Reprinted with permission from the September 14, 2017 issue of The Legal Intelligencer. © 2017 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.
A fundamental benefit of Chapter 11 is a debtor's ability to assume and assign executory contracts and unexpired leases over the objection of a nondebtor counterparty, even when the contract contains otherwise valid anti-assignment provisions. Moreover, as demonstrated in a recent decision by the U.S. District Court for the District of Delaware, this statutory tool can be used despite its negative impact upon the underlying economics of the original contract, as in Antone v. Haggen Holdings (In re Haggen Holdings), 2017 U.S. Dist. LEXIS 139272 (D. Del. Aug. 30). Specifically, in Haggen, the district court effectively negated a profit sharing obligation contained within a commercial real estate lease by finding it to be an unenforceable restriction on assignment and unenforceable as a matter of law.
The debtors operated 164 grocery stores prior to filing Chapter 11 in September 2015. After filing, a sale process for certain of the stores was commenced, which included the proposed assumption and assignment of the underlying store leases. Antone Corp. was the lessor at one of the affected stores and objected to the assignment of its commercial property lease. The lease contained a profit sharing provision, which gave the landlord 50 percent of any net profits made by the debtors from the assignment of the lease. Antone objected because the proposed sale did not require the debtors to honor its profit sharing obligation. The landlord argued that any assumption and assignment of the lease must be conditioned upon full compliance with its terms, including payment of half the net profits. In support of its argument, Antone submitted declarations demonstrating that the profit sharing agreement was a bargained for right provided by the debtors as consideration for the landlord accepting below-market rent, and therefore must be enforced.
In response, the debtors argued that profit sharing was nothing more than an unenforceable anti-assignment provision pursuant to Bankruptcy Code Section 365(f). Section 365(f) prevents the enforcement of anti-alienation and other anti-assignment clauses contained in leases and executory contracts that would prevent a debtor from realizing the full value of its assets to the detriment of the creditor body. The Bankruptcy Court agreed with the debtors and approved the sale, authorized assumption and assignment of the lease and prohibited enforcement of the profit sharing provision.
On appeal, the landlord again pressed its argument that the court was required to examine the facts and circumstances of the particular lease, including those set forth in the declarations submitted in support of its objection that demonstrated the profit sharing provision was a bargained for element provided in exchange for below-market rent. The district court noted that the 365(f) anti-assignment prohibition not only deals with blanket prohibitions on assignment, but also prohibits any clause that restricts or conditions assignment to the extent it limits the debtor's ability to realize the full value of its assets for the bankruptcy estate. Thus, the district court would not allow a landlord to circumvent such a fundamental benefit of Chapter 11 through artful drafting in the lease. Consequently, it agreed with the Bankruptcy Court and found the profit sharing provision to be unenforceable as a matter of law pursuant to the plain language of Section 365(f).
In reaching its conclusion, the district court noted that the other courts which considered the issue have similarly refused to enforce profit sharing as a de facto anti-assignment provision, including a recent decision by the U.S. Bankruptcy Court for the Southern District of New York in the A&P bankruptcy cases. The district court found there to be no question that the provision conditioned assignment in a way that prevented the debtors from obtaining the full benefit of assignment. Notwithstanding any negotiated bargain, the landlord's interest could not rise above the policy interest of maximizing value to the estate for the benefit of all creditors. Interestingly, the district court noted that a court is not always required to look at the specific facts and circumstances, but rather only that a profit sharing provision is unenforceable as a matter of law. Accordingly, the district court upheld the Bankruptcy Court's ruling, with the result that the debtors were not required to pay the landlord any of the net profits received from assignment.
The ability of a debtor to maximize value through assumption and assignment of executory contracts and unexpired leases is fundamental to the bankruptcy process and employed in connection with sales under Bankruptcy Code Section 363 in a variety of Chapter 11 bankruptcy cases. Bankruptcy Code Section 365(f) protects that process by allowing assumption and assignment notwithstanding anti-assignment provisions in such contracts or leases. The ruling in Haggen is in accordance with other decisions on this issue and demonstrates that the courts will apply the plain language of the code and Congressional intent to provide debtors the opportunity to maximize value for creditors. Nevertheless, it makes matters a bit more difficult for landlords attempting to balance various economic interests at the outset of lease negotiations when there is some uncertainty over what terms might be found to be unenforceable restrictions on assignment and which are simply a spreading out of the economic cost of the lease over the lease term.