Landlords Beware: Seventh Circuit Finds Commercial Lease Termination is a "Transfer" Under Bankruptcy Code | Practical Law

Landlords Beware: Seventh Circuit Finds Commercial Lease Termination is a "Transfer" Under Bankruptcy Code | Practical Law

Reversing the Bankruptcy Court, the US Court of Appeals for the Seventh Circuit held that a commercial tenant's lease termination before it filed for bankruptcy may be an avoidable transfer.

Landlords Beware: Seventh Circuit Finds Commercial Lease Termination is a "Transfer" Under Bankruptcy Code

by Practical Law Real Estate
Published on 20 Apr 2016USA (National/Federal)
Reversing the Bankruptcy Court, the US Court of Appeals for the Seventh Circuit held that a commercial tenant's lease termination before it filed for bankruptcy may be an avoidable transfer.
On March 11, 2016, the US Court of Appeals for the Seventh Circuit, in In Re Great Lakes Quick Lube LP v. T.D. Investments I, LLP, ruled that a commercial tenant's lease termination, occurring before it filed for bankruptcy, may be considered an avoidable transfer under Chapter 11 of the Bankruptcy Code ( (7th Cir. Mar. 11, 2016)). The ruling was a reversal of the bankruptcy court's decision.

Background

In 2012, Great Lakes Quick Lube, a company that owned several stores in the midwest providing automotive services, filed for bankruptcy under Chapter 11 of the Bankruptcy Code. TD Investments had leased two stores to Great Lakes. As its debts loomed, Great Lakes terminated the leases 52 days before Great Lakes filed for bankruptcy, despite the fact that both leased stores were profitable.
The committee representing Great Lakes' unsecured creditors filed an adversary action against TD Investments, alleging that:
  • The termination was either:
    • a fraudulent transfer, which is a transfer made by a debtor to anyone within two years before bankruptcy that gives the debtor less than what it transferred (11 U.S.C. § 548(a)(1)); or
    • a preferential transfer, which is a transfer made by a debtor to a favored creditor within 90 days before filing for bankruptcy that gives the creditor more than it would have gotten if it waited for the debtor's assets to be distributed in the bankruptcy proceeding (11 U.S.C. § 547(b)).
  • The value of the leases should be available to Great Lakes' creditors.
At trial, the bankruptcy judge ruled in favor of TD Investments, holding that the lease terminations were not transfers. The creditors' committee appealed.

Outcome

On appeal, the Seventh Circuit Court of Appeals disagreed with the bankruptcy court. The court examined the broad meaning of "transfer" under the statute, noting that it includes disposing of or parting with "an interest in property" (11 U.S.C. § 101(54)(D)). Great Lakes had an interest in the property, which it transferred to the landlord.
The court concluded that the transfer of leases would be fraudulent if either:
  • Great Lakes received less than the equivalent value for the leases.
  • TD received more as a result of the termination than it would have if the leases were terminated as part of the bankruptcy estate.
The court reversed and remanded the case to the bankruptcy court to make the factual determination as to the value of the transfer, and whether or not it was avoidable.

Practical Implications

This decision is notable because it is a departure from previous case law holding that consensual lease terminations did not constitute transfers under the bankruptcy code. Commercial landlords and tenants must consider this holding and evaluate future exposure when determining whether to voluntarily terminate a lease.
In addition to commercial leases, this case has broad implications for other types of terminations of contracts conveying an interest in property, such as franchise or license agreements.
For more information on these topics, see Practice Notes: