A profit-sharing agreement in a lease is a restriction on assignment that is “routinely invalidated” under Section 365(f), according to a decision by a district judge in New York upholding a ruling by Bankruptcy Judge Robert D. Drain.
Even though the profit-sharing clause would have reduced the profit from assignment without blocking a sale of the lease outright, District Judge Nelson S. Román invalidated the provision based in part on “countervailing public policy” shown by the section’s design to maximize the value of the bankruptcy estate for the benefit of creditors.
The issue arose in the chapter 11 case of Great Atlantic & Pacific Tea Co., a supermarket operator that has been in bankruptcy twice. The lease called for A&P to pay the landlord one-half of the net profit each month resulting from assignment of the lease. The profit-sharing agreement was applicable to any assignment, not just in bankruptcy.
A purchaser bought the lease at auction. The bankruptcy judge approved the sale, denying the landlord’s objection to approval of assignment without enforcing the profit-sharing agreement. The landlord appealed and lost once again in Judge Román’s Oct. 17 opinion.
The case tuned on Section 365(f)(1), which overrides any provision that “prohibits, restricts, or conditions the assignment” of a lease. Judge Román said that Congress designed Section 365(f) to be a “powerful tool” to maximize the value of a bankrupt estate.
Judge Román relied in large part on a 1996 decision in the Jamesway bankruptcy by Bankruptcy Judge James L. Garrity and on a 1991 Ninth Circuit Bankruptcy Appellate Panel opinion, both holding that profit-sharing agreements were impermissible restrictions on assignment.
The decision by the A&P bankruptcy judge, according to Judge Román, was based on “long-standing precedent” holding that a profit-sharing clause is “an unenforceable anti-assignment provision under at least Section 365(f)(1).”
Although the profit-sharing clause was “carefully negotiated” between the parties, Judge Román said it must “give way to countervailing public policy considerations” in bankruptcy.