Anti-Assignment Clause?

The commencement of a Chapter 11 bankruptcy case by a tenant will typically give rise to myriad issues and challenges for a commercial landlord, based upon various Bankruptcy Code provisions that may, and often will, change the parties' otherwise applicable rights and obligations pursuant to the terms of the lease and applicable non-bankruptcy law.

One such issue that landlords often faced is the post-petition enforceability of anti-assignment provisions that are commonly found within lease agreements. Last year, the Third Circuit weighed in on this issue by affirming an order from the Delaware Bankruptcy Court reopening a Chapter 11 case of a reorganized debtor in order to permit the debtor's assignee to exercise a purchase option in a lease, notwithstanding the anti-assignment clauses contained therein. See In re Lazy Days' RV Center Inc., No. 12-4047, — F3d. –, No. 12-4047 (3d Cir. July 30, 2013). In doing so, the Third Circuit reaffirmed the policy underlying anti-assignment provisions in connection with bankruptcy cases, and the extent of bankruptcy courts' jurisdiction after closure of a case.

The I-4 Lease and Related Settlement Agreement

I-4 Land Holding Limited Co. (I-4) owned certain property in Florida, which it leased to Lazy Days' R.V. Center, Inc. (Lazy Days) pursuant to a written lease (the Lease) entered into in July 1999. The lease provided Lazy Days with an option to purchase the real property in question, and otherwise prohibited its assignment or transfer without I-4's written consent, with certain exclusions. Beginning in 2008, Lazy Days failed to pay rent as it came due, and informed I-4 of its intention to file for Chapter 11 and to assign the Lease to LDRV Holding Corp. (LDRV).

Lazy Days and I-4 ultimately reached a settlement agreement in October 2009 (the Settlement) pursuant to which: 1) I-4 consented to the proposed assignment; and 2) Lazy Days agreed that it would not “argue against the bankruptcy court abstaining from consideration of Lease interpretation issues ' except to the extent necessary in connection with the assumption and assignment of the Lease as contemplated herein.” Id . at * 1. While the Settlement did not specifically address whether the purchase option would survive the assignment, the Settlement did provide that “there is no intent to, nor is the Lease modified in any respect and the Lease and all terms and conditions thereof remain in full force and effect.” Id.

The Chapter 11 Case

Lazy Days and LDRV (the “Reorganized Debtors”) commenced their respective bankruptcy cases in November 2009. The bankruptcy court confirmed a plan of reorganization incorporating the Settlement in December 2009. The Chapter 11 case was ultimately closed in March 2010, and, thereafter, the Lease was assigned to LDRV in accordance with the terms of the Settlement.

In May 2011, LDRV attempted to exercise the purchase option contained in the Lease, and when I-4 refused to honor the purchase option, LDRV and I-4 filed lawsuits in Florida state courts, requesting adjudication of their rights in connection with the Lease. Contemporaneously therewith, the Reorganized Debtors moved in the bankruptcy court to reopen the Chapter 11 cases, arguing that the anti-assignment provision of the Lease was unenforceable pursuant to Section 365(f)(3) of the Bankruptcy Code, which provides in relevant part that an unexpired lease may not be terminated pursuant to an anti-assignment provision contained therein. 11 U.S.C. ' 365(f)(3).

Following opposition by I-4 and a contested hearing, the bankruptcy court held that: 1) the anti-assignment provision was unenforceable; and 2) I-4's refusal to honor the purchase option violated the Settlement. As a result, the bankruptcy court ordered I-4 to honor the option. I-4 appealed to the federal district court which then vacated the bankruptcy court's order, holding that the bankruptcy court's judgment was an advisory opinion directed at the Florida state courts in which the parties' litigation was pending.

The Third Circuit Appeal and Decision

On appeal, the Third Circuit reversed the decision of the district court and remanded the case to the bankruptcy court. The Third Circuit upheld the bankruptcy court's subject matter jurisdiction to reopen the cases to address the dispute over the Settlement, which it confirmed as part of the Reorganized Debtors' plan of reorganization.

For similar reasons, the Third Circuit held that the bankruptcy court was not required to abstain under 28 U.S.C. ' 1334(c)(2). Moreover, the Third Circuit found the provision in the lease providing that the Reorganized Debtors would not argue against abstention to be unavailing, as the provision provided an exception for matters asserted “in connection with the assumption and assignment of the Lease[,]” id. at *5, and the instant dispute concerned the assignment.

The Third Circuit concluded that, “[e]ven assuming arguendo that the parties may waive the protections of ' 365(f)(3), neither of these provisions unambiguously eliminates the purchase option, as both could be read to mean that LDRV steps into Lazy Days['] shoes and acquires all the rights and obligations that Lazy Days had, notwithstanding any anti-assignment provisions.” Id . Moreover, the Third Circuit noted that the principle of ' 365(f)(3) “is that anti-assignment clauses are unenforceable in bankruptcy.” Accordingly, the Third Circuit found that the Settlement did not waive the anti-assignment protections of ' 365(f)(3).

Practical Considerations

By reversing the decision of the district court, the Third Circuit reaffirmed the significance of bankruptcy jurisdiction after closure of a bankruptcy case. Indeed, notwithstanding that state court litigation had been commenced to determine the parties' respective rights under the Lease, the bankruptcy court was permitted to intervene, essentially to interpret and enforce the confirmation order it previously approved which incorporated the Settlement.

Practically speaking, the Lazy Days ' decision re-emphasizes the use of bankruptcy as a strategic tool and stresses the importance of the fundamentals associated with anti-assignment provisions in leases adjudicated under the Bankruptcy Code. Landlords should be mindful, however, that there are pre and post-petition steps that can ' and, depending upon the particular facts and circumstances, should ' be taken in order to minimize risk and mitigate damage, including: 1) the pre-petition enforcement of any and all available state law rights and remedies, such as preemptive termination, or eviction for nonpayment; 2) the inclusion in a lease agreement of a liquidated damages clause, which may help to quantify damages in the event of a lease rejection; 3) the collection of any and all necessary cure payments; 4) challenging the assumption of a lease; and 5) the filing of a proof of claim in the bankruptcy case.

Steven B. Smith is a partner and Dana Gale Hefter is an associate at Edwards Wildman Palmer LLP.

The commencement of a Chapter 11 bankruptcy case by a tenant will typically give rise to myriad issues and challenges for a commercial landlord, based upon various Bankruptcy Code provisions that may, and often will, change the parties' otherwise applicable rights and obligations pursuant to the terms of the lease and applicable non-bankruptcy law.

One such issue that landlords often faced is the post-petition enforceability of anti-assignment provisions that are commonly found within lease agreements. Last year, the Third Circuit weighed in on this issue by affirming an order from the Delaware Bankruptcy Court reopening a Chapter 11 case of a reorganized debtor in order to permit the debtor's assignee to exercise a purchase option in a lease, notwithstanding the anti-assignment clauses contained therein. See In re Lazy Days' RV Center Inc., No. 12-4047, — F3d. –, No. 12-4047 (3d Cir. July 30, 2013). In doing so, the Third Circuit reaffirmed the policy underlying anti-assignment provisions in connection with bankruptcy cases, and the extent of bankruptcy courts' jurisdiction after closure of a case.

The I-4 Lease and Related Settlement Agreement

I-4 Land Holding Limited Co. (I-4) owned certain property in Florida, which it leased to Lazy Days' R.V. Center, Inc. (Lazy Days) pursuant to a written lease (the Lease) entered into in July 1999. The lease provided Lazy Days with an option to purchase the real property in question, and otherwise prohibited its assignment or transfer without I-4's written consent, with certain exclusions. Beginning in 2008, Lazy Days failed to pay rent as it came due, and informed I-4 of its intention to file for Chapter 11 and to assign the Lease to LDRV Holding Corp. (LDRV).

Lazy Days and I-4 ultimately reached a settlement agreement in October 2009 (the Settlement) pursuant to which: 1) I-4 consented to the proposed assignment; and 2) Lazy Days agreed that it would not “argue against the bankruptcy court abstaining from consideration of Lease interpretation issues ' except to the extent necessary in connection with the assumption and assignment of the Lease as contemplated herein.” Id . at * 1. While the Settlement did not specifically address whether the purchase option would survive the assignment, the Settlement did provide that “there is no intent to, nor is the Lease modified in any respect and the Lease and all terms and conditions thereof remain in full force and effect.” Id.

The Chapter 11 Case

Lazy Days and LDRV (the “Reorganized Debtors”) commenced their respective bankruptcy cases in November 2009. The bankruptcy court confirmed a plan of reorganization incorporating the Settlement in December 2009. The Chapter 11 case was ultimately closed in March 2010, and, thereafter, the Lease was assigned to LDRV in accordance with the terms of the Settlement.

In May 2011, LDRV attempted to exercise the purchase option contained in the Lease, and when I-4 refused to honor the purchase option, LDRV and I-4 filed lawsuits in Florida state courts, requesting adjudication of their rights in connection with the Lease. Contemporaneously therewith, the Reorganized Debtors moved in the bankruptcy court to reopen the Chapter 11 cases, arguing that the anti-assignment provision of the Lease was unenforceable pursuant to Section 365(f)(3) of the Bankruptcy Code, which provides in relevant part that an unexpired lease may not be terminated pursuant to an anti-assignment provision contained therein. 11 U.S.C. ' 365(f)(3).

Following opposition by I-4 and a contested hearing, the bankruptcy court held that: 1) the anti-assignment provision was unenforceable; and 2) I-4's refusal to honor the purchase option violated the Settlement. As a result, the bankruptcy court ordered I-4 to honor the option. I-4 appealed to the federal district court which then vacated the bankruptcy court's order, holding that the bankruptcy court's judgment was an advisory opinion directed at the Florida state courts in which the parties' litigation was pending.

The Third Circuit Appeal and Decision

On appeal, the Third Circuit reversed the decision of the district court and remanded the case to the bankruptcy court. The Third Circuit upheld the bankruptcy court's subject matter jurisdiction to reopen the cases to address the dispute over the Settlement, which it confirmed as part of the Reorganized Debtors' plan of reorganization.

For similar reasons, the Third Circuit held that the bankruptcy court was not required to abstain under 28 U.S.C. ' 1334(c)(2). Moreover, the Third Circuit found the provision in the lease providing that the Reorganized Debtors would not argue against abstention to be unavailing, as the provision provided an exception for matters asserted “in connection with the assumption and assignment of the Lease[,]” id. at *5, and the instant dispute concerned the assignment.

The Third Circuit concluded that, “[e]ven assuming arguendo that the parties may waive the protections of ' 365(f)(3), neither of these provisions unambiguously eliminates the purchase option, as both could be read to mean that LDRV steps into Lazy Days['] shoes and acquires all the rights and obligations that Lazy Days had, notwithstanding any anti-assignment provisions.” Id . Moreover, the Third Circuit noted that the principle of ' 365(f)(3) “is that anti-assignment clauses are unenforceable in bankruptcy.” Accordingly, the Third Circuit found that the Settlement did not waive the anti-assignment protections of ' 365(f)(3).

Practical Considerations

By reversing the decision of the district court, the Third Circuit reaffirmed the significance of bankruptcy jurisdiction after closure of a bankruptcy case. Indeed, notwithstanding that state court litigation had been commenced to determine the parties' respective rights under the Lease, the bankruptcy court was permitted to intervene, essentially to interpret and enforce the confirmation order it previously approved which incorporated the Settlement.

Practically speaking, the Lazy Days ' decision re-emphasizes the use of bankruptcy as a strategic tool and stresses the importance of the fundamentals associated with anti-assignment provisions in leases adjudicated under the Bankruptcy Code. Landlords should be mindful, however, that there are pre and post-petition steps that can ' and, depending upon the particular facts and circumstances, should ' be taken in order to minimize risk and mitigate damage, including: 1) the pre-petition enforcement of any and all available state law rights and remedies, such as preemptive termination, or eviction for nonpayment; 2) the inclusion in a lease agreement of a liquidated damages clause, which may help to quantify damages in the event of a lease rejection; 3) the collection of any and all necessary cure payments; 4) challenging the assumption of a lease; and 5) the filing of a proof of claim in the bankruptcy case.

Steven B. Smith is a partner and Dana Gale Hefter is an associate at Edwards Wildman Palmer LLP.