The April 2003 Seventh Circuit Court of Appeals decision in Precision Industries, Inc. and Circo Leasing Co., LLC v. Qualitech Steel SBQ, LLC could create problems for tenants of a landlord/property owner who files bankruptcy if the tenants do not properly protect their leasehold interest in the landlord/property owner’s bankruptcy proceeding. This was a case of first impression in the Seventh Circuit, which is located in Illinois.
In Precision, several lenders held a mortgage on Qualitech Steel SBQ LLC’s (“Qualitech”) 138-acre steel mill facility in Pittsboro, Indiana. When Qualitech began experiencing financial problems, it decided to file for bankruptcy. Shortly before its bankruptcy filing, Qualitech executed an agreement with Precision Industries, Inc. and Circo Leasing Co., LLC (collectively “Precision”) to build a supply warehouse at the Pittsboro facility. The agreement required Precision to operate the warehouse and provide on-site supply services to Qualitech for ten years. By a separate lease, Precision leased the land under the warehouse for ten years at a rent of $1 per year.
During the bankruptcy proceeding, the court ordered Qualitech to sell its assets free and clear of all liens, claims and encumbrances except those of the group of senior pre-petition lenders who purchased the assets for $180 million. The order approving the sale provided that all parties holding interests in Qualitech’s assets, including the Pittsboro property, were barred from asserting those interests against the new owner of the assets. Thereafter, the new owner changed the locks on the warehouse, thereby preventing Precision from taking possession. Precision then sought to vacate the order approving the sale of Qualitech’s assets free and clear of any liens.
In ruling the bankruptcy judge had authority to approve the sale of land subject to a lease, the court stated Section 365(h) of the United States Bankruptcy Code (the “Code”) allows a lessee to retain possession of property despite the decision of the trustee or the debtor-in-possession to reject an unexpired lease. The court also noted, however, Section 363(e) of the Code directs the bankruptcy court to provide “adequate protection” for the rights of parties whose interests might be damaged or terminated by the sale of a debtor’s property, including a lessee. While adequate protection does not necessarily guarantee a lessee will be able to continue in possession of the property, it does require the lessee be compensated for the value of its leasehold interest, usually from the proceeds of the sale of the debtor’s assets.