BUSINESS RESTRUCTURING REVIEW
VOL. 21 • NO. 3
MAY–JUNE
2022
1
IN THIS ISSUE
1 Fifth Circuit Weighs In
on Bankruptcy Asset
Sales Free and Clear of
Leasehold Interests
6 Bright-Line Rule:
No Modification
of Substantially
Consummated Chapter 11
Plan
9 Delaware Bankruptcy
Court Rejects Use of Tax
Code Look-Back Period in
Avoidance Action
12 Florida District Court:
Foreign Debtor Need
Not Have U.S. Residence,
Assets, or Place of
Business to Be Eligible for
Chapter 15 Recognition
18 Fifth Circuit Rules that
Chapter 11 Debtors May
Reject Filed-Rate Contracts
Without FERC Permission
22 Newsworthy
FIFTH CIRCUIT WEIGHS IN ON BANKRUPTCY ASSET SALES FREE AND
CLEAR OF LEASEHOLD INTERESTS
Oliver S. Zeltner • Mar k G. Douglas
The ability of a trustee or chapter 11 debtor-in-possession (“DIP”) to sell bankruptcy estate
assets “free and clear” of competing interests in the property has long been recognized as
one of the most important advantages of a bankruptcy filing as a vehicle for restructuring
a debtor’s balance sheet and generating value. Still, section 363(f) of the Bankruptcy Code,
which delineates the circumstances under which an asset can be sold free and clear of
“any interest in such property,” has generated a fair amount of controversy. This is so in part
because the statute itself does not define “interest.”
Although section 363(f) is generally acknowledged to encompass liens and security inter-
ests, some courts, taking into account both the language of the provision and its under-
lying purpose, have interpreted it much more broadly to also include leasehold interests,
among other things. Broadly applied, however, section 363(f) arguably conflicts with certain
other provisions of the Bankruptcy Code.
One of those provisions is section 365(h)(1) of the Bankruptcy Code. That section provides
that, if the trustee or DIP rejects an unexpired real property lease under which the debtor
is the lessor, the nondebtor lessee (and any permitted successor or assign, pursuant to
subsection (h)(1)(D)) has the option of retaining its rights under the lease for the balance of
the lease term “to the extent that such rights are enforceable under applicable nonbank-
ruptcy law.”
Courts disagree as to whether the rights of a lessee (or sublessee) under section 365(h)
(1) are effectively extinguished where the debtor does not reject the lease and the leased
real property is sold free and clear under section 363(f). Until 2022, only two federal courts
of appeals had weighed in on this question, both staking out what was previously consid-
ered to be the minority view. In Precision Industries, Inc. v. Qualitech Steel SBQ, 327 F.3d
537 (7th Cir. 2003), the U.S.Court of Appeals for the Seventh Circuit disagreed with several
lower courts and held that a real property lease can be extinguished in a free-and-clear
sale of the property under section363(f), at least where the lease has not been formally
rejected. In Pinnacle Rest. at Big Sky, LLC v. CH SP Acquisitions, LLC (In re Spanish Peaks
Holding II, LLC), 872 F.3d 892 (9thCir. 2017), the Ninth Circuit essentially endorsed this posi-
tion, with certain caveats.
2
The Fifth Circuit is the latest circuit court to examine this issue,
but in an oblique way. In In re Royal Street Bistro, L.L.C., 26 F.4th
326 (5th Cir. 2022), the court denied certain tenants’ motion
for a writ of mandamus directing a district court to issue a stay
pending appeal of a bankruptcy court order approving the sale
of leased real property free and clear of the tenants’ leasehold
interests. However, instead of issuing a summary order without
explanation, the Fifth Circuit issued a brief per curiam opinion in
which it agreed with the result reached by the lower courts, but
signaled disagreement with Qualitech’s holding and cautioned
courts against “blithely accepting Qualitech’s reasoning and
textual exegesis.”
FREE-AND-CLEAR SALES
Section 363(f) of the Bankruptcy Code authorizes a trustee or DIP
to sell property “free and clear of any interest in such property
of an entity other than the estate” under any one of five speci-
fied conditions. These include, among other things, if applicable
nonbankruptcy law permits a sale free and clear, if the sale price
exceeds the aggregate value of all liens encumbering the prop-
erty, or if the interest is in bona fide dispute.
A bankruptcy court’s power to order sales free and clear of com-
peting interests without the consent of the party asserting the
interest has been recognized for more than a century. See Ray v.
Norseworthy, 90 U.S. 128, 131–32 (1875); Van Huffel v. Harkelrode,
284 U.S. 225, 227 (1931). A court-ordered free-and-clear sale
promotes the expeditious liquidation of estate assets by avoiding
delay attendant to sorting out disputes concerning the validity
and extent of competing interests, which can later be resolved
in a centralized forum. It also facilitates the estate’s realization of
the maximum value possible from an asset. A prospective buyer
would discount its offer significantly if it faced the prospect of
protracted litigation to obtain clear title to an asset.
Section 363(e) of the Bankruptcy Code provides that, upon the
request of an entity that has an “interest” in property proposed to
be sold by the trustee or DIP, the court “shall prohibit or condition”
the sale “as is necessary to provide adequate protection of such
interest.” Section 361 provides that “adequate protection may
be provided” by periodic cash payments to protect against any
decrease in value of the interest; an additional or replacement
lien (if the interest is a lien); or other relief, such as an administra-
tive expense claim, “as will result in the realization by such entity
of the indubitable equivalent of such entity’s interest in such
property.”
“ANY INTEREST” BROADLY CONSTRUED
Section 363(f) has been applied to a wide range of interests.
Courts, however, disagree regarding the precise scope of the
term “interest,” which is not defined in the Bankruptcy Code
or its accompanying legislative history. Most courts reject the
narrow approach adopted in a minority of cases under which
section363(f) is limited to in rem property interests or only those
claims that have already been asserted at the time the property
is sold. Instead, the majority have construed the term broadly
to encompass other obligations that may flow from ownership
of property, including, for example, successor liability claims.
See, e.g., Indiana State Police Pension Tr. v. Chrysler LLC (In re
Chrysler LLC), 576 F.3d 108 (2d Cir. 2009), judgment vacated on
other grounds, 558 U.S. 1087 (2009); In re Trans World Airlines, Inc.,
322 F.3d 283 (3d Cir. 2003); UMWA 1992 Benefit Plan v. Leckie
Smokeless Coal Co. (In re Leckie Smokeless Coal Co.), 99 F.3d
573 (4th Cir. 1996); In re PBBPC, Inc., 484 B.R. 860 (B.A.P. 1st Cir.
2013); In re ARSN Liquidating Corp., 2017 WL 279472 (Bankr. D.N.H.
Jan.20, 2017).
The scope of section 363(f) becomes an issue if a debtor-lessor
seeks to sell property free and clear of the possessory inter-
ests of tenants or subtenants. This is so because section 365(h)
(1) specifically protects such interests. As noted previously,
section 365(h)(1) provides that, if the trustee or DIP rejects an
unexpired real property lease under which the debtor is the
lessor, the nondebtor lessee (and any permitted successor or
assign) has the option to either: (i) treat the lease as terminated
and file a claim for breach; or (ii) retain its rights under the lease
for the balance of the lease term (including any renewal or
extension periods) “to the extent that such rights are enforceable
under applicable nonbankruptcy law.”
In enacting section 365(h)(1), lawmakers sought to “codify a deli-
cate balance between the rights of a debtor-lessor and the rights
of its tenants” by preserving the parties’ expectations in a real
estate transaction. In re Lee Road Partners, Ltd., 155 B.R. 55, 60
(Bankr. E.D.N.Y. 1993). The provision’s legislative history indicates
that lawmakers intended that rejection of a lease by a debtor-les-
sor should not deprive the tenant of its estate for the term for
which it bargained. SeeH.R. Rep. No. 95-595, 349–50 (1977); S.
Rep. No. 95-989, 60 (1978).
QUALITECH
The apparent conflict between sections 363(f) and 365(h)(1) was
considered as a matter of first impression at the court of appeals
level by the Seventh Circuit in Qualitech. In that case, a chapter 11
debtor sold substantially all of its assets (including a steel mill
with a warehouse leased to Precision Industries, Inc. (“Precision”)
for 10 years) to the mortgagee of the property. At the time of the
sale, the debtor had neither assumed nor rejected the Precision
lease. The order approving the sale provided that the assets
were to be conveyed “free and clear of all liens, claims, encum-
brances, and interests,” other than those specifically excepted.
The Precision lease, which was unrecorded, was not among the
exceptions. Precision was notified of the sale but chose not to
object. Instead, it negotiated with the ultimate buyer of the prop-
erty regarding the assumption of its lease. Those negotiations
proved futile, and Precision’s lease agreement ultimately was
deemed rejected in accordance with the terms of the debtor’s
chapter 11 plan.
Precision commenced litigation seeking a determination that,
pursuant to section 365(h) of the Bankruptcy Code, it retained a
