Proper Termination of an Option to Repurchase Under the Bankruptcy Code

Aria Lugo

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff

In In re Pazzo Pazzo Inc., the United States Court of Appeals for the Third Circuit held that the proper termination of an option to repurchase was not a “transfer” that could be avoided under Chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”). In this instance, Berley Associates, LTD (“Berley”) owned and leased real estate (the “Property”) to Pazzo Pazzo Inc. (“Pazzo Pazzo”), who operated a restaurant on the premises.[1] Facing financial distress, Berley, filed a petition for relief under Chapter 11 of the Bankruptcy Code.[2] Pursuant to Berley’s confirmed Chapter 11 reorganization plan, Speedwell Ventures, L.L.C. (“Speedwell”) purchased the Property and agreed to lease it to Pazzo Pazzo for ten years.[3] The plan further furnished Berley with an option to repurchase the Property before the termination of the lease or within thirty days thereafter. By its terms, Speedwell could terminate the lease before ten years had passed by providing Berley and Pazzo Pazzo with a termination notice ten days prior to the date of termination.[4]

Speedwell issued four notices to Berley and Pazzo Pazzo from April to August 2017, pursuant to which Speedwell informed the parties that it was terminating the lease and Berley would have thirty days from termination to exercise its right to repurchase.[5] The final two notices further informed Berley and Pazzo Pazzo that their rights had lapsed.[6] Neither Berley nor Pazzo Pazzo responded to the notices. Thereafter, Speedwell sold the Property to 62-74 Speedwell Ave. LLC (“62-74 Speedwell”).[7]  

Following the sale of the Property, Berley (for the second time) and Pazzo Pazzo (collectively, the “Debtors”) filed for relief under Chapter 11 of the Bankruptcy Code in the New Jersey Bankruptcy Court. In their bankruptcy schedules, the Debtors listed the lease and the option to repurchase the Property as assets.[8] Thereafter, Speedwell filed a complaint against the Debtors seeking a judgment declaring that the lease and the option did not belong to the Debtors. In response, the Debtors asserted a fraudulent transfer claim against Speedwell, arguing that the termination of the option was avoidable under section 548(a)(1)(B) of the Bankruptcy Code, which generally allows a debtor to avoid a transfer of a property interest made with actual intent to defraud creditors or for less than reasonably equivalent value when the debtor is in financial distress.[9] According to the Debtors, if the termination of the lease and option was avoided, then the Debtors would have had an interest in the property and the sale from Speedwell to 62-74 Speedwell would have failed to acknowledge said legal interest. If that were the case, then the transfer would have been fraudulent because it was sold without the consent of all parties with rights to it. Speedwell and 62-74 Speedwell responded, asserting that the lease and the option had been properly terminated, leaving the Debtors with no property interest that could have been fraudulently transferred. Following a trial, the Bankruptcy Court found that the lease and the option had been properly terminated.[10] The Bankruptcy Court held that the termination of the lease was not recoverable as a fraudulent transfer because it was not a “transfer” under the Bankruptcy Code. On the Debtors’ appeal, the New Jersey District Court affirmed the decision of the Bankruptcy Court.[11] The Debtors then appealed to the United States Court of Appeals for the Third Circuit.[12]

The Third Circuit affirmed that “Pazzo's lease and Berley's option to repurchase the Property from Speedwell were validly terminated, and the termination of the option was not a ‘transfer’ under the Bankruptcy Code.”[13] A lease may be terminated if the tenants have abandoned the property, which occurs when tenants intend to vacate a property and act in furtherance of that goal.[14] After evaluating the totality of the circumstances, the Third Circuit found that the Debtors’ lack of response to the notices, as well as the unpaid taxes and utility bills, unrenewed liquor and food licenses, lack of employees, numerous maintenance failings, suspended website, and lack of security system (all of which occurred prior to June of 2017), strongly favored an inference that Debtors intended to abandon the property.[15]The Third Circuit found that the property had been deprived of substantial value, and held the lease was properly terminated for abandonment and vacation.[16]

Additionally, the Third Circuit affirmed the finding that the termination of the offer was not a “transfer” under the Bankruptcy Code. The Third Circuit found that Berley’s interest in potential ownership had already lapsed when Berley filed for bankruptcy.[17] Berley did not possess the rights that had not been pursued, and thus, the termination of the option would not have been a “transfer” under section 548(a)(1)(B) of the Bankruptcy Code.[18]

A confirmed reorganization plan may provide a debtor and its creditors with certain rights, such as an option to repurchase. However, those rights can be abandoned and rendered of no import if the party does not exercise said rights. Failure to exercise an abandoned right may not necessarily result in a transfer that can be avoided under section 548 of the Bankruptcy Code.