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Assumption and Assignment Upheld Notwithstanding its Prohibition by an Exclusive Use Provision

By: Kristin Catalano

St. Johns Law Student

American Bankruptcy Institute Law Reviewstaff

            Section 365(b)(3) of title 11 of the United States Code (the “Bankruptcy Code”) provides that a debtor can assume and assign a lease only if it provides “adequate assurance of future performance.”[1]Section 365(b)(3)(C) specifically requires adequate assurance[2]“that assumption or assignment of such a lease is subject to all the provisions, including . . . [a] use or exclusivity provision, and will not breach [] such [a] provision . . . relating to such shopping center.”[3]However, a “court may permit deviations from strict performance of any provision including a use clause.”[4]A use clause provides that the premises shall be used for limited business purposes.[5]Additionally, section 363(b)(3)(D) requires adequate assurance “that assumption or assignment of such lease will not disrupt any tenant mix or balance in such shopping center.”[6]

          In In Re Toys R Us, the Bankruptcy Court for the Eastern District of Virginia held that the assumption and assignment of the unexpired lease at issue did not violate section 365 although the lease was subsumed in the exclusive use provision of another store’s lease in the shopping center.[7]Further, there was no disruption of the tenant mix or balance within the shopping center.[8]Toys R Us (“TRU”), a debtor in a chapter 11 filing, was a tenant renting space in a shopping center from the landlord, Brea Union Plaza (“Brea I”).[9]In its bankruptcy case, TRU conducted an auction for the sale, assumption and assignment of the property and unexpired leases in accordance with an order of the bankruptcy court (the “Bidding Procedures Order”).[10]The Bidding Procedures Order approved the bidding procedures for soliciting and selecting the best offers for TRU’s assets, including the assumption and assignment of unexpired store leases.[11]TRU ultimately filed a notice proposing to assume and assign a particular lease to Burlington Coat Factory Warehouse Corporation (“Burlington”).[12]Burlington intended to use the premises to operate a Burlington Coat Factory department store for the off-price sale of apparel and other merchandise.[13]Brea I opposed the proposed assumption and assignment of the lease to Burlington.[14]Brea I alleged that TRU failed to satisfy the adequate assurance requirements, as the assignment and assumption to Burlington would violate the exclusivity provision contained in the lease of Ross Dress for Less (“Ross Lease”), another store within the shopping center, and further, would disrupt the balance of the tenant mix.[15]The bankruptcy court overruled Brea I’s objection to the assumption and assignment because TRU met its burden of providing adequate assurance of future performance.[16]

          An exclusivity provision, such as the provision prohibiting Brea I from allowing a tenant to operate an off-price retail store is applicable when the relevant party has sufficient legal capacity to require performance.[17]The law excuses performance that has been rendered legally impossible by the implementation of governmental regulation or order.[18]The court approval of the assumption and assignment of the lease to Burlington rendered Brea I without the capacity to prevent Burlington’s intended use of the premises and thus excuses TRU from performance pursuant to the Ross Lease.[19]Moreover, TRU’s lease came into existence before the Ross Lease and contained no provision requiring compliance with the Ross Lease use restrictions,[20]while the Ross Lease failed to contemplate such an occurrence.[21]Further, the court stated that determining whether a tenant mix was disrupted “must be interpreted to refer to contractual protections and not undefined notions of tenant mix.”[22]Brea I failed to identify any provision in any master agreement or the lease at issue that relates to the tenant mix and that would prohibit assignment of the lease to Burlington.[23]

          The In Re Toys R Us decision adheres to the principle that section 365(b)(3)(C) of the Bankruptcy Code is intended “to protect the landlord’s economic expectations rather than those of other tenants.”[23]If an exclusivity provision was to prevent the assignment to an otherwise eligible tenant, the economic benefit of the landlord would essentially be subordinate to the perceivable benefit of that tenant whose lease contained that provision.[25] The “construction of section 365(b)(3)(D) is consistent with the notion that a court should avoid infringement of property rights.”[26]Without sufficient evidence to show a contractual provision will be violated, a court will likely be reluctant to prohibit an assumption or assignment pursuant to section 365(b)(3)(D).[27]



[1]11 U.S.C. § 365(b)(3) (2012); see alsoRichmond Leasing Co. v. Capital Bank, N.A., 762 F.2d 1303, 1310 (5th Cir. 1985) (The provision provides a means “whereby a debtor can force another party to an executory contract to continue to perform under the contract if [] the debtor can provide adequate assurance that it, too, will continue to perform”).

[2]See Richmond Leasing Co., 762 F.2d at 1310 (explaining that the bankruptcy statute borrows critical language from Section 2–609 of the Uniform Commercial Code, and “[t]he Commentaries to the Code note that adequate assurance . . . is to be determined by factual conditions; the seller must exercise good faith and observe commercial standards; his satisfaction must be based upon reason and must not be arbitrary or capricious”).

[3]Id. at §365(b)(3)(C).

[6]Matter of U. L. Radio Corp., 19 B.R. 537, 544 (Bankr. S.D.N.Y. 1982).

[5]See e.g.,In ReTSW Stores of Nanuet, Inc., 34 B.R. 299, 301 (Bankr. S.D.N.Y 1983) (The lease contains a restrictive use clause which limits the business: “solely for the purpose of conducting the retail business of the sale of general merchandise” and further prohibits certain uses).

[6]11 U.S.C. §365(b)(3)(D).

[7]SeeIn ReToys R Us, 587 B.R. 304, 310 (Bankr. E.D. Va. 2018).

[8]See id.

[9]Id.at 307 (stating that Brea I and TRU were parties to a ground lease entered into on December 20, 1996, for a parcel in Brea Union Plaza, a retail shopping center). 

[10]Id.at 307-308 (“On March 23, 2018, the Court entered the Order (I) Establishing Bidding Procedures and (II) Granting Related Relief.”).

[11]Id. at 308 (asserting that the Bidding Procedures Order included the lease of Brea I and TRU as one of the assets).

[12]Id. at 308.

[13]Id.

[14]Id.

[15]Id. (explaining that on October 1, 2009, Brea I entered into a lease with Ross, an off-price retailer of apparel, which contained an exclusive use clause that prohibited Brea I from leasing any space in the shopping center to a party that would use the premises for off-price sales).

[16]Id.at 310–311.

[17]Id. 

[18]See In ReMartin Paint Stores, 199 B.R. 258, 265–266 (Bankr. S.D.N.Y. 1996).

[19]Id.  (“[A] court order approving the assumption and assignment of a lease is a judicial action that may render the landlord unable to comply with a restriction contained in another lease.”).

[20]Id.(highlighting that the lease to Burlington was first executed in 1996, while the Ross Lease didn’t come into existence until 2009, and did not require compliance with provisions of the Ross Lease);but cf. In re Heiling-Meyers Co., 294 B.R. 660, 662-663 (Bankr. E.D. Va. 2001) (ruling that because the debtors lease contains a provision that they will not “assign or sublet the premises to any business that would violate any non[-]compete agreements in which [l]andlord has with other [t]enants in the Shopping Center,” the debtors lease must therefore comply with the exclusive rights provision of another tenants lease).

[21]In re Toys R Us, 587 B.R. at 310. See alsoIn Re Martin Paint Stores, 199 B.R. at 265–266 (stating that a court-approved auction will prevent a landlord from complying with an exclusivity use provision, unless there is evidence to show that during negotiations, such an occurrence was contemplated).

[22]In re Toys R Us, 587 B.R. at 310 (quotingIn Re Ames Department Stores, Inc., 121 B.R. 160, 165 (Bankr. S.D.N.Y. 1990)).

[23]Id.

[24]Id. at 309 (quoting In Re Martin Paint Stores, 199 B.R. 258, 262 (Bankr. S.D.N.Y. 1996)).

[25]SeeIn Re Martin Paint Stores, 199 B.R. at 266.

[26]In Re Ames Department Stores, Inc., 121 B.R. 160, 166 (Bankr. S.D.N.Y. 1990).

[27]See id.

 

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