Sons v. Bay Condos LLC

510 B.R. 696

DISHI & SONS, Appellant,

v.BAY CONDOS LLC, 11 East 36 Note Buyer LLC, New York Pubs, Inc. d/b/a The Ginger Man, and Munitalp Corp., Appellees.

No. 13 Civ. 8300(JPO).

United States District Court, S.D. New York.

Signed May 28, 2014.

Lewis W. Siegel, Lewis W. Siegel, Esq., New York, NY, for Appellant.

Mark Allen Frankel, Backenroth Frankel & Krinsky, LLP, New York, NY, for Appellees.

OPINION AND ORDER

J. PAUL OETKEN, District Judge.

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. Alternatively, 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 declines to endorse the majority interpretation. Although § 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 notwithstandingthe trustee's rejection of the lease. Section 363(f), in turn, authorizes the trustee to extinguish the lessee's appurtenant rights—like any other interest in property—but only if one of five conditions is satisfied with respect thereto. The two sections thus work in harmony to establish that the lessee's appurtenant rights may not be terminated by rejection and must be taken into account in any proposed free and clear sale. If § 363(f) authorizes the trustee to sell property free and clear of such rights, nothing in § 365(h) mandates a contrary result. As this case demonstrates, however, § 363(f) will rarely permit such a sale, and consequently, the lessee's rights will generally be enforceable against the transferee of the property. In any event, the bankruptcy court did not abuse its discretion in holding that the lessee was entitled to continued possession as adequate protection of its interest. Accordingly, the judgment below is affirmed.

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.¹ Unit 101 is leased by New York Pubs, Inc. d/b/a The Ginger Man (“TGM”), which operates a bar on the premises. TGM's lease expires on December 31, 2015. Unit 102 is leased by JYA Cleaners, Inc. (“JYA”), which operates a laundromat. The Debtor owes 11 East 36th Note Buyer LLC (“Creditor”) approximately $13.5 million, which is secured by a mortgage on the Property (“Mortgage”).

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. All 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 ² No. 41 (“Initial Plan”) §§ 4.1, 6.1.) The Debtor filed its own plan on September 5, 2012, which proposed the sale of Unit 101 “free and clear of all liens, claims, taxes and non-permitted encumbrances,” but provided for “the assumption and assignment of the existing lease with [TGM].” (BkD No. 45 at 1.)

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 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 value of the Property at $4.45 million. (BkD No. 75 § 9.) On February 27, the bankruptcy court issued an order approving the Disclosure Statement and bidding and sale procedures, and scheduled a confirmation hearing for the Plan. On March 4, the Creditor submitted an Amended Proof of Service reflecting that notice of the sale, plan, and hearing had been mailed to all creditors and lessees, including TGM and JYA. (BkD No. 80.) A notice of sale was published in the New York Times on March 15. ( Id.)

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.³ (BkD No. 96.) The Creditor subsequently filed a motion seeking a determination of TGM's rights under the lease.

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., 255 F.3d 87, 92 (2d Cir.2001) (citations omitted). “In reviewing final decisions of bankruptcy courts, ... [f]indings of fact are reviewed for clear error. Legal conclusions are reviewed de novo.” Secs. Inv. Protection Corp. v. Bernard L. Madoff Inv. Secs. LLC, 474 B.R. 76, 80 (S.D.N.Y.2012) (citations omitted).

III. DiscussionA. 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) ⁴to “sell property [of the estate] ... free and clear of any interest in such property of an entity other than the estate,” provided that one of five conditions is met:

(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, 327 F.3d 537, 545–46 (7th Cir.2003). Where property is to be sold free and clear of an interest, the court must provide “adequate protection of such interest” upon request. 11 U.S.C. § 363(e). This may entail a cash payment, an additional or replacement lien, or “such other relief ... as will result in the realization by such entity of the indubitable equivalent of such entity's interest in such property.” Id.§ 361. Thus, at least in some cases, § 363(f) appears to authorize the sale of a debtor-lessor's property free and clear of leasehold interests, and the lessee's sole recourse is to request “adequate protection,” which may or may not amount to continued possession.

Section 365(h), in turn, governs the trustee's rejection of leases of a debtor-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 assume 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...