Can a Commercial Real Estate Lease Be Voided by a Bankruptcy Sale of the Underlying Property?

A new ruling by the Third Circuit Court of Appeals in IDEA Boardwalk, LLC v. Revel AC, Inc. (In re Revel AC, Inc.), __ F.3d __ (3d Cir. Sept. 30, 2015), raises a bankruptcy issue that has so far not been definitively resolved by the appellate courts: Whether a bankrupt lessor of commercial property may effectively destroy its tenant’s rights by selling the underlying property in a bankruptcy sale “free and clear” of all claims and interests, including the tenant’s rights in its leasehold.

Revel AC vs. IDEA Boardwalk

In this case, the Revel casino, as lessor, had a 10-year lease with IDEA Boardwalk, under which IDEA could run two night clubs and a beach club at the Revel casino. After a successful trip through Chapter 11, Revel’s operations failed to recover, and it had to file a second bankruptcy. In the second proceeding, it sought to sell all of its assets, free and clear of all liens, claims, and interests – including that of the IDEA lease. Needless to say, IDEA objected.

The battle highlighted a conflict between two different provisions of the Bankruptcy Code. Section 365(h) states that, if a bankrupt-lessor of real property seeks to “reject” the lease, the non-debtor tenant may choose to retains its rights under the lease. On the other hand, section 363(f) provides that a debtor may sell property free and clear “of any interest in such property” by a non-debtor. Use of this provision, however, requires that, among other things: non-bankruptcy law permit the sale “free and clear;” the non-debtor consent; the interest be a lien; or the interest be in bona fide dispute.

Precision Industries vs. Qualitech Steel

Revel sought to rely upon section 363(f) and claimed that it took precedence over the right of IDEA in the lease. In doing so, Revel relied upon a 2003 decision by the Seventh Circuit, Court of Appeals in Precision Industries, Inc. v. Qualitech Steel SBQ, LLC, 327 F.3^rd 537 (7^th Cir. 2003). This held that a debtor’s authority to sell property free and clear of any interests, including that of a lease, takes precedence over the right of a tenant to keep its leasehold interest.

The Bankruptcy Court in the Revel case relied upon this opinion, as well as on the fact that, according to Revel, the lease was in fact in bona fide dispute, since IDEA was allegedly more akin to Revel’s partner rather than a mere tenant. The Bankruptcy Court accordingly allowed the sale to go forward, thereby threatening to void the IDEA lease.

The case was then appealed from the Bankruptcy Court’s decision, on an emergency motion to stay the sale order. Ultimately, the Third Circuit granted the stay. This will enable the matter to be fully decided on the merits, and hopefully for the Third Circuit to provide some clarity to what is now a murky area of bankruptcy law.

Are you a creditor in a bankruptcy?  Have you been sued by a bankrupt?  If you have any questions about your rights, please contact me, Joel Glucksman, at 201-806-3364.