909 F.3d 597
3rd Cir.2018Background
- Revel AC, Inc. (debtor) owned a casino in Atlantic City; IDEA Boardwalk, LLC operated two nightclubs and a beach club there under a long-term Lease.
- Revel filed Chapter 11 and sold its assets to Polo North Country Club, Inc. under a Purchase Agreement and a Sale Order that generally transferred assets “free and clear” but carved out tenant rights, including rights under 11 U.S.C. § 365(h) and any setoff/recoupment defenses.
- The Lease included an interrelated rent/recoupment scheme: IDEA paid rent only when venues met profit formulas; Revel had contractual periodic “recoupment” payments to offset IDEA’s rent in early years when returns were negative.
- Bankruptcy Court granted IDEA partial summary judgment holding IDEA may offset rent by the Lease’s recoupment amounts, relying on (1) § 365(h) tenant-rights election and (2) equitable recoupment; District Court affirmed.
- The Third Circuit affirmed, holding IDEA may reduce post-rejection rent obligations by the contractual recoupment amounts, and that equitable recoupment also permits such offsets; the opinion clarifies offsets apply to pre- and post-petition/rejection amounts but do not authorize affirmative recovery beyond reducing rent owed.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether IDEA’s § 365(h) election preserves the Lease’s recoupment offsets against rent owed after rejection | IDEA: § 365(h) preserves tenant rights "relating to the amount and timing of payment of rent," which includes the recoupment mechanism that defines rental terms | Polo: Recoupment is separate from "rent" or was extinguished by the § 363 sale/assignment to Polo | Held: Yes. § 365(h) preserves the recoupment component as part of the Lease’s rental terms, permitting IDEA to reduce rent by recoupment amounts after rejection |
| Whether equitable recoupment allows IDEA to offset rent with recoupment amounts (including pre- and post-petition/rejection obligations) | IDEA: Rent and recoupment arise from the same integrated lease transaction; equity permits netting so tenant is not forced to pay full rent without downward adjustments | Polo: Sale under § 363(f) and assignment-free-and-clear extinguished such defenses/claims against the assignee | Held: Yes. Equitable recoupment applies because rent and recoupment arise from the same transaction; the Sale Order carved out tenant defenses and equitable recoupment is a defense, not an interest extinguished by the sale |
Key Cases Cited
- Megafoods Stores, Inc. v. Flagstaff Realty Assocs., 60 F.3d 1031 (3d Cir. 1995) (tenant who elects under § 365(h) remains under the same rental terms)
- In re Univ. Med. Ctr., 973 F.2d 1065 (3d Cir. 1992) (defines equitable recoupment as arising from same transaction; mere logical relation insufficient)
- In re Anes, 195 F.3d 177 (3d Cir. 1999) (discusses equitable recoupment as a nonstatutory, narrow equitable exception)
- Folger Adam Sec., Inc. v. DeMatteis/MacGregor, JV, 209 F.3d 252 (3d Cir. 2000) (sale § 363(f) does not extinguish defenses such as recoupment)
- In re Trans World Airlines, Inc., 322 F.3d 283 (3d Cir. 2003) (reaffirming that recoupment and similar defenses survive § 363 asset sales)