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In re Reval And The Protection Of Lessee Property Rights In The Face Of 11 U.S.C. 363

By: Aaron Z. Leaf

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

For over a decade, courts have struggled with how to reconcile sections 363 and 365(h) of the United States Bankruptcy Code (the “Code”). While neither statute working alone in bankruptcy cases presents much challenge, when invoked together some courts have found them to be incompatible. A court cannot simultaneously allow a trustee to sell property “ free and clear of any interest in such property” and allow a lessee to retain all rights that are “appurtenant to the real property for the balance of the term.” The United States Bankruptcy Court for New Jersey recently addressed sections 363 and 365(h) in In re Reval. After years of poor financial performance, Revel AC, Inc. and its partners, filed petitions under chapter 11 of the Code. Debtors subsequently filed a motion under section 365(a) to reject lease agreements with its tenants. In response, IDEA Boardwalk and other lessees gave a notice of their intent to continue to exercise their “possessory leasehold rights under section 365(h).” Upon the debtor’s request, the court thereafter approved a sale of the debtors’ property to Polo North under section 363 of the Code. After finding that the agreement between the Debtors and Tenants were true leases, the court addressed how the sale would affect Tenants section 365(h) possessory rights. The court held that the tenants possessory rights under section 365(h) eviscerates a debtor’s right under section 363of the Code to sell its property free and clear of any interest.

A Sublessee’s Rights in the Face of A Debtor-Sublessor’s Rejection of an Unexpired Lease Under Chapter 11

By: Adam Lau

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In In re Overseas Shipholding Group, Inc., a bankruptcy court held that rejection of a lease by a debtor constituted a pre-petition breach of the lease and was not a termination of the lease. The debtor, Overseas Shipholding Group, Inc., entered into a lease agreement with TST/Commerz East Building (“TST”) that was set to expire on December 31, 2020. Two years into the lease, debtor subleased a part of the space to Maritime Overseas Corporation (“Maritime”). After filing voluntary petitions under chapter 11, the debtor and Maritime entered into a stipulation with the assignee of TST whereby the debtor and Maritime agreed to reject the lease and the sublease. Maritime then vacated the premises and proceeded to file a claim against debtor for $30,788.32 for return of its security deposit under the sublease, but amended its claim, adding $367,858 for damages from rejection of the sublease, including moving expenses, increased rent, electricity, and legal fees relating to Maritime’s relocation. The debtor objected to the amended claim, and asked the court to disallow the claim for rejection damages and to limit the recovery to the amount of the security deposit. The debtor argued that the rejection of the lease constituted a termination of the lease, which would, under Clause 2 in the sublease, preclude Maritime from recovering rejection damages. Clause 2 provided that, “this Sublease shall terminate (in whole or in part, as applicable) on the date of such termination as if such date had been specified in this Sublease as the Expiration Date and Tenant shall have no liability to Subtenant with respect to such termination.” The debtor relied on Chatlos Systems, Inc. v. Kaplan, where the court held that a debtor’s rejection of a non-residential lease resulted in termination of the lease. In response, Maritime argued the Bankruptcy Code establishes that the rejection of the overlease was not a termination of the lease but merely a pre-petition breach. The court was not persuaded by the debtor’s argument, finding that the Chatlos case was not applicable because that case involved a lessee of the debtor who chose to remain in possession of the property, whereas Maritime did not elect to remain on the premises. However, while the bankruptcy court agreed with Maritime’s argument that the rejection of the lease constituted a breach and not termination, Maritime was still precluded from claiming rejection damages because Clause 22(j) in the sublease provided that the “subtenant shall look solely to Tenant's interests in the Lease to enforce Tenant's obligations hereunder and shall not seek any damages against Tenant or any of the Tenant's Related Parties.”

Yet Again, the Tenth Circuit Rejects a Bankruptcy Trustee’s Attempt to Avoid a Mortgage Under a “Splitting-the-Note” Theory

By: Alana Friedberg

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, in Royal v. First Interstate Bank (In re Trierweiler), the Tenth Circuit held that a mortgage granted in favor of the private electronic database Mortgage Electronic Registration Systems, Inc. (“MERS”), which records transfers of notes and mortgages, was enforceable as to a bankruptcy trustee even though the promissory note was held by a third-party. In Trierweiler, the debtors took out a loan from and granted a mortgage to First Interstate Bank (“First Interstate”) in order to purchase real property. The mortgage identified First Interstate as the “lender,” and MERS as both the “mortgagee” and the “nominee for the lender and lender’s successors and assigns.” Sometime thereafter, First Interstate assigned the note to Fannie Mae, but remained as the servicer for the loan. The debtors subsequently defaulted on the loan and filed for bankruptcy under chapter 7 of the Bankruptcy Code. The chapter 7 trustee then sought to avoid the mortgage, using his “strong arm” powers under section 544(a). In particular, the chapter 7 trustee claimed that MERS “was powerless to foreclose on the property” because it did not hold the note and instead was merely the mortgagee. The trustee also claimed that while Fannie Mae held the note, it “had no ability to enforce the mortgage because it was not listed as the mortgagee in the land records . . . .” Therefore, the trustee asserted that this “combination rendered the mortgage unenforceable and void as to [him].” The bankruptcy court, however, rejected the trustee’s arguments and ruled that the mortgage was a properly recorded and enforceable security interest that could not be avoided in bankruptcy.[13] On appeal, the Bankruptcy Appellate Panel of the Tenth Circuit and the United States Court of Appeals for the Tenth Circuit both affirmed.

Abatements Enforceable as Forfeiture Provisions

By: Shantel M. Castro

St. John’s Law Student

American Bankruptcy Institute Law Review Staff


Recently, in In re The Great Atlantic & Pacific Tea Company, Inc.,[i] the District Court for the Southern District of New York upheld a bankruptcy-court order enforcing an abatement provision in a lease.[ii] The case involved a twenty-year lease between a commercial landlord and a grocery store.[iii] Under the terms of the lease, the grocery store was to construct its own building on the leased premises, and the landlord would pay the grocery store a $1.9 million construction allowance within ninety days of the grocery store opening to the public.[iv] A provision in the lease stated that if the landlord failed to pay the construction allowance, the grocery store’s obligation to pay fixed rent and other charges would abate until the allowance was paid with interest.[v] The lease further provided that the grocery store would have title to the building until such time. [vi] A subsequent section of the lease entitled “Landlord default” detailed the remedies available to the grocery store in the event of a default by the landlord.[vii] After the grocery store opened, but just prior to the deadline for payment of the construction allowance, the grocery store filed for bankruptcy under chapter 11 of the Bankruptcy Code.[viii] The landlord’s financing for the construction allowance was conditioned on the grocery store assuming the lease.[ix] The lease was not assumed prior to the payment deadline for the construction allowance, therefore the landlord could not close on its financing.[x] Consequently, the landlord did not pay the construction allowance on time.[xi] Therefore, the grocery store withheld rent payments and property taxes due under the lease until the construction allowance was paid nine months later.[xii] The landlord commenced an adversary proceeding to collect the rent and filed a cure claim after the grocery store assumed the lease.[xiii] The bankruptcy court dismissed the adversary proceeding and denied the cure claim.[xiv] On appeal, the district court affirmed.[xv]

The Earmarking Doctrine’s Viability as a Defense to Preference Actions Involving Home-Loan Refinancing Transactions

By: Michael Benzaki

St. John’s Law Student

American Bankruptcy Institute Law Review Staff


Recently, in In re Flannery,[i] the bankruptcy court held that the earmarking doctrine was not an appropriate defense to a preference action seeking to avoid a late-filed mortgage that was granted as part of a home-loan refinancing.[ii] In Flannery, the debtors financed the purchase of their home through an initial home-mortgage loan, which was secured by a mortgage. Further, within a year of granting the first mortgage, the debtors also granted a second-priority mortgage to secure a home equity line of credit. Subsequently, a new bank acquired both loans and mortgages from the initial lender.[iii] In 2012, the debtors refinanced the initial loan with the new bank through the Home Affordable Refinancing Program (“HARP”).[iv] In connection with the refinancing loan, the debtors granted the new bank a new mortgage against their property and the new bank executed a subordination of mortgage, subordinating the home equity mortgage to the new mortgage.[v] The proceeds from the refinancing loan were used to pay off the initial loan on January 25, 2012, and a discharge of the initial mortgage was recorded on February 21, 2012.[vi] However, the new mortgage was not recorded until April 18, 2012.[vii] Subsequently, on June 28, 2012, less than ninety days later, the debtors filed for bankruptcy under chapter 7 of the Bankruptcy Code. Since the mortgage was recorded within ninety days of the bankruptcy filing, the chapter 7 trustee for the debtors sought to avoid the refinance mortgage as a preference pursuant to section 547 of the Bankruptcy Code.[viii] Ultimately, the court rejected the new bank’s argument that, given the facts of the case at hand, the earmarking doctrine successfully defended the transaction in question from being designated an avoidable preference.[ix]