Can a profit-sharing provision in a commercial lease survive assumption and assignment by a debtor? Analyzing such a provision, the Third Circuit answered “no,” finding the provision to constitute an unenforceable anti-assignment provision. Haggen Holdings, LLC v. Antone Corp, 739 Fed. Appx. 153 (2018).

Legal and Factual Background

Under Section 365(f)(1) of the Bankruptcy Code, with certain exceptions, a trustee (or a debtor-in-possession) in a bankruptcy case may assume and assign an executory contract notwithstanding anti-assignment provisions. As the Third Circuit explained, this Section “was designed to prevent anti-alienation or other clauses in leases and executory contracts assumed by the Trustee from defeating his or her ability to realize the full value of the debtor’s assets in a bankruptcy case.”

In Haggen Holdings, the Debtors sought to assume and assign several executory contracts and unexpired leases, one of which included a profit-sharing provision. According to the provision, in the event the Debtors assigned the lease or sublet more than 50% of the premises, they would pay the landlord 50% of “net profits.” The landlord objected to the assumption and assignment of the lease, asking the Bankruptcy Court to determine that the profit-sharing provision must be respected notwithstanding any assignment. Among other things, the landlord argued that the profit-sharing provision was the product of a bargained-for exchange, i.e., the landlord agreed to certain contractual terms favorable to the tenant in exchange for half of the tenant’s leasehold interest in any profits derived from an assignment of the lease.

The Bankruptcy Court denied the objections and approved the sale, holding that the profit-sharing provision was an unenforceable anti-assignment provision under Section 365(f)(1). The District Court affirmed and the landlord appealed to the Third Circuit.

The Third Circuit’s Ruling

The Third Circuit affirmed the District Court, explaining that the plain language of Section 365(f)(1) “encompasses more than merely provisions that actually prohibit the assignment of an executory contract or an unexpired lease.” Instead, the Court held, the statutory provision also extends to any clause that “restricts, or conditions” such assignment. The Court reasoned that the purpose of Section 365(f)(1) is to allow the trustee to realize the full value of the estate, and while profit sharing provisions are often part of carefully negotiated bargain, “benefits of bargain [may give] way to countervailing bankruptcy policy considerations.”

Finally, the Court distinguished between a profit-sharing provision and right of first refusal. The Court explained that while a right of first refusal is likely to “benefit a debtor’s estate by creating a bidding war between potential purchasers of estate assets[,]” a profit-sharing provision “function[s] only to extract value that would otherwise accrue to a debtor’s estate.”

Implications

While the Third Circuit’s ruling in Haggen Holdings was rendered in a non-precedential opinion, it signals how courts within the Circuit (and potentially elsewhere) are likely to treat profit-sharing provisions in bankruptcy. When negotiating profit-sharing provisions, parties should take stock of this decision and consider alternative mechanisms to accomplish their desired goal.

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