Bankruptcys Effect on Multiple Property Leases

Journal Issue

Apr 2002

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As bankruptcy practitioners, we can all agree on one fundamental rule of executory
contracts and unexpired real property leases: For the contract or lease to be assumed
or rejected pursuant to <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §365</a>, it must be assumed or rejected in
its entirety.<a href="#2" name="2a">2</a> Said another way, a debtor-in-possession (DIP) or trustee cannot
assume an executory contract or unexpired lease in part and reject it in part.
Recently, property owners have used this all-or-nothing principle in §365 of the
Bankruptcy Code to hedge against bankruptcy risks when leasing multiple properties by
executing a single "lease."<a href="#3" name="3a">3</a> While using the single lease may be beneficial to the
landlord, it can greatly hamper the debtor's ability to reorganize because it cannot
reject unprofitable locations.

Surprisingly, there is a dearth of cases addressing multi-property leases in
bankruptcy. However, the Middle District of North Carolina recently released an
opinion in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Convenience USA Inc., 2002 WL 230772 (Bankr.
M.D.N.C. Feb. 12, 2002)</a>, addressing this issue.

Before filing for bankruptcy, Convenience USA consolidated convenience stores.
When acquiring 27 of its convenience stores, rather than purchasing the real estate
directly from the seller, Convenience USA arranged for US Restaurant Properties Inc.
(USRP) to purchase the convenience stores and then lease them to Convenience USA.
To effectuate the lease, Convenience USA and USRP entered into a single lease
agreement.<a href="#4" name="4a">4</a>

After operating the convenience stores for a few years, Convenience USA concluded
that six of the 27 properties leased from USRP were unprofitable. Consequently,
Convenience USA filed a motion to reject the six store leases. USRP objected,
arguing that since the properties were leased pursuant to a single "lease" document,
Convenience USA could not assume the lease in part and reject the lease in part.<a href="#5" name="5a">5</a>

The court employed a two-prong analysis. The first prong was whether, under state
law, the concept of divisible contracts is recognized and whether the lease was a
divisible contract. Under applicable Texas law, contracts can be divided, and the
primary inquiry is the intent of the parties.<a href="#6" name="6a">6</a> The court concluded that the lease
agreement was divisible because many terms in the agreement, including that (1) USRP
had the right to sell one or more stores, and Convenience USA's rent obligations
would be reduced accordingly; (2) the lease agreement provided specific rent for each
property and (3) in the event of default, USRP could terminate Convenience USA's
right of possession to one or more of the stores.<a href="#7" name="7a">7</a>

<blockquote><blockquote>
<hr>
<big><center>
Under applicable Texas law, contracts can be
divided, and the primary inquiry is the intent
of the parties.
</center></big>
<hr>
</blockquote></blockquote>

The second prong the court considered was whether under <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §365</a> the
debtor may reject part of the "lease" agreement and assume part of the "lease"
agreement. USRP argued that since Convenience USA's right to possess any store was
cross-defaulted with the obligation to pay rent on all the stores, the lease agreement
was a single integrated contract that could only be assumed or rejected in full. The
court disagreed, stating:

In the present case, because the [lease] is divisible, the debtor in effect
is a party to 27 separate unexpired leases. If given effect, the
cross-default provisions in this case would prevent the debtors from utilizing the
provisions of §365 to reject some of those leases, while reserving the
decision whether to reject or to assume and assign the remaining leases to a
later time. If the cross-default provisions were permitted to operate in such
a fashion they would have the effect of foreclosing the ability of the debtors
possibly to assume and assign the other 21 leases pursuant to §365. Such
a result is contrary to §365(f) and is not permissible under bankruptcy law.
It follows that the default provisions in the present case do not limit the
ability of the debtors to reject six of the leases at this time, while leaving
to another day the decision whether to reject the remaining leases or whether to
assume and assign them in accordance with the provisions of §365.<a href="#8" name="8a">8</a>

Thus, the Convenience USA court concluded that Convenience USA could reject the
leases on six of the properties, even though the six properties were part of a larger
agreement. The court's ruling impairs the efforts of property landlords to hedge against
their tenant's bankruptcy. However, the court's ruling provides flexibility to debtors
in their reorganization efforts and potentially increases the recovery available to
unsecured creditors.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> The author is a shareholder with Jenkens & Gilchrist in Dallas. <a href="#1a">Return to article</a>

<a name="2">2</a> See, e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Title v. Old Republic National Title, 83 F.3d 735, 741 (5th Cir. 1996)</a>. <a href="#2a">Return to article</a>

<a name="3">3</a> As was explained to this author by the principal of one landlord, the landlord was concerned about the viability of its tenant and wanted
to prevent the use of the Bankruptcy Code by the tenant to "cherry pick" the good locations and leave the landlord stuck with more undesirable
locations. <a href="#3a">Return to article</a>

<a name="4">4</a> Convenience USA at p. 1. <a name="#4a">Return to article</a>

<a name="5">5</a> Convenience USA at p. 2. <a href="#5a">Return to article</a>

<a name="6">6</a> See, e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Payless Cashways Inc., 230 B.R. 120, 135 (8th Cir. BAP 1999)</a> aff'd., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… F.3d
1081 (8th Cir. 1999)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Walker, 821 S.W.2d 184, 187 (Tex.App. Ft. Worth 1991)</a>. <a href="#6a">Return to article</a>

<a name="7">7</a> Convenience USA at p. 3-5. <a href="#7a">Return to article</a>

<a name="8">8</a> Convenience USA at p. 5-6; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Sambo's Rest. Inc., 24 B.R. 755, 758-58 (Bankr. C.D. Cal. 1982)</a>. <a href="#8a">Return to article</a>

Journal Authors

Gregory G. Hesse

Journal Date

Monday, April 1, 2002 - 12:00

Bankruptcy Rule

2002