Section 363(f) of title 11 of the United States Code (the “Bankruptcy Code”) gives the trustee or debtor in possession a powerful tool to sell property of the estate “free and clear of any interest in such property.” Before the estate can sell an asset “free and clear of any interest in such property,” the Bankruptcy Code requires that a debtor or trustee satisfy the statutory requirements enumerated in section 363(f). A sale of property of the debtor’s estate is permissible only if:
(1) applicable nonbankruptcy law that permits such a sale, (2) the nondebtor entity consents, (3) the nondebtor’s property interest is a lien, and the sale price exceeds the value of all liens encumbering the property, (4) the nondebtor’s property interest is in bona fide dispute; or (5) the nondebtor entity could be compelled, at law or equity, to accept a money satisfaction of its property interest.
Once a single condition is met, section 363(f) allows the estate to unlock the value of certain assets that would potentially be unmarketable or severely diminished in value by unknown claims against such assets.
In the context of a debtor-landlord, section 363(f) can be invoked to extinguish the interests of unwanted tenants in the debtor-landlord’s real property; thus “embod[ying] the general Bankruptcy Code policy of maximizing the value of the bankruptcy estate.” Obviously, permitting such a 363 sale would adversely affect the interests of tenants who expect to continue occupying the leased premises. Cognizant of this tension, courts have yet to reach a unanimous decision permitting a “free and clear” sale of leasehold interests due to the existence of section 365(h) governing the assumption and rejection of leases.
When a debtor-landlord or trustee rejects an unexpired lease of real property, section 365(h) allows the non-debtor tenant to either: (i) treat the lease as terminated and file a claim for breach; or (ii) “retain its rights under such lease . . . that are in or appurtenant to the real property for the balance of the term of such lease and for any renewal or extension of such rights.” In permitting a debtor-lessor to reject an undesirable lease, section 365(h) simultaneously protects the lessee’s property rights providing the lessee with certain statutory protections such as the right to stay. Furthermore, after rejection of a lease, the debtor-lessor is not required to perform the covenants under the lease, but the lessee is entitled to offset the damages caused by nonperformance against rent. In enacting section 365(h), lawmakers sought to codify a delicate balance between the rights of a debtor-lessor and the rights of its tenants “by preserving the parties’ expectations in a real estate transaction.”
Absent judicial resolution of the issue or legislative clarification, it is unclear whether a debtor-landlord may sell real property “free and clear” under section 363(f) and strip a lessee of its statutory rights under section 365(h). This memorandum explores this issue in a threefold approach. Part I addresses how courts construe “any interest in such property” under section 363(f). Part II discusses the apparent conflict between section 363(f) and section 365(h) of the Bankruptcy Code by examining the majority and minority positions. Part III concludes by analyzing the implications of these interpretations in the context of the landlord-tenant relationship whereby adequate protection must be demanded.