Seventh Circuit Holds that Pre-Bankruptcy Lease Terminations May Be Avoidable

March 28, 2016

In a case of first impression, the Seventh Circuit recently issued an opinion that may cause landlords and their advisors to re-evaluate the consequences of terminating a financially distressed commercial tenant’s lease prior to bankruptcy. Official Comm. of Unsecured Creditors of Great Lakes Quick Lube LP v. T.D. Investments I, LLP (In re Great Lakes Quick Lube LP), — F.3d —, 2016 WL 930298 (7th Cir. Mar. 11, 2016) (Posner, J.).

A. Factual and Procedural Background

The debtor, Great Lakes, operated a number of oil change centers. As part of its business model, Great Lakes would buy a location, sell it to an investor (here, T.D. Investments), and then lease it back. Approximately two months before filing for bankruptcy, Great Lakes voluntarily terminated several of its leases with T.D., including leases for two profitable locations. T.D. later leased those locations to another oil-change company.

The creditors’ committee argued that the pre-petition termination of these two leases was avoidable as preferential or constructive fraudulent transfers. The bankruptcy court held that the lease terminations were not transfers, and even if they were considered transfers, they were not avoidable. See 528 B.R. 893, 898-900 (Bankr. E.D. Wisc. 2015).

B. Seventh Circuit’s Ruling

On a direct appeal, Judge Posner reversed the bankruptcy court’s ruling and held that the termination of the two leases amounted to transfers under the Bankruptcy Code. Judge Posner further intimated that Great Lakes may not have received reasonably equivalent value for terminating the leases. Consequently, he reversed and remanded the matter to the bankruptcy court to determine the value of Great Lakes’ transfers to T. D., and whether T.D. has any defenses to the committee’s preferential and/or constructive fraudulent transfer claims.

C. Conclusions

Landlords and distressed commercial tenants regularly agree to terminate leases as a matter of course, without concern to whether the termination could later be avoided in bankruptcy. This assists the tenants in their wind-down or workout efforts, while permitting the landlord to lease the premises to another tenant. It remains to be seen whether other courts adopt Judge Posner’s reasoning. However, landlords with property in the Seventh Circuit should carefully consider how this opinion impacts lease-termination negotiations with distressed commercial tenants.