In a recent case, the 9th Circuit allowed the sale of property ‘free and clear’ of tenant interests. The case decided in July, In re Spanish Peaks Holdings II, LLC, ruled that despite the tenant protections contained in § 365(h)of the Bankruptcy Code, a bankruptcy estate may sell property free and clear of leases. The court also ruled that tenants are entitled to “adequate protection” of their interests, as long as that they provide sufficient evidence and timely request it.
While the tenants in the Spanish Peaks argued that § 365(h) of Title 11 gave them the absolute right to remain at the property, they failed to both request adequate protection and provide evidence of the ensuing harm if they were forced to leave the property. As a result of these costly pleading omissions, the rental property was sold free and clear of their leases and the tenants received nothing to show for their losses.
In Spanish Peaks, the borrower owed the secured lender more than $122 million for a loan for a resort and casino in Montana. The underlying leases were inexpensive and involved insiders. The secured lender and the bankruptcy trustee stipulated that the property would be sold at auction for not less than $20 million, free and clear of all liens and interests.
The borrower objected to the sale arguing that § 365(h) of the Bankruptcy Code gave them the right to retain possession of the property. The Motion did not request adequate protection of their interests. After the property was sold for $26.1 million, the order approving the sale was ambiguous as to whether the property was sold free and clear of the leases. Motions for clarification of the sale order were then filed.
Pointing out that the lessees had not requested adequate protection for their leasehold interests prior to the sale, the bankruptcy court ruled that the sale was free and clear of the leases. In affirming the bankruptcy court’s decision, the district court held that the sale extinguished the leases because, under Montana law, the foreclosure of a mortgage would terminate any leasehold interest junior to the mortgage.
The lesson of Spanish Peaks for trustees and debtors-in-possession is that commercial leases should not be rejected unless the lessee is certain that the property will not be sold. Once rejected, tenants receive some rights as the provisions of 365(h) take effect.
The lesson of Spanish Peaks for trustees and debtors-in-possession is that rejection of a lease may actually secure their right to retain possession of the property if a later sale should occur. Also, if the lender files a motion to sell, tenants must actively and affirmatively request adequate protection providing evidence of any ensuing harm if forced to relocate from the subject property. Adequate protection would include the costs of moving and alternative rentals, as well as compensation for any disruption to the business.
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