Fracas in the French Quarter: Fifth Circuit Weighs in on the Ongoing Controversy Over the Intersection of Bankruptcy Code Sections 363(f) and 365(h) By: David Farrell The Fifth Circuit Court of Appeals joins other Circuits in finding that a bankruptcy sale can be “free and clear” of a tenant’s rights to remain in possession under Section 365(h) of the Bankruptcy Code. The Court’s reasoning on the facts before it are highlighted in this article. Reaching an outcome in line with two other circuit courts, on February 16, 2022, the Fifth Circuit Court of Appeals permitted a Chapter 11 trustee to sell a debtor’s real property free and clear of the leasehold estates held by certain nondebtor lessees. See In re Royal Street Bistro, L.L.C., 2022 WL 499938 (5th Cir. February 16, 2022) (the “Ruling”)
The dispute before the Fifth Circuit arose out of the bankruptcy proceedings of Royal Alice Properties, LLC (the “Debtor”), a single-member limited liability company that filed for Chapter 11 in the United States Bankruptcy Court for the Eastern District of Louisiana (the “Bankruptcy Court”). At the time of its bankruptcy filing, the Debtor held title to three parcels of real property in New Orleans’ famed French Quarter. Before the Chapter 11 filing, the Debtor entered into a series of leases with insiders at below-market rates (collectively, the “Insider Lessees”). The Debtor admitted it filed bankruptcy to prevent a secured lender from foreclosing upon a senior mortgage encumbering all three parcels. After the Debtor lingered in Chapter 11 for over a year without confirming a Chapter 11 plan, the Bankruptcy Court appointed a Chapter 11 trustee. Following his appointment, the Chapter 11 trustee sought approval to sell all three parcels free and clear of any liens and interests, including the interests of the non-debtor lessees. The Chapter 11 trustee relied on Bankruptcy Code Section 363(f )(1), which allows a bankruptcy trustee or debtor-in-possession to sell property of the bankruptcy estate free and clear of third-party “interests” when “applicable non-bankruptcy law permits a sale of such property free and clear of such interests.” 11 U.S.C. §363(f )(1). Background Historically, most lower courts did not allow Chapter 11 debtors and trustees to use Bankruptcy Code Section 363(f ) to sell real property free and clear of leasehold interests over the objections of the non-debtor lessees. These courts reasoned that a sale free and clear of leasehold interests was incompatible with Section 365(h), which generally
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