Fifth Circuit Ruling Gives Commercial Lessees Likely Protection In Bankruptcy Court Free and Clear Asset Sales

The Court of Appeals stressed that the lower courts "made the mistake of relying on" the Seventh Circuit's heavily criticized decision in Precision Indus Inc. v. Qualitech Steel S.B. Q., 327 F.3d 537, 547 (7th Cir. 2003) (Section 365(h) lessee protections against a debtor-lessor do not supersede the free and clear sale terms of Section 363(f)). On the facts of the limited motion before it, the Fifth Circuit rejected the lower courts' "overstatement of their reasoning," based on their "serious misinterpretation of law or facts." 2022 WL 499938, at *2. Because the "essential state law rights of the tenants in this case [were] limited by the senior mortgagee's prior lien on the" property being sold, however, "neither [Code] Section 363(e) nor 365(h)(A)(ii) offers [the lessee-appellants] protection." Id. "[S]tate law [was] all that the bankruptcy court needed to decide this case" against the lessees. Id.

Relevance

The Third Circuit stressed in another similar case that a bankruptcy trustee or Chapter 11 debtor-in-possession cannot summarily use a free and clear sale under Code §363(f) to sell property subject to a lease free and clear of the lease and thus extinguish a tenant's possessory interest. In re Revel AC, Inc., 802 F.3d 558, 564, 573 (3d Cir. 2015) (2-1) (lessee sought stay pending appeal from sale order that would "wipe out" the lessee's interest; stay granted because, among other things, "success to it on the merits was assured"). It stressed that Code §365(h) protects the lessee's interest after the trustee's rejection of the lease when the interest is not disputed in good faith. Id. Although the Fifth Circuit in Royal Bistro did not cite Revel, it noted the heavy criticism of Qualitech by other courts and commentators. See, e.g., Dishi & Sons v. Bay Condos LLC, 510 B.R. 696, 704 (S.D.N.Y. 2014) (criticizing Qualitech); In re Samaritan Alliance LLC, 2007 WL 4162918, *4 (Bankr. E.D. Ky. Nov. 21, 2007); In re Haskell L.P., 321 B.R. 1, 9 (Bankr. D. Mass. 2005); Michael S. Patrick Baxter, "Section 363 Sales Free and Clear of Interests: Why The Seventh Circuit Erred in Precision Industries v. Qualitech Steel," 59 Bus. Law. 475, 500-01 (2004) (Baxter) (Qualitech had "the potential to profoundly impact the bankruptcy world"; Qualitech "is wrongly decided and should not be followed"; "a debtor's right to sell free and clear of interests under §363(f) is expressly limited by §365(h)."); Robert M. Zimman, "Precision in Statutory Drafting: The Qualitech Quagmire and the Sad History of §365(h) of the Bankruptcy Code," 38 John Marshall L. Rev. 97, 106-8 (2004) (acknowledging turmoil created by Qualitech; Congress has consistently reaffirmed lessees' rights under Code §365(h)).