Dishi & Sons v. Bay Condos LLCDishi & Sons v. Bay Condos LLC
OPINION AND ORDER
Section 363(f) of the Bankruptcy Code,
This Court rеaches the same result, but declines 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 (“Disсlosure Statement”). Like the Initial Plan, the Plan proposed the sale of the Property “free and clear” of interests, 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 April 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
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 authоrizes the trustee to assume or reject unexpired leases or executory contracts of the debtor, subject to court approval.
(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.
Read and applied in isolation,
Advocates of the majority interpretation generally make three arguments. First, “it is a commonplace of statutory construction that the specific governs the general.” Morales v. Trans World Airlines, Inc.,
The rationale for the 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
[NJothing in the express terms ofsection 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 ofsection 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
This is a case in point. The Plan and Sale Approval Order unambiguously invoke both
The purported conflict between
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
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,
Consequently, extending
This interpretation also allows for the best reading of the Code as a whole. If
In sum,
B. Sale of the Property Free and Clear of the TGM Lease
The bankruptcy court did not state what grounds, if any, would permit a sale free and clear of TGM’s rights, and TGM argued that none would.
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 “apрlicable 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 tо 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.... ”
Regardless of how one reads “permits sale,” however, рaragraph (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 form 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.
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
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.”
Nor was the bankruptcy court’s decision unprecedented or otherwise unreasonable. 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....”
. 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 estate 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 convеys 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
. 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.