The U.S. Court of Appeals for the First Circuit has held that a debtor’s interest in its liquor license constitutes property of the estate pursuant to section 541 of the Bankruptcy Code.

The First Circuit further held that the debtor’s rejection of its lease ended the debtor’s contractual right to continued use of its liquor license, and left the landlord with ordinary remedies for breach of contract—such as specific performance to obtain recovery of the license. See In re Ground Round, Inc. (Abboud v. Ground Round), 482 F.3d 15 (1st Cir. 2007).

In 1977, Joseph Abboud and several partners (collectively, the “Partnership”) leased certain real property located in West Chester, Pa. to the Howard Johnson Company (“Howard Johnson”) for use as a restaurant. The 10-year lease contained options for the lessee to extend for six periods of five years each. The debtor, The Ground Round, Inc., later succeeded Howard Johnson as lessee of the premises. In 1978, Ground Round obtained title to a Pennsylvania liquor license for use at the premises.

The lease addendum pertaining to the contemplated liquor license provided: “At the termination of the Lease, Lessee shall, in consideration of this Lease and One ($1) Dollar transfer such liquor license to Lessor free of all claims or violations….”

The debtor filed for chapter 11 protection in early 2004, while operating under the extended lease. Subsequently, Ground Round as debtor in possession rejected the lease under section 365 of the Bankruptcy Code, claiming the right to retain the liquor license after rejection of the lease. The Partnership commenced an adversary proceeding in the bankruptcy court, seeking specific performance of the lease provision requiring return of the license at the termination of the lease.

On cross-motions for summary judgment, the bankruptcy court granted the Partnership’s motion and granted the requested relief. The debtor appealed, and the Bankruptcy Appellate Panel for the First Circuit affirmed the bankruptcy court’s order. The debtor subsequently appealed the BAP’s decision, and the First Circuit affirmed the lower courts’ holdings.

The Partnership had argued that when the lease was executed, the Pennsylvania Liquor Code considered a liquor license to be “a personal privilege” and not “property,” and thus fell outside the purview of “property of the estate” pursuant to section 541 of the Bankruptcy Code. See 47 Pa. Stat. Ann. § 4-468(b.1) (1977).

The First Circuit rejected the Partnership’s contention. In doing so, the court noted that the Bankruptcy Code defines the debtor’s estate as “all legal or equitable interests of the debtor in property as of the commencement of the case,” and determined that this language must be broadly construed.

The court further noted that a bankruptcy estate generally cannot succeed to a greater interest in property than the debtor held prior to bankruptcy. The court found that, on the petition date, Ground Round had legal title to the license, and the right to retain and enjoy its benefits during the pendency of the lease; however, the debtor also had an obligation to restore the license to the Partnership at the end of the lease.

The First Circuit clarified that while rejection of the lease pursuant to section 365(g) of the Bankruptcy Code did not terminate the debtor’s title to the lease, rejection did, in fact, end Ground Round’s right under the lease to continued use of the liquor license. The court further noted that rejection of the lease also left the Partnership with ordinary remedies for breach of contract, including but not limited to, specific performance to retrieve the license.

The First Circuit rejected the debtor’s argument that allowing specific performance would undercut the right of rejection under section 365. The court held that where a claimant holds something akin to a property right in something held by the debtor, thatright survives bankruptcy and remains enforceable to recover property of the estate unless that right is cut off by provisions of the Bankruptcy Code.

The debtor also asserted that the Partnership’s request for specific performance and return of the license constituted a “claim” as defined by section 101(5) of the Bankruptcy Code. Since the Partnership had a claim, the debtor argued, granting the requested specific performance would violate the principle of equal treatment of creditors.

The First Circuit conceded that the Partnership’s equitable remedy could be classified as a claim under the Bankruptcy Code. However, the court also concluded that the debtor had failed to provide any reason for why classification of the remedy of the “claim” mattered, particularly in light of the fact that the Partnership did not seek a share of remaining assets, but a return of specific property.