Section 365(h) of the Bankruptcy Code provides tenants special protections in the event their landlord files for bankruptcy, by giving tenants the option of retaining their possessory rights under their leases, notwithstanding the landlord’s rejection of such leases. A question that has divided courts across the county is what happens to a tenant’s possessory interest in the leasehold when the debtor-in-possession (“DIP”) or a trustee seeks to sell the underlying real property free and clear of all “interests” pursuant to section 363(f)? In other words, does a sale of the property “free and clear” extinguish a tenant’s possessory interests in the real property notwithstanding section 365(h)? Nearly all courts that have considered the issue had held that section 365(h) trumps section 363(f) under the canon of statutory construction that “the specific prevails over the general,” and that a section 363(f) sale order cannot extinguish a lessee’s possessory interest in the real property being sold.
On July 13, the Ninth Circuit weighed in on the interplay between sections 363(f) and 365(h) of the Bankruptcy Code in a dispute between the undersecured lender, which purchased certain estate assets from the chapter 7 trustee (including real property leased by the debtor to non-debtor tenants Pinnacle and Opticom) and Pinnacle and Opticom. In Pinnacle Restaurant at Big Sky, LLC v. CH SP Acquisitions, LLC (In the Matter of Spanish Peaks Holdings II), No. 15-35572 (hereinafter “Spanish Peaks”), the Ninth Circuit held that a non-ordinary course sale of estate assets pursuant to sections 363(b) and 363(f) was free and clear of the possessory rights of a non-debtor tenant codified in section 363(h) of the Bankruptcy Code. By so holding, the Ninth Circuit deviated from the “majority approach” and instead followed the approach of the Seventh Circuit in Precision Industries, Inc. v. Qualitech Steel SBQ, LLC (In re Qualitech Steel Corp. & Qualitech Steel Holdings Corp.), 327 F.3d 537 (7th Cir. 2003) (hereinafter “Qualitech”). Continue Reading