused by the rejection itself; and, thus (b) that cap does not apply to the landlord’s claims for failures to repair or restore, and other such non-monetary breaches that would exist by act or omission of the tenant separate from the tenant’s rejection or acceptance of the lease. In re El Toro Materials Company, Inc., 2007 U.S. App. LEXIS 22991, Bankr. L. Rep (CCH) P81,021, 48 Bankr. Ct. Dec. 255 (2007). Even those surviving claims not subject to the cap, however, would be only unsecured non-priority claims.
Of course, several business considerations will influence the landlord’s inclination to encourage the tenant to accept or reject the lease and when to do so. Such considerations include: (a) whether the lease is below market (given that, regardless of the language of the lease, the landlord is unlikely to get any profits from the assignment, but could wind up stuck with the remaining term of a below market lease); (b) whether the assumption will result in the tenant’s curing prior defaults, the monies for which would otherwise not be available for unsecured non-priority creditors; (c) whether, after the assumption, the tenant is likely to remain a credit or default risk, including whether the tenant is likely to wind up rejecting the lease after assuming it; (d) to what extent the tenant will be a draw or a hindrance to the shopping center or office complex; (e) whether the landlord can find better, or even suitable, replacement tenants who would be interested in leasing the premises, how long that process would take, and how much it would cost the landlord in funds not reimbursable from the bankruptcy estate; and (f) other business relations, if any, the landlord has or may have with the tenant or its principals.
The applicable changes wrought by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”), to the following provisions, are noted below.
1. NEW DEADLINE FOR THE TENANT TO ACCEPT OR REJECT A COMMERCIAL LEASE
Subsection 365(d)(4) provides:
(4) (A) Subject to subparagraph (B), an unexpired lease of nonresidential real property under which the debtor is the lessee shall be deemed rejected, and the trustee shall immediately surrender that nonresidential real property to the lessor, if the trustee does not assume or reject the unexpired lease by the earlier of--
(i) the date that is 120 days after the date of the order for relief; or
(ii) the date of the entry of an order confirming a plan.
(B) (i) The court may extend the period determined under subparagraph (A), prior to the expiration of the 120-day period, for 90 days on the motion of the trustee or lessor for cause.
(ii) If the court grants an extension under clause (i), the court may grant a subsequent extension only upon prior written consent of the lessor in each instance.
The days of the tenant’s getting endless extensions to assume or reject commercial leases appear to be over. BAPCPA re-wrote this entire Subsection. Under BAPCPA, the Bankruptcy Court may grant only one extension without the landlord’s consent and it must be granted, if at all, within the deadline specified above.
Federal Rule Bankruptcy P. 9006, which allows the Court to extend deadlines on account of “excusable neglect,” (a) applies only deadlines to set by the Bankruptcy Rules, not to deadlines set by statute; and (b) usually does not excuse “inadvertence, ignorance of the rules, or mistakes construing the rules.” In re: Tubular Technologies, LLC, 348 B.R. 699, 2006 Bankr. LEXIS 1653 (2006), the foregoing being a quote from In re Roasters Corp., 2000 Bankr. LEXIS 1916, 2000 WL33673776, which in turn was citing and quoting Pioneer Investment Services Co. v. Brunswick Associates Ltd. Partnership, 507 U.S. 380, 113 S.Ct. 1489, 123 L.Ed.2d 74 (1993) (“Tubular 2”). See also In re Tubular Technologies, LLC, 362 B.R. 243, 2006 Bankr. LEXIS 1282, 46 Bankr. Ct. Dec. 215 (2006). Furthermore, the general equity powers of the Court under Subsection 105(a) cannot be used to extend a statutory deadline or otherwise go beyond the confines of the statute. Tubular 2, id. See also In re Tubular Technologies, LLC, 372 B.R. 820, 2007 Bankr. LEXIS 2633, 48 Bankr. Ct. Dec. 204 (2007) (attorney’s possible malpractice, in this case, for not acting timely). and Bowles v. Russell, 127 S. Ct. 2360 (2007) (courts have no power to extend deadlines set by statute).
The foregoing requires the tenant: (a) to file a motion for the 90-day extension, usually with a motion for a expedited hearing date therefor, in time to allow for the normal time for responses to motions [20 days under Fed.R.Bankr.P. 2002(a)(2)] in case the Court does not grant the motion to expedite; and (b) to get the hearing scheduled in time for the Court to hear argument, and to render its decision, on the motion to extend, within the Subsection 365(d)(4)(A) deadline. The tenant may be excused, however, if the delay is for reasons beyond the tenant’s control, such as a failure by the Court to render its decision despite the tenant’s diligent efforts to remind it to do so. Tubular 2, id at 348 B.R. at 710.
2. METHODS OF CHOOSING AN ASSIGNEE
A. Holding an Auction, Usually with a Stalking Horse Bid
Usually, to sell a debtor/tenant as a going concern or to sell its assets, the bankruptcy estate hires a business broker, to work with the debtor or the trustee, to market the property. The best response, for purchase either as a going concern or of particular assets, is then negotiated into an asset purchase agreement and that agreement becomes what is generally referred to as the “Stalking Horse Bid.” Then, an auction is held. If a Stalking Horse Bid is obtained, it is used as the floor for that auction. An auction can proceed without a Staking House Bid, however, if one cannot be timely obtained. See, for example, In re: The Bombay Company, Inc., et al., Jointly Administered under Case No. 07-44084 in the U.S. Bankruptcy Court for the Northern District of Texas, Fort Worth Division (2008) (Order entered authorizing an auction to assign numerous retail leases promptly after the bankruptcy estate sold the tenant’s inventory in going out of business sales, so as to close the stores as soon as possible in order to minimize administrative rent in the interim. See Item 2 of the Introduction above.) Regardless of the procedure employed, at each step, the appropriate court orders need to be obtained to authorize and govern the process and give interested parties an opportunity to object. Several cases explain the applicable procedures and contain some of the documents, motions and orders employed to implement such bids and auctions. See, for example, In re Dura Automotive Systems, 2007 Bankr. LEXIS 2764 (2007); and the motions filed, and the Orders entered, in In re: The Bombay Company, supra and In Re: Three A’s Holdings, LLC, Case No. 06-10886 in the U.S. Bankruptcy Court for the District of Delaware (2006) (the “Tower Records” case). If the lease is in default, accompanying court orders are necessary to establish (1) the amounts and actions necessary to cure those defaults, to compensate for actually pecuniary loses, and to provide the requisite adequate assurances of such cures or compensation or of future performance; and (2) how those amounts and actions are to be paid or performed and such assurances given. (See Item 3 of the Introduction above.)
In negotiating the Stalking Horse Bid, the contract purchaser (the “Stalking Horse Bidder”) may seek to include various provisions, in that bid, to be incorporated in the accompanying Court motions and orders, that may give it advantages in the auction process or discourage other potential bidders. For example:
(1) Break-Up Fees and Expense Reimbursements. Break-up fees and expense reimbursements are amounts payable, generally with priority as administrative expenses, to the Stalking Horse Bidder in the event the subject assets are sold to another bidder at the auction. Those provisions are similar to those encountered in a number of non-bankruptcy merger and acquisition agreements. They are justified as necessary costs of preserving the bankruptcy estate under Subsections 503(b)(1) and 507(a)(2) since (a) the Stalking Horse Bidder is taking a major risk, because of the auction process or because of the usual reservations of rights contained in the bidding documents, of losing all of the time, money and lost opportunity costs it has invested in the negotiations and in performing the accompanying due diligence; (b) by showing its interest in purchasing the assets, the Stalking Horse Bid induces other bids in a compressed negotiation and due diligence period; and (c) the Stalking Horse Bid provides a floor to the bidding. On the other hand, break-up fees and expense reimbursements advantage the Stalking Horse Bidder because they are credited against the amount of its bid, but not against the amount of the bid by any other bidder. In fact, those fees and reimbursements are valuable enough that the Stalking Horse Bid may mandate that the purchaser thereunder be the only Stalking Horse Bidder. Consequently, the Bankruptcy Court may require that (a) the non-privileged due diligence materials, even if gathered by the Stalking Horse Bidder, be placed in an on-line “war room” available to all bidders; (b) the amount of the Break-Up Fee take into account the value of those materials thus made available to the other bidders (generally Break-Up Fees do not exceed 2% to 3% of the ultimate purchase price of the subject assets); and (c) the amount of the expense reimbursement be limited accordingly. See Dura Automative, id.; and In Re: Food Management Group, LLC, 359 B.R. 543, 2007 Bankr. LEXIS 381, 47 Bankr. Ct. Dec. 225 (2007). However, see Calpine Corp. v. O’Brien Environmental Energy, Inc., 181 F.3d 527 (3rd Cir. 1999) refusing to approve a break-up fee, finding that it was not necessary to induce the bidding in that case.
(2) Short Auction Date. Having less time to perform due diligence may discourage potential bidders. On the other hand, the Stalking Horse Bidder may have performed a great deal of due diligence while negotiating the Stalking Horse Bid. (See above regarding break-up fees and expense reimbursements.)
(3) High Deposits and Irrevocable Bids. The bidding deposit set, by the Stalking Horse Bid and the accompanying court orders, may be so high as to discourage potential bidders who would not be able to raise that much cash or a letter of credit so quickly. On the other hand, the Stalking Horse Bidder has had time and information, while negotiating the Stalking Horse Bid. Furthermore, to protect the bankruptcy estate by retaining its alternatives in case of a default by the winning bidder, the bidding procedures may require that the bids and the deposits of the losing bidders (or at least of the second highest bidder) be irrevocable and be held until the actual transfer of the assets (via settlement) actually occurs. Tying up bids and deposits for long obviously may scare away other potential bidders.
(4) High Bid Increments. The bidding procedures will often set the minimum increments between bids. Obviously, the higher those increments are, the more they tend to weed-out other bidders.
(5) Short Settlement Dates. The bidding procedures will also set the outside settlement date. Obviously, the shorter that is the less time potential bidders have to raise the requisite funds. Again, on the other hand, the Stalking Horse Bidder has had time and information during the negotiations.
(6) Requiring Disclosure of Bidder’s Confidential Financial Information. If the bidding procedures require the other potential bidders to disclose their own confidential financial information to the debtor (whose principals may later become competitors) or to the Stalking Horse Bidder, under the theory that that is necessary for such other bidders to show that they are financially qualified, that requirement may, obviously, discourage certain of those potential bidders.
(7) Requiring All Bids to be on the Same Form as the Stalking Horse Bid. If and to the extent that the bidding procedures require that all bids be on a form of contract that is substantially identical (but for price) as the Stalking Horse Bid, that requirement may discourage certain potential bidders.
(8) Requiring the Winning Bidder to Pay-Off Related Financing. If the bidding procedures require payment of the debtor’s existing financing and such financing was provided by the Stalking Horse Bidder, or a party related to the Stalking Horse Bidder, and contains substantial applicable prepayment penalties. Such a requirement may add a substantial burden to potential bidders.
B. Selling Designation Rights
The Bankruptcy Code does not expressly provide for designation rights; they are creatures of practice. In a designation-rights situation:
(1) The tenant assigns to a third party (a “Designation Rights Purchaser”), all of tenant’s rights, under Section 365, to determine which of the tenant’s leases shall be assumed and assigned, and thus which ones shall be rejected, all subject to the requirements of Section 365. That assignment is set forth in a designation-rights agreement entered into by and between the tenant and the Designation Rights Purchaser and approved by the Court (a “Designation Rights Agreement”).
(2) The person or entity selected to be the Designation Rights Purchaser is selected by an auction process approved by the Court.
(3) The sale of designation rights process is usually used, if at all, in a situation in which the tenant is a retailer who (a) has a large number of leases; (b) needs a lot of cash up-front to continue to operate its business and/or to wind-down; (c) would rather have a fixed amount, than take its chances in the marketplace, for assignments of the leases; and (d) may not have sufficient retained employees or time to handle the marketing of those leases.
(4) Designation Rights Agreements are subject to negotiation. Consequently, they vary. Generally, however, they provide the following: (a) upon signing the Designation Rights Agreement, the Designation Rights Purchaser pays the tenant a large sum, in cash, as consideration for the assignment of the designation rights; (b) the Designation Rights Purchaser has an exclusive period, within the acceptance/rejection period described above, within which to market the leases (the “Marketing Period”), including by seeking to assign the leases to third parties or to itself or to negotiate new leases or termination agreements with the landlords; (c) the Designation Rights Purchaser may be required to pay some or all of the amounts due as rent and otherwise under the leases during the Marketing Period (see Item 2 of the Introduction above); (d) during the Marketing Period, the Designation Rights Purchaser may terminate the parties’ respective obligations, under the Designation Rights Agreement, on a lease-by-lease basis, by electing to drop leases from the program; (e) if, during the Marketing Period, the Designation Rights Purchaser selects particular leases for the tenant to assume and assign, as described above, the tenant, at the Designation Rights Purchaser’s directions, is obligated to try to obtain the requisite Court approvals therefor; (f) the Designation Rights Purchaser may be required to select, for assumption and assignment, a specified minimum number of leases; (g) for a lease that the Designation Rights Purchaser wants the tenant to assume and assign, if the lease is in default and the assumption and assignment is approved by the Court, the Designation Rights Purchaser may be required to pay some or all of the amounts, and take some of all the actions, necessary to cure defaults, to compensate for actually pecuniary loses, and to provide the requisite adequate assurances of such cure or compensation or of future performance and the ultimate assignee will be required to give the assurances as to future performance (see Item 3 of the Introduction above and Paragraph 4 below); (h) the Designation Rights Purchaser keeps all of the proceeds of the assignment and assumption for those leases it thus selects; and (i) the tenant may remain liable for all rejection damages (see Items 5 and 6 of the Introduction above).
For examples of post-BAPCPA decisions in which Designation Rights Agreements have been used, see In re Three A’s Holdings, L.L.C., 364 B.R. 550, 2007 Bankr. LEXIS 820, 47 Bankr. Ct. Dec. 281 (2007); and In re Ames Department Stores, Inc., 348 B.R. 91, 2006 Bankr. LEXIS 1898, 46 Bankr. Ct. Dec. 213 (2006).
3. TENANTS’ RIGHTS NOT TO CURE NONMONETARY DEFAULTS THAT ARE IMPOSSIBLE TO CURE AT THE TIME THAT THE LEASE ASSUMPTION IS SOUGHT BY THE TENANT
Subsection 365(b)(1) provides:
(b) (1) If there has been a default in an executory contract or unexpired lease of the debtor, the trustee may not assume such contract or lease unless, at the time of assumption of such contract or lease, the trustee--
(A) cures, or provides adequate assurance that the trustee will promptly cure, such default other than a default that is a breach of a provision relating to the satisfaction of any provision (other than a penalty rate or penalty provision) relating to a default arising from any failure to perform nonmonetary obligations under an unexpired lease of real property, if it is impossible for the trustee to cure such default by performing nonmonetary acts at and after the time of assumption, except that if such default arises from a failure to operate in accordance with a nonresidential real property lease, then such default shall be cured by performance at and after the time of assumption in accordance with such lease, and pecuniary losses resulting from such default shall be compensated in accordance with the provisions of this paragraph;
(B) compensates, or provides adequate assurance that the trustee will promptly compensate, a party other than the debtor to such contract or lease, for any actual pecuniary loss to such party resulting from such default; and
(C) provides adequate assurance of future performance under such contract or lease.
(emphasis added)
All of the language underlined or emphasized in the above quote of Subsection 365(b)(i)(A) was added by BAPCPA.
The “impossibility” terminology was added by BAPCPA and generally refers to defaults that, by the time of the attempted assumption of the lease, are “historic facts.” “Historic facts” (such as a violation of an operating covenant and a failure to maintain the premises) cannot be cured by going back in time. In re Bankvest Capital Corp., 360 F.3d 291, 2004 U.S. App. LEXIS 4810, Bankr. L. Rep. (CCH) P80,062, 42 Bankr. Ct. Dec. 210 (2004); In re Michael and Janell Williams, 299 B.R. 684, 2003 Bankr. LEXIS 1084 (2003); In re Christopher Vitanza, 1998 Bankr. LEXIS 1497 (1998); In the Matter of: GP Express Airlines, Inc., 200 B.R. 222, 1996 Bankr. LEXIS 1128 (1996). BAPCPA also added the duty to reimburse the landlord for pecuniary losses, but did not define how to calculate the amount of such reimbursements.
4. THE COURT’S POWER TO IGNORE LEASE CLAUSES IN CONNECTION WITH AN ASSIGNMENT
Subsections 365(b), (f) and (l) provide, in relevant part:
(b) . . .
(3) For the purposes of paragraph (1) of this subsection and paragraph (2)(B) of subsection (f), adequate assurance of future performance of a lease of real property in a shopping center includes adequate assurance--
(A) of the source of rent and other consideration due under such lease, and in the case of an assignment, that the financial condition and operating performance of the proposed assignee and its guarantors, if any, shall be similar to the financial condition and operating performance of the debtor and its guarantors, if any, as of the time the debtor became the lessee under the lease;
(B) that any percentage rent due under such lease will not decline substantially;
(C) that assumption or assignment of such lease is subject to all the provisions thereof, including (but not limited to) provisions such as a radius, location, use, or exclusivity provision, and will not breach any such provision contained in any other lease, financing agreement, or master agreement relating to such shopping center; and
(D) that assumption or assignment of such lease will not disrupt any tenant mix or balance in such shopping center.
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(f) (1) Except as provided in subsections (b) and (c) of this section, notwithstanding a provision in an executory contract or unexpired lease of the debtor, or in applicable law, that prohibits, restricts, or conditions the assignment of such contract or lease, the trustee may assign such contract or lease under paragraph (2) of this subsection.
(2) The trustee may assign an executory contract or unexpired lease of the debtor only if--
(A) the trustee assumes such contract or lease in accordance with the provisions of this section; and
(B) adequate assurance of future performance by the assignee of such contract or lease is provided, whether or not there has been a default in such contract or lease.
(3) Notwithstanding a provision in an executory contract or unexpired lease of the debtor, or in applicable law that terminates or modifies, or permits a party other than the debtor to terminate or modify, such contract or lease or a right or obligation under such contract or lease on account of an assignment of such contract or lease, such contract, lease, right, or obligation may not be terminated or modified under such provision because of the assumption or assignment of such contract or lease by the trustee.
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(l) If an unexpired lease under which the debtor is the lessee is assigned pursuant to this section, the lessor of the property may require a deposit or other security for the performance of the debtor's obligations under the lease substantially the same as would have been required by the landlord upon the initial leasing to a similar tenant.
(emphasis added)
Only the language underlined or emphasized above in Subsection 365(f)(1) was added by BAPCPA.
Generally, the tenant is required to assume and assign the entire lease, not just the favorable parts thereof. In re: Fleming Companies, Inc., 499 F.3d 300, 2007 U.S. App. LEXIS 19927, Bankr. L. Rep. (CCH) P80,996, 48 Bankr. Ct. Dec. 188 (2007); Michael and Janell Williams, supra; GP Express Airlines, Inc., supra. That conclusion would seem to be reinforced, as to shopping center leases, by the amendment made by BAPCPA to Subsection 365(f)(1) as stated above.
Nevertheless, the general rule seems to be that stated, in the pre-BAPCPA case of In re Joshua Slocum Ltd, 922 F.2d 1081, 1990 U.S. App. LEXIS 22426 (3d Cir. 1990), as follows:
The bankruptcy court does have some latitude in waiving contractual provisions when authorizing a trustee to assume and assign an unexpired lease. Section 365(b)(2) 6 on its face permits the court to ignore so-called ipso facto and forfeiture clauses. See In re TSW Stores of Nanuet, Inc., 34 Bankr. 299, 305 (Bankr. S.D.N.Y. 1983); In re U.L. Radio Corp., 19 Bankr. 537 (Bankr. S.D.N.Y. 1982). However, the court's authority to waive the strict enforcement of lease provisions in the context of shopping center cases like this one is further qualified by § 365(b)(3) of the Bankruptcy Code. 7 Even under the tightly drawn definition of "adequate assurance" in the shopping center context, Congress did not envision literal compliance with all lease provisions; insubstantial disruptions in, inter alia, tenant mix, and insubstantial breaches in other leases or agreements were contemplated and allowed. 8 11 U.S.C. [*1091] § 365(b)(3)(C), (D); see also U.L. Radio Corp., 19 Bankr. 537, 544; TSW Stores, 34 Bankr. 299.
* * *
8 The court's authority to waive strict enforcement of lease provision in the non-shopping center cases will permit deviations which exceed those permitted in shopping center cases. U.L. Radio, 19 Bankr. 537, 544. See also In re Peterson's Ltd., Inc., 31 Bankr. 524 (Bankr. S.D.N.Y 1983) (a change in use was authorized to permit an assignment of a so-called high class tobacco shop to an assignee who sold discounted cigars); In Re Fifth Avenue Originals, 32 Bankr. 648 (Bankr. S.D.N.Y 1983 (a lease assumption and assignment from a high-class boutique selling clothing and accessories for both sexes to Diane von Furstenberg, a designer offering women's clothing and accessories, was approved).
* * *
Congress has suggested that the modification of a contracting party's rights is not to be taken lightly. Rather, a bankruptcy court in authorizing assumptions and assignment of unexpired leases must be sensitive to the rights of the non-debtor contracting party (here, George Denney) and the policy requiring that the non-debtor receive the full benefit of his or her bargain. See U.L. Radio Corp., 19 Bankr. 537; TSW Stores of Nanuet, 34 Bankr. 299. Congress' solicitous attitudes toward shopping centers is reflected in the legislative history regarding § 365(b)(3), which states: . . .
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Appellant takes issue with the bankruptcy court's conclusion that paragraph 20 of the lease at issue, allowing for the termination of the lease by either the landlord, Denney or the debtor-tenant, Joshua Slocum, Ltd., if certain minimum sales figure were not realized, was not enforceable. Central to the bankruptcy court's view was the notion that unless the landlord establishes that a leasehold is in a "shopping center," such a restrictive clause is only enforceable if the landlord is able to establish that such terms are material and jeopardize the economic position of the landlord and/or the landlord's other tenants. The bankruptcy court, working from the premise that the Denney Block is not a "shopping center," looked to case law interpreting § 365 of the Bankruptcy Code and distilled the concepts of "materiality and economic significance." Those cases state that "the [bankruptcy] court does retain some discretion in determining that lease provisions . . . may still be refused enforcement in a bankruptcy context in which there is no substantial economic detriment to the landlord shown, and in which enforcement would preclude the bankruptcy estate from realizing the intrinsic value of its assets." In re Mr. Grocer, Inc., 77 Bankr. 349, 354 (Bankr. D.N.H. 1987); see also In re Tech Hifi, Inc., 49 Bankr. 876, 879 (Bankr. D. Mass. 1985).
Again, we note our disagreement with the bankruptcy court's premise that the Denney Block is not a "shopping center" within the meaning of 11 U.S.C. § 365(b)(3). We find that although the bankruptcy court was correct in its reliance on those legal precepts in this context, it was incorrect in finding that on these facts, paragraph 20 of the lease, addressing the right of the parties to terminate the leasehold is not "material or economically significant." That conclusion flies in the face of logic and simple common sense. The average sales provision of the lease is material in the sense that it goes to the very essence of the contract, i.e., the bargained for exchange. This clause, intended to benefit both the landlord and the tenant, was negotiated at arms length to accommodate the commercial expectations of the parties. This average sales provision is also reflective of the economic terms of the lease agreement governing occupancy. However, most importantly, the materiality and economic significance of paragraph 20 turn on the fundamental right to remain in or end a contractual relationship.
* * *
In this case, however, the bankruptcy court did not have the authority to excise paragraph 20 of the shopping center lease which addresses the landlord and/or tenant's option to terminate dependent upon the average sales generated by the tenant. We note that even if the Denney Block were not a shopping center, the bankruptcy court's authority to excise paragraph 20 of the lease is questionable. That paragraph must be read in conjunction with paragraph 4, the percent rent clause of the lease which provides a formula . . .
Thus, the appellate court held that, in approving an assignment of even a shopping lease, it could ignore a clause that would impede or prevent that assignment, but is otherwise not “material and economically significant.” Furthermore, it so held while reading Section 365 in the same manner as though that Section has already contained the BAPCPA amendment referred to above.
Joshua Slocum’s holding was approved and clarified, to strengthen it, in Fleming Companies, supra, a post-BAPCPA, non-shopping center case. Fleming Companies indicates that materiality is judged at the time the subject lease was entered into, not based upon the economics in effect at the time of the proposed assignment.
Today, bankruptcy courts still seem inclined to apply Joshua Slocum’s material and economically significant test to shopping center leases despite the apparent effect of the language of BAPCPA. See, for example, Paragraphs 9 through 17 of Exhibit “A” hereto, which is a copy of an Order issued by that Court in that case. Those Paragraphs are consistent with the provisions of the Asset Purchase Agreement approved, and accompanying orders issued, by the Bankruptcy Court in that case. As shown there, the Court deleted, from that lease, among other things, as anti-assignment provisions and solely for purpose of implementing the purposed assignment of that lease, the rights the landlord had, under the terms of that lease, to recapture the premises, to share in the profits of the assignment, to convert percentage rent to fixed rent, to prevent the particular use or trade name or accompanying alterations or signage, to enforce a radius restriction, and to treat the renewal options as personal to the named tenant. Admittedly, those Court Orders do not indicate that any of those deletions were contested by the affected landlords and do not contain any legal analysis of the Court’s reasons for disregarding the applicable statutory restrictions. They do show, however, how far Bankruptcy Courts feel they can go, in re-writing leases, absent a challenge. By contrast, in a contested matter in the same Tower Records case, at 364 B.R. 550, 2007 Bankr. LEXIS 820, 47 Bankr. Ct. Dec. 281 (2007), the same Bankruptcy Court, held, based upon the history of the negotiations of the subject lease, held that the “Health Supplies” use restriction in that lease did not permit a use of the premises by Walgreens, the proposed assignee, as a drugstore or pharmacy.
Although a search did not reveal such arguments in any published cases, the following technical arguments can be made as to why the BAPCPA amendment to Subsection 365(f)(1) does not totally exempt shopping center leases from that Subsection, and, thus, why the Bankruptcy Courts have rendered orders such as the attached. First, the only applicable portion of Subsection 365(b) is clause (3), which deals only with determining what constitutes “adequate assurance of future performance” in connection with the assignment of a shopping center lease. Thus, carving Subsection 365(b) out of Subsection 365(f)(1) does not address the anti-assignment case law that developed pre-BAPCPA. Secondly, the Subsection 365(b) carve out was made only in Subsection 365(f)(1), not in Subsection 365 (f)(3). The latter addresses anti-assignment clauses that seek to “terminate or modify” leases.