In re Haggen Holdings, LLC, No. BR 15-11874 (KG), 2017 WL 3730527 (D. Del. Aug. 30, 2017), a landlord objected to a sale of its lease by a Chapter 11 debtor on the basis that the landlord was entitled under its lease to 50% of the tenant’s net profit upon any lease assignment. The Delaware Bankruptcy Court overruled the landlord’s objection citing case law holding that the net profit provision in the lease was unenforceable as an impermissible condition to assignment under Sec. 365 (f)(1) of the Bankruptcy Code. Under Sec. 365(f)(1) a lease provision that “prohibits, restricts, or conditions” the assignment of a lease is unenforceable. Notwithstanding adverse case law, the landlord argued that the Bankruptcy Court should enforce the net profit provision in its lease under the equities of the case. The landlord introduced evidence that the lease rent was set below market in consideration of the tenant’s agreement to share a profit on any lease assignment.
On appeal of the Bankruptcy Court’s decision, the U.S. District Court for the District of Delaware affirmed. In addition to citing the plain language of Sec. 365(f)(1) and prior case law, the District Court rejected the landlord’s equities of the case argument on the basis that it was not supported by case law and that, in any event, a court is not required to consider the equities under Sec. 365(f)(1) “as a matter of law.”
It is not unusual for leases to include a provision similar to the one at issue in the Haggen Holdings decision. Even where the provision is shown to be supported by consideration, bankruptcy courts are unlikely to enforce them. However, note the case law on this issue applies only in federal bankruptcy proceedings. It has no application to most state court receiverships, which are not subject to similar statutory restrictions.
For questions, please contact Larry Coppel (410) 576-4238.
A strong economic argument can be made that Antone Corp. v. Haggen Holdings, LLC should have been decided differently. Section 365(f)(1) of the Bankruptcy Code invalidates a provision in a contract or unexpired lease that prohibits, restricts, or conditions the assignment of the contract or lease. The provision would be triggered if, for example, a lease stated that the landlord had the right to approve the identity of an assignee, and the landlord indicated that it would not consent to an assignment to a particular person or entity.
Antone v. Haggen Holdings, LLC, however, does not present this situation. To understand what is going on with respect to a lease assignment it is first necessary to appreciate the nature of the estate of the tenant (the debtor) under the lease. The tenant’s estate is what is set forth in the lease. It includes the right of occupancy upon paying the stated rent for the term of the lease (as well as any renewal terms). In this case it also includes the right to assign the lease and receive one-half of the net profit upon an assignment. Conversely, the landlord’s estate includes the right to receive one-half of the net profit if the tenant assigns the lease. Presumably, splitting the profit was bargained for as part of the economic package when the lease was signed.
Now the tenant (debtor) wants to assign its interest in the lease. A case can be made that Section 365(f)(1) should not be implicated. Nothing in the lease is stopping the tenant (debtor) from assigning the interest that it has. For better or for worse, that interest includes the right to half of the net profit at the time of the assignment – not all of the profit. Why should the landlord be deprived of a portion of its bargained for interest because its tenant filed for bankruptcy and then wants to assign its lease?
For questions on this comment, please contact Ed Levin (410) 576-1900.