OPINION AND ORDER
Section 363(f) of the Bankruptcy Code, 11 U.S.C. § 101 et seq., authorizes the trustee to sell property of a bankrupt’s estate “free and clear of any interest in such property.” Section 365(h), however, provides that if the trustee “rejects” a lease of a debtor — lessor, “the lessee may retain its rights under such lease ... that are in or appurtenant to the real property,” such as the right to continued possession at the specified rent (“appurtenant rights”). This bankruptcy appeal presents the question whether § 365(h) preserves the lessee’s appurtenant rights even if they could otherwise be extinguished in a § 363(f) sale. The bankruptcy court answered in the affirmative, apparently adopting the majority view that §§ 365(h) and 363(f) stand in conflict and the former trumps the latter. Aternatively, the court held that even if § 363(f) permits such a sale, the lessee was entitled to continued possession as “adequate protection” of its interest under § 363(e).
This Court reaches the same result, but dеclines to endorse the majority interpretation. Athough § 365(h) is applicable to § 363(f) sales, it does not give the lessee absolute rights that take precedence over the trustee’s right to sell free and clear of interests. Rather, it clarifies that the lessee may retain its appurtenant rights not
I. Background
Bay Condos LLC (“Debtor”) is the owner of a 97.2% interest in two commercial condominium units (“Property”) located at 11 East 36th Street, New York, New York.
On December 22, 2011, the Debtor filed a voluntary petition for relief under Chapter 11 in the Bankruptcy Court for the Southern District of New York. The Creditor filed a Chapter 11 plan on August 8, 2012, proposing in relevant part:
The transfer of the Property under the Plan shall be free and clear of all commercial leases not assumed under the Plan, liens, claims, and encumbrances ....
The Plan deems the unexpired lease to JYA Cleaners, Inc. to be assumed under the Plan. Ml other non-residential unexpired leases and executory contracts not assumed prior to the Effective Date shall be deemed rejected under the Plan, including commercial leases.
(BkD
On February 19, 2013, the Creditor filed a Second Amended Plan (“Plan”) and a Third Amended Disclosure Statement (“Disclosure Statement”). Like the Initial Plan, the Plan proposed the sale of the Property “free and clear” of intеrests, assumed the JYA Lease, and rejected all other “non-residential unexpired leases” not timely assumed. (BkD No. 74 (“Plan”) §§ 4.1, 6.1.) The bidding and auction procedures and notice of sale similarly indicated that the sale would be “conducted pursuant to Bankruptcy Code section 363” and “free and clear of liens, claims, [and] commercial leases not assumed under the Plan.” (Id. at 17, 29.) The Disclosure Statement listed the Debtor’s estimated
Appellant Dishi & Sons (“Dishi”) was the successful bidder for the Property at an Aрril 8 auction with a bid of $6,075,000. At a hearing on May 9, the bankruptcy court approved the sale and confirmed the Plan. Before an order was entered, however, TGM submitted a letter to the court on May 14 asserting its right to retain possession of Unit 101 for the duration of its lease under § 365(h), and alternatively, as adequate protection under § 363(e). TGM claimed that it had received notice of the sale and hearing only one day earlier, on May 13, and requested that the court hold a hearing regarding its rights before entering an order.
On September 25, after a hearing, the bankruptcy court issued the Sale Approval Order, which approved the sale to Dishi, held that TGM has a right to remain in possession for the duration of its lease at the specified rent, and confirmed the Plan. With respect to TGM’s rights, the court stated two independent grounds for its holding: (i) TGM’s “rights under section 365(h) ... including, but not limited to, the right to elect to remain in possession of the Property [are] fully preserved”; and (ii) “as adequate protection for the sale of the Property free and clear of the TGM Lease, [TGM] may remain in possession of the Property pursuant to sections 361(3) and 363(e).” (BkD No. 123 (“Sale Approval Order”) at 4-5.) Dishi filed a timely notice of appeal on October 8, 2013. The Court held oral argument on April 17, 2014.
II. Legal Standard
28 U.S.C. § 158(a)(1) grants district courts jurisdiction to hear appeals from “final judgments, orders, and decrees” of bankruptcy courts. As a “confirmation of a plan in a Chapter 11 proceeding,” the Sale Approval Order is a final order subject to appeal. In re Am. Preferred Prescription, Inc.,
III. Discussion
A. Applicability of Section 365(h) to Section 363(f) Sales
This case requires the reconciliation of two seemingly conflicting provisions of the Bankruptcy Code. Section 363(f) authorizes the trustee (or debtor-in-possession)
(1) applicable nonbankruptcy law permits sale of such property free and clear of such interest;
(2) such entity consents;
(3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property;
(4) such interest is in bona fide dispute; or
(5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.5
Courts have construed the broad language of “any interest” to encompass leasehold interests. See, e.g., Precision Indus., Inc. v. Qualitech Steel SBQ, LLC,
Section 365(h), in turn, governs the trustee’s rejection of leases of a debt- or-lessor. Section 365 authorizes the trustee to assume or reject unexpired leases or executory contracts of the debtor, subject to court approval. 11 U.S.C. § 365(a). Assumption, familiar from general contract law, is the trustee’s decision to аssume the rights and obligations of the debtor under the contract. Michael T. Andrew, Executory Contracts in Bankruptcy: Understanding “Rejection,” 59 U. Colo. L.Rev. 845, 846-47 (1988). In contrast, “rejection is a bankruptcy estate’s election to decline a contract or lease asset. It is a decision not to assume, not to obligate the estate on the contract or lease as the price of obtaining the continuing benefits of the non-debtor party’s performance.” In re Lavigne,
Section 365 thus “permits the trustee ... to use valuable property of the estate and to renounce title to and abandon burdensome property.” In re Orion Pictures Corp.,
(i) if the rejection by the trustee amounts to such a breach as would entitle the lessee to treat such lease as terminated by virtue of its terms, applicable nonbankruptcy law, or any agreement made by the lessee, then the lessee under such lease may treat such lease as terminated by the rejection; or
(ii) if the term of such lease has commenced, the lessee may retain its rights under such lease (including rights such as those relating to the amount and timing of payment of rent and other amounts payable by the lessee and any right of use, possession, quiet enjoyment, subletting, assignment, or hypoth-ecation) that are in or appurtenant to the real property for the balance of the term of such lease and for any renewal or extension of such rights to the extent that such rights are enforceable under applicable nonbankruptcy law.
11 U.S.C. § 365(h)(l)(A)(i)-(ii). Thus, the lessee may either treat the lease as terminated or retain its appurtenant rights under the lease. If the lessee does the former, it may assert an unsecured claim for damages against the estate. Id. § 365(g). If it does the latter, it may offset its damages against the rent. Id. § 365(h)(1)(B).
Read and applied in isolation, §§ 363(f) and 365(h) are relatively straightforward. But when a trustee seeks to sell property free and clear of a leasehold interest, the two sections appear to require inconsistent results. Section 363(f) grants the trustee an unqualified right to sell property unencumbered by the leasehold interest, provided its conditions are met, while § 365(h) grants the lessee an unqualified right to stay in possession if the lease is rejected. Most courts have concluded that the two sections are indeed irreconcilable and that § 365(h) trumps § 363(f), providing the “exclusive remedy available to the debtor in an executory lease situation.” In re LHD Realty Corp.,
Advocates of the majority interpretation generally make three arguments. First, “it is a commonplace of statutory construction that the sрecific governs the general.” Morales v. Trans World Airlines, Inc.,
The rationale for thе minority interpretation was succinctly stated in Cheslock-Bakker: “¡Ejection 365(h) applies when a debtor-lessor remains in possession of its property and rejects a lease, not when the debtor-lessor sells property subject to an interest (such as a lease) free and clear of that interest pursuant to Section 363. Thus, when the debtor-lessor sells property subject to a lease free and clear of that lease pursuant to Section 363(f), the Court will not apply Section 365(h).”
[NJothing in the express terms of section 365(h) suggests that it applies to any and all events that threaten the lessee’s possessory rights. Section 365(h) instead focuses on a specific type of event — the rejection of an executory contract by the trustee or debtor-in-possession — and spells out the rights of parties affected by that event. It says nothing at all about sales of estate property, which are the province of section 363.
Where estate property under lease is to be sold, section 363 permits the sale to occur free and clear of a lessee’s posses-sory interest — provided that the lessee (upon request) is granted adequate protection of its interest. Where the property is not sold, and the debtor remains in possession thereof but chooses to reject the lease, section 365(h) comes into play and the lessee retains the right to possess the property.
Id. at 548.
The minority interpretation has certain advantages over the majority view. It avoids carving out a category of interests from § 363(f), adheres to that section’s
This is a case in point. The Plan and Sale Approval Order unambiguously invoke both §§ 363(f) and 365(h). (Plan §§ 1.23,1.37, 4.1, 6.1; Sale Approval Order 2, 5.) Because § 365(h) has been triggered, Qualitech and its progeny offer little assistance, and the concerns underlying the majority view are front and center. The Creditor attempts to make sense of the case law by arguing that the procedural posture of a case — whether a trustee explicitly rejects a lease by the time of a sale — is critical. See In re Zota Petroleums, LLC,
The purported conflict between §§ 363(f) and 365(h) is amenable to resolution if one first considers the role of § 365(h) in isolation. The commencement of a bankruptcy case results in the creation of an estate that consists, inter alia, of “all legal or equitable interests of the
Leases presents special complications due to their dual-asset nature. A lease is both a conveyance of an interest in property and a contract. 219 Broadway Corp. v. Alexander’s, Inc.,
As with other executory contracts, a lease of a debtor-lessor could undermine the bankruptcy process if the lessor’s obligations under the lease outweigh the benefits to the estate. Accordingly, the Code empowers the trustee to decline to assume — or “reject” — the lease. As previously noted, rejection is not termination. It is merely the trustee’s decision not to obligate the estate to an unprofitable agreement. As a practical matter, rejection of a lease frees the estate from the debtor-lessor’s obligations thereunder, such as providing heat, water, and electricity. See, e.g., In re Flagstaff Realty Assocs.,
This raises a question as to whether rejection terminates or otherwise affects the lessee’s rights under the lease, such as the right to continued possession. The predecessor to § 365(h)— § 70B of the 1898 Bankruptcy Act — clarified that while the trustee was empowered to makе the lease unenforceable against the estate through rejection, this power did not affect the lessee’s “estate.” See 11 U.S.C. § 110(b) (repealed 1978) (“[A] rejection of the lease or any covenant herein by the trustee of the lessor does not deprive the lessee of his estate.”); see also In re Stable Mews Assocs.,
Three conclusions follow from the foregoing. First, at the commencement of the bankruptcy case, the estate acquires two relevant interests: (i) the lessor’s reversion, and (ii) the lease. Although the latter is subject to assumption or rejection, the former is not.
Understood in this manner, §§ 365(h) and 363(f) are consistent. The former 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. The latter, 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. Thus, § 363(f) must necessarily take the lessee’s rights under the lease into account. In re MMH Auto. Grp. LLC,
Consequently, extending § 363(f) to leasehold interests does not undermine legislative intent, because the intent is to preserve the lessee’s appurtenant rights in the event of rejection, not to grant the lessee absolute rights that it would not enjoy outside of bankruptcy. 126 Cong. Rec. 31,917 (1980) (statement of Congressman Edwards) (“Section 365(h) is not intended to provide the debtor’s lessees rights that would not otherwise exist outside of bankruptcy.”); In re Scharp,
This interpretation also allows for the best reading of the Code as a whole. If § 365(h) provides lessees with an absolute right to possession that trumрs the trustee’s power to sell under § 363(f), it is difficult to see why the lessee’s right does not also trump the trustee’s other powers, such as the power to avoid interests as a bona fide purchaser, 11 U.S.C. § 544(a)(1), or to avoid interests that were fraudulently transferred by the debtor, id. § 548(a)(1); see also In re Sheets,
In sum, §§ 363(f) and 365(h) should be read harmoniously as addressing distinct issues. Whether there is a rejection triggering § 365(h) or not, the lessee may retain its appurtenant rights under the lease, which must be respected in any subsequent action by the trustee, including a free and clear sale. Here, because the TGM Lease was rejected in a timely manner, TGM was entitled to retain its appurtenant rights under the lease pursuant to § 365(h). That does not mean, however, that such rights are unavoidable. Instead, the Court must assess whether there is any basis for a sale free and clear of TGM’s rights under § 363(f).
B. Sale of the Property Free and Clear of the TGM Lease
The bankruptcy court did not stаte what grounds, if any, would permit a sale free and clear of TGM’s rights, and TGM argued that none would.
1. Section 363(f)(1)
Paragraph (1) authorizes the trustee to sell the Property free and clear of TGM’s appurtenant rights if “applicable nonbankruptcy law permits sale of such property free and clear of such interest.” The parties dispute the meaning of “applicable nonbankruptcy law.” Dishi contends that it refers to New York foreclosure law, which allows a mortgagee to extinguish a commercial leasehold interest that is junior or subordinate to the mortgage. See, e.g., Dime Sav. Bank of N.Y., FSB v. Montague St. Realty Assocs.,
The starting point of the analysis is, as always, the statutory text. Notably, paragraph (1) is not limited by its terms to “voluntary” sales. It is, however, arguably limited to actions that could be taken by the trustee: “The trustee may sell property ... free and clear of any interest ... if ... applicable nonbankruptcy law permits sale.... ” 11 U.S.C. § 363(f)(1) (emphasis added). The question is whether “permits sale” should be interpreted passively (and broadly) to refer to instances of free and clear sale by any persоn, or actively (and narrowly) to refer only to instances where a free and clear sale could be accomplished the trustee. The trustee is just the representative of the estate, id. § 323, which, in turn, is the assignee of the debtor’s property interests. Therefore, if one adopts the narrow interpretation, paragraph (1) would allow sale free and clear only when the owner of the property could accomplish such a sale under applicable non-bankruptcy law.
Regardless of how one reads “permits sale,” however, paragraph (1) is clearly limited to free and clear sales permitted under “applicable nonbankruptcy law.” Foreclosure is “nonbankruptcy law,” but so too is the law governing voluntary transfers. The question is which is “applicable,” meaning “fit, suitable, or right to be applied.” Webster’s Third International Dictionary 105. Because it cannot be both — or else paragraph (1) would be internally inconsistent — the Court must consider which law is more analogous to free and clear sales in bankruptcy.
At the outset, it is noteworthy that the Code distinguishes between bankruptcy and foreclosure proceedings. Section 362(a) automatically stays other proceedings against the debtor upon commencement of the case. See, e.g., In re Warburton Ave. Realty Corp.,
[A] sale of assets of a going (but floundering) concern in bankruptcy is not a foreclosure sale.... By purchasing assets rather than going through a foreclosure, the buyer obtained a going business and some important benefits, including the right to have the debtor assume any favorable contracts or leases and assign those to the buyer. Having chosen that fоrm of transaction, the buyer must take the bitter with the sweet.
In light of these substantial and material differences, the Court holds that paragraph (1) refers not to foreclosure sales, but rather “only to situations where the owner of the asset may, under nonbank-ruptcy law, sell an asset free and clear of an interest in such asset.” In re Jaussi,
2. Section 363(f)(5)
Paragraph (5) authorizes the trustee to sell the Property free and clear of the TGM Lease if “[TGM] could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of [its] interest.” Dishi cites the possibility of foreclosure by the Creditor as such a proceeding. See, e.g., In re Boston Generating, LLC,
In contrast, the narrow interpretation provides a limited role for paragraph (5), but avoids rendering the remaining paragraphs mere surplusage. See In re PW,
C. Adequate Protection Under Section 363(e)
Dishi also argues that the bankruptcy court abused its discretion in holding, in the alternative, that TGM is entitled to continued possession as adequate protection of its interest. Dishi argues that the court should have awarded a sum of money to TGM, or possession for a limited term, and that because Dishi reasonably believed that the sale would not be subject to the TGM Lease it is unfair to impose the entire burden of adequate protection upon it. Dishi does not cite any authority in support of the theory that a bankruptcy court must “fairly” allocate the burden of adequate protection. On the contrary, § 363(e) is focused upon protecting the entity whose interest is threatened, not other creditors or the purchaser. Section 363(e) directs that the court “shall prohibit or condition such use, sale, or lease as is necessary to provide adequate protection of such interest,” and § 361 defines such protection, inter alia, as such “relief ... as will result in the realization by such entity of the indubitable equivalent of such entity’s interest.” 11 U.S.C. §§ 361(3), 363(e) (emphases added). Absent any authority to the contrary, the Court must follow the plain language of the Code, which requires the bankruptcy court to provide “adequate protection,” which may include the indubitable equivalent of the interest, namely, continued possession.
Nor was the bankruptcy court’s decision unprecedented or otherwise unreasonаble. Where it is improbable that the lessee will receive any compensation for its interest from proceeds of the sale, and it is difficult to value the lessee’s unique property interest, other courts have similarly concluded
IV. Conclusion
For the foregoing reasons, the September 25, 2013 Order of the bankruptcy court is AFFIRMED.
The Clerk of Court is directed to enter judgment accordingly.
Notes
. The remaining 2.8% interest is owned by 11 East 36th LLC ("11 East 36th”), an affiliate of the Debtor. 11 East 36th has also filed a voluntary petition for Chapter 11 bankruptcy in a separate proceeding. 13-rg-l 1506.
. "BkD” refers to the docket for the bankruptcy court proceedings, ll-rg-15844. "Dkt” refers to the docket for the instant proceedings.
. The original Proof of Service submitted by the Creditor did not include the lessees as recipients of the notice, and the Debtor’s Schedule of Executory Contracts and Unexpired Leases did not contain any entries, lending credence to TGM’s claim that it lacked timely notice. (BkD Nos. 9 & 79; Sch. G.)
. In Chapter 11 proceedings, the debtor will ordinarily retain possession of its assets and operations and, as the “debtor in possession shall have all the rights ... and shall perform all the functions and duties ... of a trustee....” 11 U.S.C. § 1107(a). Accordingly, references herein to the trustee are also references to the debtor-in-possession.
. Section 363 is entitled "Use, sale, or lease of property.” Subsections (b) and (c) authorize the trustee to use, sell, or lease property of the estate within or outside the course of ordinary business. Subsection (f) is one subset or category of such sales.
. Some courts have taken a middle ground, holding that the two sections are irreconcilable but declining to adopt a per se rule in favor of weighing the interests in each case to determine which section should control. See, e.g., In re Spanish Peaks Holdings II LLC,
. Presumably, the minority interpretation holds that even when § 365(h) has been expressly triggered, § 363(f) governs because it specifically addresses the sale of property. This does not reconcile the provisions, but merely accepts the majority’s premise that there is a conflict and differs on which section ought to prevail.
. There is some dispute as to whether the lease automatically vests in the estate upon commencement of the estate but is unenforceable against the еstate absent assumption, or whether the lease does not vest in the estate absent assumption. See In re Taylor,
. In contrast, the trustee’s decision to assume, reject, or do nothing as to the lease does affect the lessee’s non-appurtenant rights and its remedies for breach. In the event of assumption, the "expenses and liabilities incurred [by the estate in administering the lease as lessor] may be treated as administrative expenses, which are afforded the highest priority on the debtor’s estate.” N.L.R.B. v. Bildisco & Bildisco,
Notwithstanding these variations, the important point is that the trustee’s decision whether and how to exercise the assume-or-reject power does not affect the lessee's appurtenant rights under the lease. Consequently, it is irrelevant for present purposes whether the failure to timely assume the lease should be deemed a de facto rejection triggering § 365(h), or instead (non-rejection) abandonment. Compare Qualitech,
. As noted, the lessor’s reversion is not created by the lease. It is the remainder of the lessor’s property interest, which exists after the lessor conveys an estate for years to the lessee. Thus, whatever the fate of the lease, the reversion is unaffected. Cf. Matter of Minges,
. It is not even clear whether the bankruptcy court approved the sale free and clear of TGM's rights, or instead approved the sale free and clear of interests other than such rights. (Compare Sale Approval Order 2 ("[T]he Debtor is directed to sell, transfer and convey the Property to the Purchaser as set forth in the Plan, free and clear of all liens, encumbrances.”), 5 ("[A]s adequate protection for the sale of the Property free and clear of the TGM Lease, [TGM] may remain in possession of the Property pursuant to sections 361(3) and 363(e).”), with id. at 5 ("[TGM’s] rights under section 365(h) of the Bankruptcy Code, including, but not limited to, the right to elect to remain in possession of the Property is fully preserved, notwithstanding the Debtor's sale of the Property and the rejection of the lease.”). This ambiguity stems, at least in part, from the disjunctive nature of the holding. The Court assumes that one basis for the holding is the bankruptcy court’s conclusion that § 365(h) preserves TGM’s rights notwithstanding the fact that § 363(f) was satisfied with respect thereto.
. Although Dishi states that it believed the sale would not be subject to the TGM Lease because the lease was rejected, this constitutes lack of notice as to the legal consequences of rejection, not ignorance of the lease's existence.
. For this reason, the Court is unpersuaded by the argument that paragraph (1) should be read to refer to foreclosure law because bankruptcy proceedings ought to mirror what would happen outside of bankruptcy. This merely begs the question of what scenario bankruptcy should tty to emulate.