Section 365(h) of the Bankruptcy Code provides considerable protection to a tenant in the event of a bankruptcy filing by its landlord. Despite rejection of its lease, the tenant can elect to retain its rights, including the right to possession, for the balance of the term of the lease, including any renewal or extension period.[1] This is black-letter bankruptcy law reflecting a sound policy judgment: it would be ruinous to business (not to mention an individual or family) if a landlord could upend a tenant’s possession whenever economic circumstances made a bankruptcy filing necessary or desirable.
Section 363(f) of the Bankruptcy Code permits the sale of a debtor’s assets “free and clear” of any interest in those assets if one of five factors are satisfied.[2] The ability to strip assets of liens, claims and other interests enhances their value because purchasers would pay far less for assets that remain subject to the claims of a debtor’s creditors.
But what happens when these two sections are implicated by the same transaction? The sale of real property by a landlord “free and clear” of a tenant’s leasehold interest would terminate the tenant’s right to possession in apparent contravention of Section 365(h). But, Section 363(f) brooks no exception for a leasehold interest: it clearly provides for the sale of assets free and clear of “any interest” in the property.
Majority Approach – Conflict Must be Resolved In Favor of 365(h)
Most courts to consider this issue have found that Section 365 must prevail over Section 363 because basic rules of construction hold that “the specific prevails over the general.”[3] Courts in the majority have also found that allowing landlords to circumvent the protection afforded to tenants by Section 365(h) would be at odds with Congressional intent.[4] And, if the conflict between the two sections were resolved in favor of Section 363(f), then “the application of Section 365(h)(1)(A)(ii) as it relates to non-debtor lessees would be nugatory.”[5]
Minority Approach
A minority of courts, however, have concluded that the application of Section 365(h) is limited to lease rejection, not a sale of the debtor’s property. As one court has explained, “Section 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).”[6] The Seventh Circuit Court of Appeals adopted substantially this same view a few years later, holding that “the terms of section 365(h) do not supersede those of section 363(f)” because: (1) “the statutory provisions themselves do not suggest that one supersedes or limits the other,” (2) the plain language of section 365(h)(1)(A) suggests that it has a limited scope,” and (3) “section 363 itself provides for [adequate protection] to protect the rights of parties whose interests may be adversely affected by the sale of estate property.”[7]
In 2014, a judge in the Southern District of New York also declined to adopt the majority view.[8] Dishi & Sons v. Bay Condos, LLC concerned a request from the tenant of a debtor to remain in possession of a leased condominium unit despite the “free and clear” sale of the unit to a buyer pursuant to Section 363(f). After evaluating the majority and minority positions, the Dishi court began by noting its dissatisfaction with an outcome that would turn entirely on the precise timing of rejection and sale:
[In the view of some courts,] if a trustee explicitly rejects a lease by the time of the sale, he triggers the protections for lessees set forth in § 365(h), but if there is no timely rejection, § 363(f) permits a free and clear sale because § 365(h) is irrelevant.[9] [. . .] This reading may reconcile the outcomes in the case law, but it does not address the underlying interpretive arguments. The majority can still argue that § 363(f) will be used to undermine the protections of § 365(h), and the minority can still assert that the sections ought to be read harmoniously (at least when possible).[10]
Rejecting the majority view, the Court concluded that there is no conflict between sections...
