Under Section 365(h) of the Bankruptcy Code, where a debtor, as lessor, rejects a lease, the debtors contractual obligations under the lease generally disappear. However, the non-debtor tenant may elect to remain in possession of the premises as long as it continues to perform its obligations under the lease. In apparent contradiction to the possessory rights of a non-debtor tenant under Section 365(h), Section 363(f) of the code allows a debtor to sell its assets, including real estate, subject to a lease, free and clear of liens, claims and encumbrances.
On October 1, 2012, in In re Zota Petroleums, No. 11-35079-DOT, 482 B.R. 154 (E.D. Va. 2012), the U.S. Bankruptcy Court for the Eastern District of Virginia, Richmond Division, considered whether the assignment of an assumed lease could extinguish a sublessees statutory rights under Section 365(h) of the code. In Zota, the assignment was made as part of a sale of the debtors assets free and clear of all interests pursuant to Section 363 of the code. In its opinion, the bankruptcy court added its voice to the ongoing debate concerning the interplay of Sections 365(h) and 363(f) of the code, an issue most notably discussed by the U.S. Court of Appeals for the Seventh Circuit in Precision Industries v. Qualitech Steel SBQ (In re Qualitech Steel), 327 F.3d 537 (7th Cir. 2003). Concluding that the Section 365(h) rights of the sublessee survived the Section 363 sale, the bankruptcy court in Zota distinguished the Seventh Circuits interpretation of the scope and effect of Section 363, particularly where the lease interest at issue was rejected before or alongside the Section 363 sale.
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