In one of the adversary proceedings arising out of the Chapter 11 case involving the Revel casino in Atlantic City, the United States Bankruptcy Court for the District of New Jersey issued a significant ruling on third party acquisition of tenanted distressed properties. In October 2016, Judge Kaplan examined §365(h) of the bankruptcy code: specifically the landlord tenant relationship after rejection of an unexpired lease by a debtor/landlord. Here, Revel is the debtor, IDEA Boardwalk is the tenant. After Revel’s Chapter 11 filing in 2014, it rejected the lease with its tenant. The issue was that the tenant elected to stay, and sued for continued possession.
Section 365(h) of the bankruptcy code permits a tenant to remain in possession of a leasehold under a rejected lease and, as its sole remedy, offset any damages resulting from the landlord’s post-rejection nonperformance against the rent reserved under the lease.
The debtor, Revel, meanwhile had entered into an asset purchase agreement with third-party purchaser Polo North. The debtor then sold the real property to Polo North free and clear of all claims and interests except for the tenant’s rights under section 365(h).
Although the sale of the premises was free and clear of all claims and interests, the tenant’s recoupment right under the lease was viewed to arise from the same transaction that gives rise to its rent obligation. Therefore, the tenant could recoup its claim for that payment from the rent it owes under the lease.
Judge Kaplan held that the tenant, having chosen to remain in possession, was required to comply with the lease “subject only to its offset rights under §365(h)”; further, Polo North, as the landlord (having stepped into the shoes of the debtors as landlord following the sale), “was excused from its performance obligations” by virtue of the debtors’ rejection of the lease post-petition, subject only to the tenant’s continued possession and quiet enjoyment of the venues. Lastly the Judge held that Polo North was required to comply with the recoupment mechanism under the lease.
A key component of the Court’s ruling was that “rejection” of the lease did not equate to “termination” of the lease, thus the leasehold interest remained intact and the lease continued to operate between the parties. However, the bankruptcy court also held that while a tenant in possession is required to continue to adhere to the terms of an unexpired lease that was rejected by the debtor-landlord post-petition, the landlord need not (subject only to the tenant’s possession, use and quiet enjoyment of the premises). This case has been viewed as clarifying the rights and obligations of tenants and landlords pursuant to § 365(h) of the Bankruptcy Code. Any potential third party purchaser is advised to research lease terms and perform its due diligence before acquiring a tenanted distressed asset.
IDEA Boardwalk, LLC v. Polo N. Country Club, Inc. (In re Revel AC, Inc.), ___ B.R. ___, 2016 Bankr. LEXIS 3805 (Bankr. D.N.J. Oct. 21, 2016).