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Fifth Circuit Ruling Gives Commercial Lessees Likely Protection In Bankruptcy Court Free and Clear Asset Sales
A bankruptcy court gave "unnecessary and likely incorrect" reasoning to support its "excessively broad proposition that sales free and clear under [Bankruptcy Code ("Code")] Section 363 override, and essentially render nugatory, the critical lessee protections against a debtor-lessor under [Code] 365(h)," said the U.S. Court of Appeals for the Fifth Circuit on Feb. 16, 2022. In re Royal Bistro, LLC, 2022 WL 499938, *1-*2 (5th Cir. Feb. 16, 2022). The court still denied the lessees' "motion for a writ of mandamus" for a "stay pending appeal" from a bankruptcy court order authorizing the trustee's sale of "the debtor's real property … free and clear" of the lessees' interests. Id. at *1. In essence, though, the Fifth Circuit signaled that it would not approve in later cases a bankruptcy court asset sale of real property that summarily cuts off the rights of the debtor's lessees.
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.
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