The federal bankruptcy court in Delaware has ruled that the individual leases incorporated into a master lease were economically interdependent, and therefore the debtor could not reject certain of the individual leases on their own, but had to accept or reject the master lease as a whole. In re Buffets Holdings, Inc., 2008 WL 2080555 (Bankr. D. Del. 2008)

The debtors were the country's largest restaurant company in the family-dining segment of the restaurant industry, and they filed for bankruptcy protection in January 2008. This decision involved the motion of the debtors to reject select restaurant leases that were part of a master lease.

Before the debtors filed for bankruptcy, however, they had attempted to restructure. As part of their restructuring, the debtors entered into a sale/ leaseback transaction in which they sold certain restaurants and the ground on which they stood, and then leased them back.

Subsequent to this transaction, the debtors entered into a sale/leaseback transaction with respect to 29 restaurants where they owned the buildings but not the land on which they stood. It is this second transaction that is the subject of the bankruptcy court's opinion. In this second transaction, the debtors assigned their ground leases and sold the buildings constructed thereon to FP. The debtors then subleased from FP the grounds and buildings pursuant to four Master Leases.

The debtors filed a motion to reject certain nonresidential real property leases, including certain leases with FP.

Rejection Rights

In its decision, the court noted that, "[u]pon the filing of a bankruptcy petition, a debtor has the right to assume or reject an unexpired non-residential real property lease in accordance with section 365 of the Bankruptcy Code." If a debtor decides to assume a lease, it must assume all the terms of the lease and may not pick and choose only favorable terms to be assumed.

Here, the debtors sought to reject certain leases that were included in the four Master Leases described above.

FP objected, stating that the Master Leases had to be assumed or rejected in their entirety.

"The determination of whether a specific contract or lease is an indivisible agreement or is several agreements in one is a question of state law," the court stated, faced with the task of interpreting Illinois law. "Under Illinois law, the test for severability depends on the intent of the parties." The issue before the court was whether the parties intended a single contract even though it may be expressed in separate agreements, or whether they intended separate contracts even though they are bundled together in one agreement.

Severability

The debtors and the creditors' committee both argued that the terms of the Master Leases clearly evidenced that the individual leases incorporated within them were independent and separate agreements. Each underlying lease in the Master Leases covered a separate restaurant that operated independently of the other restaurants in the debtors' chain and were required, under the Master Leases, to provide their financial reports separately to FP.

Though the total rent due under the Master Leases was wired by the tenants to FP in a lump sum, Exhibit B to the Master Leases reflected the allocation of the rent among the underlying restaurants. The debtors argued that the fact that the rent was apportionable was a critical factor mandating a finding that the Master Leases were severable.

The bankruptcy court, however, disagreed with this argument and reasoned that "[t]he ability to apportion the consideration to different parts of the contract is one factor to be considered in determining the intent of the parties but it is not conclusive."

The bankruptcy court noted that the U.S. Court of Appeals for the Seventh Circuit has held that the intention of the parties is critical, and even if the parties entered into a multipart contract, that contract cannot be severed after-the-fact if the parties entered it as a single whole, so that there would have been no bargain whatever, if any promise or set of promises were struck out.

The bankruptcy court was persuaded that despite the fact that the Master Leases could in certain circumstances be severed by their terms did not mean that the parties intended them to be separate agreements for all purposes. The bankruptcy court was persuaded in this regard because the severability provisions were exercisable only by FP or required FP's consent.

The bankruptcy court held

that in this case the individual leases incorporated into each Master Lease are economically interdependent. Although the underlying leases between the Debtors and the ground lessors were originally independent agreements, when the Master Leases were executed they became consolidated. Unlike the original landlords, FP had no real interest in each specific lease; its interest was in the total package. This conclusion is supported by the terms of the Master Lease: the total rent is due jointly and severally by all the tenants regardless of what happens to any of the individual leases.

The court concluded that "[t]o allow the Debtors to reject one of the leases without continuing to pay the total rent would be to destroy the essence of FP's bargain." The court was very focused on the fact that the debtors, after they entered into the leases, bundled them for purposes of monetizing them. The bankruptcy court reasoned that the debtors entered into the sale/leaseback agreement whereby the leases were bundled in exchange for one obligation. "FP agreed to pay the Debtors a substantial sum of money in exchange, inter alia, for the right to bundle the leases into four Master Leases and restrict the exercise of rights by the individual tenants. The Court concludes that the intent to treat the Master Leases as integrated indivisible agreements is clear from the face of those agreements."

The bankruptcy court even noted that during the Master Lease negotiations, the debtors expressed their preference for individual leases, but FP insisted on the Master Lease concept and that is how the transaction ultimately was structured. The bankruptcy court stated, "The Debtors agreed to the Master Lease structure because they were more interested in the favorable terms offered by FP (total proceeds and rental terms) and in getting treatment of the transaction as an operating lease."

"FP was not the original lessor; it had no reason to do business with the Debtors on any of the leases," the court added. "Instead, it was being asked by the Debtors to 'monetize' their leases. In exchange for doing that at the price that it did, FP insisted on the leases being bundled."

This case presents lessons for creditors as well as debtors. Lenders seeking to ensure that their master leases cannot be cut up into separate pieces should create a clear record in the documents that the intention of the parties is for the master lease to be a fully integrated document, and that the lender would not otherwise enter into the transaction. Debtors should be aware that steps they take to restructure and survive outside of a filing can come back to haunt them if they eventually file.

This article is presented for informational purposes only and is not intended to constitute legal advice.