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Delaware Bankruptcy Court Denies Friendly’s Lease Rejection Attempt

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On February 24, 2012, Chief Judge Kevin Gross of the United States Bankruptcy Court for the District of Delaware (the “Court”) issued an opinion sustaining a landlord’s objection to a proposed lease rejection in In re Amicus Wind Down Corp., Feb. 24, 2012 (Case No. 11-13167-KG). The decision was based on the proposed rejection of a real property lease (the “Lease”) between Tysen Associates (“Tysen”), as lessor, Friendly’s Ice Cream Corporation (“Friendly’s”), as lessee and sublessor, and Rappan Restaurants (“Rappan”), as sublessee.

On October 5, 2011, Friendly’s filed for bankruptcy protection in Delaware. Shortly after the petition date, the Court entered a lease rejection procedures order (the “Procedures Order”), allowing Friendly’s to reject real property leases after relinquishing control of the affected premises by “delivering keys and/or security codes” to the landlord.

On December 30, 2011, Friendly’s notified Tysen and Rappan it was rejecting the Lease effective as of December 31st. Tysen objected, alleging the Bankruptcy Code and Procedures Order prohibit rejection because Friendly’s was incapable of delivering possession of the property while Rappan was still operating on it. In response, Friendly’s argued that its relinquishment of interest in the premises was sufficient for rejection under section 365.

The Court held in favor of Tysen, finding Friendly’s mere surrender of interest insufficient to trigger rejection under both the Bankruptcy Code and the Procedures Order. Specifically, the Court concluded that Friendly’s could not deliver the “keys or security codes” to Tysen because Rappan’s possessory rights as subtenant under the Lease are preserved by section 365(h) of the Bankruptcy Code. Having failed to satisfy a condition precedent, Friendly’s proposed rejection failed. In ruling in Tysen’s favor, the Court expressly disagreed with an earlier decision in In re CHI-CHI’s Inc., 305 B.R. 396 (Bankr. D. Del. 2004) wherein a lease rejection was effective when the property was surrendered and the landlord was free to enter into a new agreement directly with the tenant. According to the Court, CHI-CHI’s is inconsistent with a subtenant’s continued right of possession under section 365(h).

Taking the ruling one step further, the Court instructed that Friendly’s, as the sole party in privity with Rappan, bears the burden of resolving any eviction/abandonment issues with Rappan before rejection can be effective.

A copy of the bankruptcy court’s opinion is available here.

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