Burr Alert: Who Will Think of the Tenants: Split in Authority Regarding the Interplay Between Bankruptcy Code Sections 363(f) and 365(h)(1)(A)

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A useful tool granted to trustees (and debtors-in-possession) in bankruptcy is the ability to assume or reject leases. The trustee can exploit this power to the estate's economic advantage, either assuming or rejecting the lease, in an attempt to maximize the value of the estate. For the lessee of a bankrupt landlord, who may rely on the lease to run a business, the trustee's decision to assume or reject can have a profound effect. Thus, the Code protects lessees when the debtor decides to reject its lease. Section 365(h)(1)(A) of the Code allows lessees to either: (i) treat the lease as terminated or (ii) stay in possession and continue to pay rent.

Occasionally, the trustee will attempt to sell property subject to a lease without actually assuming or rejecting the lease. Under section 363(f), the trustee can sell property "free and clear of any interest" as long one of the five enumerated conditions are met.3 A 363(f) sale transfers the property free of any encumbrances, including any leasehold interests others might have possessed. Currently, there is a split of authority over whether a sale of leased property under section 363(f) extinguishes the lessee's interest and protections contained in section 365(h), or alternatively, whether a sale is tantamount to a rejection of the lease under section 365 and thus triggers the lessee's 365(h) protections.

In interpreting the relationship between these Code provisions, courts have taken at least four different approaches. While the 11th Circuit has not weighed in on the debate (and while it appears that only one U.S. Circuit Court has addressed the issue), the Southern District of Florida has read the provisions such that they do not come in conflict, and interpreted section 363(f) to permit a sale free of a leasehold interest without violating section 365(h).

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