Rochelle's Daily Wire

District Judge Colleen McMahon of New York has a knack for predicting how higher courts will rule in notable cases. Despite authority in the Second Circuit to the contrary, she correctly predicted that the Supreme Court would bar nondebtor releases in Harrington v. Purdue Pharma L.P., 144 S. Ct. 2071 (2024).

In May, Judge McMahan predicted that the landlord of a large Sears store would take home nothing despite having won a notable victory in the Supreme Court in MOAC Mall Holdings LLC v. Transform Holdco LLC, 598 U.S. 288 (April 19, 2023). In MOAC, the Supreme Court held that Section 363(m) is not jurisdictional. Rather, it’s a limitation on the remedy available to an appellate court on an appeal from an order approving a sale. To read ABI’s report, click here.

In a per curiam opinion on December 16, the Second Circuit said that Judge McMahan got it right. Although the Sears landlord won victories from the lower courts all the way to the Supreme Court, the landlord wasn’t entitled to take over the premises because it wasn’t a “true lease.” In short, the landlord spent a boatload on attorneys’ fees but finds itself right back where it began: The Sears chapter 11 trust owns the store, not the landlord, and Sears can sell or lease the store to whomever it wishes.

The Pantheon of Appeals

Long before bankruptcy, Sears entered into a 99-year “lease” at the Mall of America in Minneapolis. Sears paid to build the store and in return took back a 99-year lease with minimal rent. Sears paid taxes and common-area maintenance. The landlord had no control over subletting.

In chapter 11, Sears moved to sell the lease. The landlord objected to the sale and assignment but lost in bankruptcy court.

On the first appeal in district court, Judge McMahon reversed, holding that the debtor could not assign the lease for failure to show adequate assurance of future performance. MOAC Mall Holdings LLC v. Transform Holdco LLC (In re Sears Holdings Corp.), 613 B.R. 51 (S.D.N.Y. Feb. 27, 2020). To read ABI’s report, click here.

The purchaser of the lease immediately filed a motion for rehearing. Although having taken a contrary position previously, the purchaser contended for the first time on rehearing that the appeal should be dismissed under Section 363(m) because the landlord had not obtained a stay pending appeal.

Granting rehearing, Judge McMahon decided that she was compelled by Second Circuit authority to dismiss the appeal for lack of jurisdiction under Section 363(m). MOAC Mall Holdings LLC v. Transform Holdco LLC (In re Sears Holdings Corp.), 616 B.R. 615, (S.D.N.Y. 2020). To read ABI’s report, click here.

The Second Circuit affirmed in a nonprecedential opinion. MOAC Mall Holdings LLC v. Transform Holdco LLC (In re Sears Holdings Corp.), 20-1846, 2021 BL 481940, 2021 US App Lexis 37358, 2021 WL 5986997 (2d Cir. Dec. 17, 2021). To read ABI’s report on the Second Circuit opinion, click here.

The landlord filed a petition for certiorari, which the Supreme Court granted. Reversing the Second Circuit, the Supreme Court ruled unanimously in April 2023 that Section 363(m) is not jurisdictional. Rather, it’s a limitation on the remedy available to an appellate court on an appeal from an order approving a sale. MOAC Mall Holdings LLC v. Transform Holdco LLC, 598 U.S. 288 (April 19, 2023). To read ABI’s report, click here. The Court remanded the case to the Second Circuit.

On remand from the Supreme Court, the Second Circuit dealt with the merits in two pages of a per curiam, nonprecedential opinion on November 6, 2023. The appeals court vacated dismissal of the appeal under Section 363(m) and remanded for further proceedings before District Judge McMahon. MOAC Mall Holdings LLC v. Transform Holdco LLC (In re Sears Holdings Corp.), 20-1846, 2023 BL 398708, 2023 US App Lexis 29477, 2023 WL 7294833 (2d Cir. Nov. 6, 2023). To read ABI’s report, click here.

On Remand in District Court

During the appeals, Sears had confirmed and consummated a chapter 11 plan. Before Judge McMahon on remand, the parties made every argument under the sun. The landlord wanted possession and ownership of the store that had been “leased” to Sears.

Judge McMahon spent 25 pages in explaining why the landlord wasn’t entitled to take over the premises. Among other things, she held that the time limitation for assuming or rejecting leases under Section 365(d)(4) did not apply, because Sears had in fact filed an assumption motion before the deadline. She also decided that the landlord should take nothing under Int’l Trade Admin. v. Rensselaer Polytechnic Inst., 936 F.2d 744 (2d Cir. 1991). There, the Second Circuit held that a purported lease was not a “true lease,” making the deadline in Section 365(d)(4) inapplicable.

Like the lease in RPI, Judge McMahon decided that the Sears lease was not a true lease and that there would be “gross inequity” if the landlord were allowed to “recapture the premises.”

Having decided that the landlord was not entitled to take over the premises, Judge McMahon ended her opinion by rejecting the landlord’s alternative theories about damages. She awarded no damages against the debtor given the exculpations contained in the confirmed chapter 11 plan.

While saying she was sympathetic to the landlord’s desire for some remedy since it wasn’t taking back the premises, Judge McMahon said that the landlord “retains all the benefit of the bargain that it made with Sears in 1991.” In other words, she said, “The only thing this ruling does not give [the landlord] is a way out of its original bargain.”

Calling the case a “Pyrrhic victory” for the landlord, Judge McMahon returned possession of the lease to the Sears Liquidating Trustee and dismissed the landlord’s appeal “as moot for lack of any remedy.” See MOAC Mall Holdings LLC v. Transform Holdco LLC (In re Sears Holdings Corp.), 661 B.R. 298 (S.D.N.Y. May 3, 2024). To read ABI’s report, click here.

Same Result in the Second Circuit

Judge McMahon’s decision was 49 pages. The Second Circuit’s 14-page per curiam affirmance reads like a summary of Judge McMahon’s tome. The landlord had spent lots of time and money but accomplished nothing aside from the satisfaction of making important bankruptcy law in the Supreme Court.

Like Judge McMahon, the appeals court began with a recitation of the facts and the procedural history, noting that that case was in the Second Circuit a third time. The analysis of the merits began with Section 365(d)(4), which pertains to “an unexpired lease of nonresidential real property under which the debtor is the lessee. . . .”

The subsection causes automatic rejection of a lease if the debtor has not assumed or rejected within 120 days of the order for relief.

To decide whether Section 365(d)(4) even applied to give Sears a deadline for assuming, the Second Circuit began with RPI and a discussion of whether the Sears “lease” was a “true lease,” just like Judge McMahon had done. The appeals court noted it was a 99-year lease where the annual rent was minimal and Sears had the ordinary incidents of ownership, such as paying taxes and utilities.

Given that Sears had built the store with its own money, the circuit court said that making the “lease” a “true lease” would “amount to giving an inequitable windfall to the landlord.” Not finding a “true lease,” the appeals court said, “it is not governed by Section 365(d)(4).” There being no “true lease,” the circuit court said “there was no basis for the . . . Lease to revert to [the landlord] once the district court vacated the assumption and assignment of the . . . Lease to” the buyer.

Having lost the principal issue on appeal, the appeals court went on to reject the same alternative arguments that the landlord had made to Judge McMahan.

The landlord contended that Sears had waived or forfeited the right to claim the lease was not a “true lease” because the parties had stipulated in the bankruptcy court that it was a shopping center lease.

The appeals court found no waiver because a stipulation that it was a shopping center lease for the purpose of Section 365(d)(3) did not mean it was a “true lease” for the purpose of Section 365(d)(4).

The circuit court was similarly “unpersuaded” that the parties’ agreement to extend the assumption deadline under Section 365(d)(4) amounted to a waiver of Sears’s right to claim it wasn’t a “true lease.” The appeals court said that the parties “neither affirmatively state that Section 365(d)(4) governs the . . . Lease nor confirm that the . . . Lease is a ‘lease of nonresidential real property’ pursuant to Section 365(d)(4).”

“At most,” the appeals courts said, the stipulation was evidence of the debtor’s “‘oversight’ or ‘thoughtlessness’ as to the applicability of Section 365(d)(4) to the . . . Lease, which is insufficient to constitute waiver.”

The circuit court also rejected the landlord’s forfeiture argument, because the debtor was not “obligated to raise the ‘true lease’ objection under Section 365(d)(4) at an earlier time in the litigation.”

The circuit court ended the opinion by saying that the district court had power to return the lease to Sears or its successor because the “district court’s vacatur of the assumption and assignment effectively rendered the transfer of the . . .  Lease to [the purchaser] void ab initio.”

“Moreover,” the circuit court said, “Section 365 and its attendant requirements simply no longer apply to the . . . Lease” because “neither the [Sears] Liquidating Trust nor its assets are now in bankruptcy.” The circuit affirmed Judge McMahon.

Observations

The opinion is not insignificant, although nonprecedential.

Several times, the debtor stipulated to the existence of a “lease” subject to Section 365. It would not have been surprising had a court somewhere along the way taken the stipulation at face value and barred the debtor from arguing it was anything other than a true lease.

The Second Circuit let the debtor off the hook for its carelessness by referring to the stipulations as “oversight” or “thoughtlessness.”

When facing allegations of malpractice in the future, a lawyer could point to the opinion as meaning that oversight and thoughtlessness are not actionable. The offended client will say that the opinion is nonprecedential.