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Third Circuit Approves Use of Section 365(f)(1) to Maximize Estate's Value via an Asset Sale

In a non-precedential opinion filed on July 17, 2018, a copy of which may be found here, the Third Circuit Court of Appeals affirmed the rulings of the Delaware District Court and Delaware Bankruptcy Court, which approved an asset purchase agreement over a landlord's objection and allowed debtors Haggen Holdings, LLC and its affiliates to sell certain assets.  The issue turned on the application of Bankruptcy Code § 365(f)(1) to a "profit sharing plan" clause in a commercial lease and whether it was an unenforceable anti-assignment provision.

Haggen Holdings, LLC and its affiliates (the "Debtors") operated 164 grocery stores and 1 pharmacy.  In 2015, the Debtors filed chapter 11 petitions in the Bankruptcy Court for the District of Delaware.  The Debtors proposed bidding procedures for the sale of stores as well as the assumption and assignment of certain executory contracts and unexpired leases.  The sale motion at issue implicated a commercial lease (the “Lease”) between one of the Debtors and its landlord, Antone Corp. (“Antone”). 

Antone objected to the Debtors’ notice of assumption, assignment and cure amounts filed as part of the bid procedures motion as well as the notice of sale.  Antone argued its commercial lease could not be assumed and assigned unless the Debtor provided for payment to Antone of one-half of the net profit realized by the Debtor upon transfer and assignment of the Lease to a third party.  During the hearing on the Debtors' sale to the successful bidder for the store subject to the Lease, the Bankruptcy Court overruled Antone’s objection, authorized the assumption and assignment of the Lease, and prohibited enforcement of the profit sharing plan clause.  On appeal, the District Court affirmed the Bankruptcy Court’s Sale Order.

Section 365(f)(1) states in relevant part that, “notwithstanding a provision in an executory contract or unexpired lease of the debtor, or in applicable law, that prohibits, restricts, or conditions the assignment of such contract or lease, the trustee may assign such contract or lease under paragraph (2) of this subsection."  The Court noted that § 365(f)(1), on its face, covers more ground than mere anti-assignment clauses and extends to any clause that restricts or conditions an assignment of a lease or executory contract.  "Section 365(f)(1) was designed to prevent anti-alienation or other clauses in leases and executory contracts assumed by the Trustee from defeating [the Trustee’s] ability to realize the full value of the debtor’s assets in a bankruptcy case.” Op. at 5, quoting In re Headquarters Dodge, Inc., 13 F.3d 674, 682 (3d Cir. 1993). 

The profit sharing plan clause here functioned only to extract value that would have accrued to the estate for the sole benefit of one landlord.  Although the provision may have been part of a carefully negotiated bargain, the public policy that anti-alienation clauses not defeat the ability of the estate to realize the full value of the estate assets outweighed the interests of Antone in receiving the full benefit of its bargain.