Lease Analysis Gives Win for Commercial Landlord In Bankruptcy Case

The principal substantive holding in the complex case ultimately turned on the district court’s analysis of the purported lease itself, something never considered in the prior three years of the litigation. First, held the Second Circuit, Code §365(d)(4) applies “only to a ‘true’ or ‘bona fide’ lease.” Id. at *3, quoting Int’l Trade Admin. v. Rensselaer Polytechnic Inst., 936 F.2d 744, 748 (2d Cir. 1991) (RPI). Focusing “on ‘the economic substance of the transaction and not its form,’” the court asked “whether the parties intended to impose obligations and confer rights significantly different from those arising from the ordinary landlord/tenant relationship.” Id. Because the lessee, the debtor here, may have “assume[d] and discharge[d] many of the risks and obligations ordinarily attributed to the outright ownership of property [e.g., payment of property taxes],” the landlord would gain “an inequitable windfall” if it were able to recover the “leased” property. Id. In other words, if the debtor effectively owned the property, no “true lease” relationship existed.

The Sears case was governed by the Second Circuit’s RPI decision, explained the court. The purported lease here “is for a term of 100 years. [The debtor] prepaid its rent for the first thirty years of the lease term, and owed [the landlord] just $10 in annual rent thereafter. … [The debtor] paid taxes and other costs associated with the property [and] could, after fifteen years of operation, cease to operate and sublease any portion of the property, or assign the entire lease, all without [the landlord’s] consent.” Id. To allow the landlord to “recapture” the property “over sixty years before the expiration of” the purported lease “would amount to a windfall [and] would be grossly inequitable,” Id.