The following article compares In re Great Lakes Quick Lube L.P., 816 F.3d 482 (7th Cir. 2016), where the Seventh Circuit Court of Appeals ruled that a commercial lease termination –constitutes a fraudulent transfer – and In re Pazzo Pazzo, Inc., No. 21-2344, 2022 WL 17690158 (3d Cir. Dec. 15, 2022), where the Third Circuit Court of Appeals ruled otherwise.
Commercial Lease Termination in the Seventh Circuit
Both courts of appeals examined whether the commercial lease terminations were transfers. The Seventh Circuit held that the debtor’s termination was an “interest in property” that was transferred to the landlord and within the definition of the Bankruptcy Code. Id. at 485.
In Great Lakes, the debtor was a retailer of a number of stores and was experiencing financial difficulties. As a result, an agreement was reached with the landlord to terminate two of the debtor’s leases within 90 days of the date the debtor filed bankruptcy. Of note was that the stores at these two locations were profitable. After bankruptcy, the landlord was sued based on the termination being either a preferential transfer or a fraudulent transfer under the Bankruptcy Code.
The preference statute under Section 547 of the Bankruptcy Code provides:
(b)Except as provided in subsections (c) and (i) of this section, the trustee may, based on reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably knowable affirmative defenses under subsection (c), avoid any transfer of an interest of the debtor in property—
(1) to or for the benefit of a creditor;
(2) for or on account of an antecedent debt owed by the debtor before such transfer was made;
(3) made while the debtor was insolvent;
(4)made—
(A) on or within 90 days before the date of the filing of the petition; or
(B) between ninety days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider; and
(5)that enables such creditor to receive more than such creditor would receive if—
(A) the case were a case under chapter 7 of this title;
(B) the transfer had not been made; and
(C) such creditor received payment of such debt to the extent provided by the provisions of this title.
11 U.S.C. § 547
A fraudulent transfer under the Bankruptcy Code is similar to a fraudulent transfer under the Uniform Fraudulent Transfer Act. The Bankruptcy Code states:
(a) (1)The trustee may avoid any transfer (including any transfer to or for the benefit of an insider under an employment contract) of an interest of the debtor in property, or any obligation (including any obligation to or for the benefit of an insider under an employment contract) incurred by the debtor, that was made or incurred on or within 2 years before the date of the filing of the petition, if the debtor voluntarily or involuntarily—
(A) made such transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted; or
(B) (i) received less than a reasonably equivalent value in exchange for such transfer or obligation; and
(ii) (I) was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation;
(II) was engaged in business or a transaction, or was about to engage in business or a transaction, for which any property remaining with the debtor was an unreasonably small capital;
(III) intended to incur, or believed that the debtor would incur, debts that would be beyond the debtor’s ability to pay as such debts matured; or
(IV) made such transfer to or for the benefit of an insider, or incurred such obligation to or for the benefit of an insider, under an employment contract and not in the ordinary course of business.
11 U.S.C. § 548.
In its reading of Sections 547 and 548, the Seventh Circuit in Great Lakes found that the agreed termination of the leases of profitable stores constituted a “transfer of an interest” of value and was not an abandonment as urged by the landlord.
Commercial Lease Termination in the Third Circuit
Conversely, the Third Circuit in Pazzo Pazzo, noted that the debtor had intended to abandon the leases after failing to respond to notices of default from the landlord along with a notice of a repurchase option. The debtor had failed to pay its taxes and utility bills, it had lost its liquor and food licenses, it had ignored maintenance issues, and did not have an active workforce. Even though it was urged that the re-purchase option was a transfer of an interest in property, the Third Circuit found that the failure to convert a contingent interest in property to actual ownership was not sufficient enough to constitute a transfer of property. Instead, the debtor merely failed to exercise its option and by doing so allowed such property interest to lapse. Thus, the termination of the purchase option did not give rise to a fraudulent transfer under Section 548 of the Bankruptcy Code.
So, Great Lakes and Pazzo Pazzo are distinguishable:
- In Great Lakes, the “transfer” occurred when the parties agreed to a termination of profitable leases, thus transferring an interest in property for less than reasonably equivalent value.
- In Pazzo Pazzo, on the other hand, the debtor simply permitted a property interest to lapse by its own terms and thus there was no property interest to transfer.
What is potentially troubling is that it may not behoove the landlord to necessarily work with the debtor to permit termination. Instead, the landlord may be better off by seeking relief from the courts to terminate and/or evict the debtor and/or simply exercise its contractual rights including locking the debtor out of tis premises and terminating the lease or terminating the debtor’s right of possession, which is much more confrontational.
