Casino Tenants Revel in Victory Enforcing Section 365(h) Rights
Reprinted with permission from the July 17, 2015 issue of The Legal Intelligencer. © 2015 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.
The ill-fated Revel Casino bankruptcy has presented a spectacle worthy of a television miniseries. From the very public destruction of a multibillion-dollar investment to the ongoing dispute with its adjoining power supplier, this case has managed to stay in the news for several years. It has also helped further develop several important legal issues that arise in contested Chapter 11 sales, one of which involves the ongoing rights of a tenant who is party to a rejected lease of property sold pursuant to Section 363. Generally, Section 365(h) of the Bankruptcy Code permits a tenant certain protections even after the debtor-landlord rejects its lease, including the ability to remain in possession for the balance of the term as well as any renewal or extension period. Obviously, this provision can be very important for tenants, particularly those with significant time remaining on a favorable lease. But what happens if the debtor sells the property "free and clear" pursuant to Section 363? The U.S. Bankruptcy Court for the District of New Jersey has shed further light on that issue by confirming that such rights are not wiped out by a "free and clear" sale of the debtors' assets under Section 363 of the Bankruptcy Code, but rather remain intact under Section 365(h), in IDEA Boardwalk LLC v. Revel Entertainment Group LLC (In re Revel AC), 2015 Bankr. LEXIS 2090 (Bankr. D.N.J. June 24, 2015).
Prior to the debtors' Chapter 11 bankruptcy filing in June 2014, IDEA Boardwalk LLC and other tenants entered into agreements to operate various retail facilities at the Atlantic City, New Jersey, casino premises. After filing, the debtors moved to reject the tenant agreements under Section 365 of the Bankruptcy Code. Less than a week after filing the rejection motion, the debtors ceased operations and barred the tenants from entering the premises. Each of the tenants gave notice of their intent to continue exercising possessory leasehold rights under Section 365(h). IDEA also immediately commenced an adversary proceeding against the debtors, seeking, among other things, a preliminary injunction prohibiting them from engaging in conduct that prevented IDEA from enjoying its possessory rights, including the right to utilities and necessary easements.
In April, the bankruptcy court approved the sale of the debtors' assets to Polo North Country Club Inc. Thereafter, IDEA filed a cross-motion to the rejection motion, seeking clarification of its Section 365(h) rights.
As a result of the sale, Polo North stood in the shoes of the debtors with respect to the rejection motion and IDEA's adversary proceeding. Polo North argued that the tenants' Section 365(h) elections were invalid because their agreements were not true leases, but instead were either management or joint venture agreements that provided no possessory rights capable of being retained. As such, the agreements were not governed by Section 365(h). In response, the tenants argued that Section 365(h) applied because the agreements were true leases.
U.S. Bankruptcy Judge Michael B. Kaplan first considered whether true leases existed under New Jersey law, which requires a determination of the parties' intention "as revealed by the language employed in establishing their relationship, and, where doubt exists, by the circumstances surrounding its making as well as by their course of operation under it." The court concluded that the express terms of the agreements, and the supporting affidavits submitted, made it clear that the debtors and the tenants unequivocally intended to enter into true lease agreements. Within the agreements, the terms "tenant," "lease," "landlord" and "rent" were used "hundreds, if not thousands" of times. Each of the agreements contained similar express language that they did not operate to create any relationship between the parties other than that of landlord and tenant. The agreements also contained quiet enjoyment provisions typically found in lease agreements and suggesting a grant of possessory rights. The court further reasoned that the agreements provided for the payment of rent, provided for a set term of years, granted the tenants possessory interests and the right to exclusive use of the leased premises during the term, and were not, absent default, revocable at any time by the landlord. The court therefore concluded that the language of the tenants' agreements and the conduct of the parties from the outset evidenced a typical landlord-tenant relationship and the existence of true leases.
Having determined that true leases existed, Kaplan next turned to whether the Section 363 sale of the debtors' assets to Polo North vitiated the tenants' rights under Section 365(h). While noting that the order approving the sale to Polo North made the sale subject to the tenants' interests, Kaplan also reasoned, more importantly, that "a Section 363 sale does not and could not trump the rights granted to the tenants by Section 365(h)." In support, Kaplan looked to a prior decision in In re Crumbs Bake Shop, 2014 Bankr. LEXIS 4568 (Bankr. D.N.J. Oct. 31, 2014), issued less than a year earlier. There, in analyzing a code provision very similar to Section 365(h), it was found that nothing in Section 363(f) trumps or overrides the rights of a licensee under Section 365(n), which provides that an intellectual property licensee whose license is rejected can either treat the license as terminated by such rejection or retain its rights for the duration of the contract, including any extension period to which the licensee may be entitled. Kaplan concluded that the Crumbs analysis was relevant to the issue at hand. The Crumbs court noted the appropriate construction of a statute demands that "the specific governs over the general." In determining licensees' rights under Section 365(n), the Crumbs court looked to decisional law interpreting Section 365(h) and concluding that Congress specifically gave lessees the option to remain in possession after a lease rejection, such that if a Section 363 sale were to be free and clear of lessees' interests, Section 365(h)'s protections would be rendered worthless. The Crumbs court also cited decisional law finding that the legislative history of Section 365(h) evidenced Congress's desire to protect the rights of tenants.
The court therefore concluded that because the tenants elected to remain in possession of the leased premises pursuant to Section 365(h), they were entitled to do so for the balance of the term set forth in their respective agreements and any renewal or extension period. After rejection, however, Polo North (as landlord) was no longer obligated to continue performance under the leases, other than to provide the tenants with possession of the premises and the rights appurtenant thereto.
IDEA's request for a preliminary injunction was also granted, which prohibited Polo North from interfering with IDEA's ability to avail itself of the rights under the lease, including the right to quiet enjoyment. In order to avoid breaching the obligation of quiet enjoyment, Polo North was required to refrain from interfering with IDEA's access to the premises, its infrastructure and distribution systems, including the provision of utilities, so long as IDEA's use and access complies with all local, state and federal regulations and laws. The court did find, however, that Polo North was not responsible for providing services, incurring costs, or otherwise increasing its liability under the lease. Kaplan also declined to grant IDEA an easement or license, to which IDEA asserted it was entitled, in granting a preliminary injunction, because to do so "would enhance IDEA's rights, rather than preserve them."
Coming on the heels of the decision in Crumbs, the Revel decision is another reminder to debtors, asset purchasers and bankruptcy practitioners that a "free and clear" sale under Section 363 of the Bankruptcy Code will not trump the rights of contractual counterparties protected under Section 365. Together, the decisions provide nondebtor tenants and licensees additional comfort that the key terms of their pre-petition agreements with a debtor will likely survive postpetition, even in the face of an intervening sale of the debtor's assets and rejection of the agreement. It also suggests that during contract negotiations for the use or possession of real property with a non-bankrupt, but financially weak counterparty, the drafting of such agreement as a true lease could provide significant benefits should the landlord subsequently seek bankruptcy protection.
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