In Re Jamesway Corp.
1996 Bankr. LEXIS 1426, 201 B.R. 73, 1996 WL 560122 (1996)
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Rule of Law:
Under Bankruptcy Code § 365(f)(1), lease provisions that condition a debtor-in-possession's right to assign an unexpired lease upon paying a portion of the assignment proceeds or 'profits' to the landlord are unenforceable, as they restrict the debtor's ability to maximize the value of its assets for the benefit of creditors.
Facts:
- On October 18, 1995, Jamesway Corporation and its affiliates filed separate petitions for relief under Chapter 11 of the Bankruptcy Code.
- Jamesway was a tenant in the Newberry Commons shopping center under a lease with Massachusetts Mutual Life Insurance Company (Mass Mutual), which contained Paragraph 17.
- Paragraph 17 of the Newberry Lease stipulated that if Jamesway assigned the lease, it would pay Mass Mutual 50% (and later 60%) of the 'profits' (excess payment over fixed and additional rent, excluding certain costs) received from the assignee.
- Jamesway also leased retail premises from Monticello Mall (Monticello) and Tri-State Mall (Tri-State), with similar lease modification paragraphs (Monticello Lease Modification ¶ 14 and Tri-State Lease Modification ¶ 13).
- These Monticello and Tri-State lease provisions required Jamesway to pay the respective landlords one-third of the 'appreciated value of the leasehold' received from an assignee (amount paid by assignee less net book value of fixtures, inventory, and improvements).
- Jamesway sought to assume and assign the Newberry Lease to Rite Aid of Pennsylvania, Inc. for $100,000.
- Jamesway also sought to assume and assign the Monticello Lease to Ames Realty II, Inc. for $2,750,000 and the Tri-State Lease to SNJ Corporation for $80,000.
Procedural Posture:
- Jamesway Corporation and its affiliates filed separate petitions for relief under Chapter 11 of the Bankruptcy Code in the U.S. Bankruptcy Court for the Southern District of New York.
- Jamesway, as debtor-in-possession, filed a motion under Bankruptcy Code § 365 to assume and assign the Newberry Lease to Rite Aid of Pennsylvania, Inc.
- Mass Mutual objected to the assignment of the Newberry Lease, but the Bankruptcy Court granted Jamesway's motion.
- During the settlement of the order for the Newberry Lease assignment, a dispute arose over the enforceability of the profit-sharing provision (Paragraph 17), leading to $50,000 of the assignment proceeds being placed in escrow.
- Jamesway subsequently moved for and received Bankruptcy Court approval to assume and assign the Monticello Lease to Ames Realty II, Inc., and the Tri-State Lease to SNJ Corporation.
- Monticello and Tri-State each filed proofs of administrative claim seeking their alleged share of the profits from these lease assignments.
- Jamesway then filed a request with the Bankruptcy Court for an order declaring the profit-sharing provisions in all three leases unenforceable under Bankruptcy Code § 365(f)(1) and for the release of the $50,000 held in escrow.
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Issue:
Does Bankruptcy Code § 365(f)(1) invalidate lease provisions that require a debtor-in-possession to pay a landlord a percentage of the 'profit' or 'appreciated value' realized from assigning an unexpired lease?
Opinions:
Majority - James L. Garrity, Jr.
Yes, Bankruptcy Code § 365(f)(1) invalidates lease provisions that require a debtor-in-possession to pay a landlord a percentage of the 'profit' realized from assigning an unexpired lease. The court emphasized that § 365 reflects a clear Congressional policy to assist the debtor in realizing the full equity in all its assets for the benefit of unsecured creditors, promoting reorganization or liquidation efforts. Provisions that condition a debtor's assignment right upon payment of 'profits' or 'appreciated value' are considered restrictions or conditions on assignment, as they limit the debtor's ability to realize the full economic value of the lease. Enforcing such clauses would compel the debtor to comply with the very condition that § 365(f)(1) was designed to invalidate, rendering the statute nonsensical. The court clarified that subsections (f)(1) and (f)(3) operate in tandem but address different problems, so a broad interpretation of (f)(1) does not render (f)(3) superfluous. Previous case law routinely invalidates such profit-sharing clauses under § 365(f)(1) (e.g., Robb v. Schindler, In re Standor Jewelers West, Inc.). The Landlords, the court stated, cannot, by artful drafting, thwart the fundamental bankruptcy policy allowing a debtor to realize maximum value from its assigned leases. The court also rejected the argument for a balancing test to enforce 'reasonable' fees, finding no support for such a test in § 365(f)(1). Finally, the court found Mass Mutual had not waived its right to challenge the enforceability of Paragraph 17, as evidenced by the $50,000 escrow agreement that explicitly preserved the dispute for later resolution.
Analysis:
This decision significantly clarifies the scope of Bankruptcy Code § 365(f)(1), firmly establishing that clauses requiring a debtor to share assignment profits with a landlord are unenforceable in bankruptcy. It reinforces the paramount policy of maximizing the debtor's estate for the benefit of creditors, preventing landlords from capturing a portion of the leasehold's appreciated value. The ruling limits the ability of landlords to use contractual terms to circumvent federal bankruptcy law's objective of assisting a debtor's reorganization or liquidation efforts. This case ensures that debtors can realize the full economic value of their leases when assigning them, promoting efficient asset disposition in Chapter 11 and providing a clearer path for debtors seeking to shed burdensome leases while maximizing returns for their creditors.
