Reversing the bankruptcy court, Chief District Judge Colleen McMahon of Manhattan ruled that a provision in a lease cannot supplant the requirement in Section 365(b)(3)(A) that the financial condition of an assignee of a lease must be “similar to the financial condition . . . of the debtor . . . as of the time the debtor became the lessee under the lease . . . .”
The appeal arose in the chapter 11 reorganization of Sears Holdings Corp. The debtor’s chief executive and others formed a new corporation to buy the bulk of Sears’ assets. The assets included about 660 store leases.
The bankruptcy court approved the sale and assignment of the leases, including the lease for the Mall of America near Minneapolis.
The Mall of America Lease
Sears was one of the original anchor tenants when the Mall of America was developed. The 100-year lease was highly favorable for Sears, the tenant. Because Sears paid for the construction of its store, Sears was paying no rent, not even percentage rent. Instead, Sears was paying about $1.1 million a year for taxes, common area charges and insurance.
The obligation of Sears to operate a department store terminated in 2007. After that, Sears was free to shut down or operate almost any other type of business. Also free of any requirement to operate any particular type of business, Sears could assign the lease without veto power in the landlord.
If Sears were to assign the lease, Sears would be absolved of further liability on the lease if the assignee had a net worth of $50 million.
The Mall of America landlord objected to assignment of the lease, principally relying on Sections 365(f)(2)(B) and 365(b)(3).
With regard to leases generally, Section 365(f)(2)(B) requires “adequate assurance of future performance by the assignee . . . .”
When the property is a “shopping center,” Section 365(b)(3) imposes four additional requirements. Two were pertinent to the case on appeal.
Subsection (b)(3)(D) says that assignment must “not disrupt any tenant mix or balance . . . .” Subsection (b)(3)(A) requires that the financial condition of the assignee of a lease must be “similar to the financial condition . . . of the debtor . . . as of the time the debtor became the lessee under the lease . . . .”
Over objection from the landlord, the bankruptcy judge held that the assignment satisfied the requirements of Section 365. The landlord appealed.
In her 43-page opinion on February 27, Judge McMahon agreed that the assignee had shown adequate assurances of future performance under Section 365(f)(2)(B). She also found no disruption of tenant mix under subsection (b)(3)(D).
However, Judge McMahon reversed the bankruptcy court on subsection (b)(3)(A) because the assignee’s financial condition was not proven to be “similar” to the financial condition of Sears in 1991 when the lease was made.
Tenant Mix
The landlord raise a multitude of clever arguments about tenant mix. None persuaded Judge McMahon.
Judge McMahon noted that the Bankruptcy Code does not define “tenant mix.” To her, it made “perfect sense to interpret the phrase ‘tenant mix’ for purposes of § 365(b)(3)(D) in light of the lease whose performance is being assured.”
Judge McMahon upheld the bankruptcy court with regard to compliance with subsection (b)(3)(D) because the lease “documents permit virtually unfettered assignment of the Lease for a host of uses.”
Assignee’s Financial Condition
The lease provided that Sears would be absolved of future liability if it were to assign the lease to an assignee with a net worth of $50 million. The bankruptcy judge believed that subsection (b)(3)(A) had to be read in conformity with the provision in the lease cutting off Sears’ liability if the assignee’s net worth were $50 million.
Based on finding it was “highly likely” that the assignee had a net worth of $50 million, the bankruptcy judge determined there was compliance with subsection (b)(3)(A).
Judge McMahan disagreed with the bankruptcy court’s interpretation of subsection (b)(3)(A). She said that the assignee “did not manage to demonstrate that its financial condition and operating performance were ‘similar’ to those of Sears in 1991.” Rather than employing the similarity standard in the statute, the bankruptcy court, she said, decided that the assignee “satisfied an entirely different standard [based on its] putative net worth.”
The “congressionally mandated requirement was not satisfied,” Judge McMahon said, because the purchaser “failed to prove financial and operating similarity between Sears in 1991 and [the assignee] today, under any standard.”
Judge McMahon said it was a “difficult question.” Admitting she “might be wrong,” Judge McMahon nonetheless reversed and remanded for further proceedings not inconsistent with her opinion.
Reversing the bankruptcy court, Chief District Judge Colleen McMahon of Manhattan ruled that a provision in a lease cannot supplant the requirement in Section 365(b)(3)(A) that the financial condition of an assignee of a lease must be “similar to the financial condition . . . of the debtor . . . as of the time the debtor became the lessee under the lease . . . .”
The appeal arose in the chapter 11 reorganization of Sears Holdings Corp. The debtor’s chief executive and others formed a new corporation to buy the bulk of Sears’ assets. The assets included about 660 store leases.
The bankruptcy court approved the sale and assignment of the leases, including the lease for the Mall of America near Minneapolis.
The Mall of America Lease
Sears was one of the original anchor tenants when the Mall of America was developed. The 100-year lease was highly favorable for Sears, the tenant. Because Sears paid for the construction of its store, Sears was paying no rent, not even percentage rent. Instead, Sears was paying about $1.1 million a year for taxes, common area charges and insurance.
The obligation of Sears to operate a department store terminated in 2007. After that, Sears was free to shut down or operate almost any other type of business. Also free of any requirement to operate any particular type of business, Sears could assign the lease without veto power in the landlord.