A&F Enters., Inc. v. Ihop Franchising LLC

• Decision Date: 07 February 2014
• Docket Number: No. 13–3192.,13–3192.
• Citation: 742 F.3d 763
• Parties: In re A & F ENTERPRISES, INC. II, et al., Debtors–Appellants. Appeal of A & F Enterprises, Inc. II, et al., Appellants, v. IHOP Franchising LLC, et al., Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

742 F.3d 763

In re A & F ENTERPRISES, INC. II, et al., Debtors–Appellants.

Appeal of A & F Enterprises, Inc. II, et al., Appellants,

v.IHOP Franchising LLC, et al., Appellees.

No. 13–3192.

United States Court of Appeals,Seventh Circuit.

Argued Dec. 11, 2013.

Decided Feb. 7, 2014.

Michael C. Moody, O'Rourke & Moody, Neal L. Wolf, Neal Wolf & Associates, LLC, Chicago, IL, for Debtors–Appellants.

Robert N. Hochman, Sidley Austin LLP, Robert E. Richards, Dentons U.S. LLP, Chicago, IL, for Appellees.

Before WOOD, Chief Judge, and FLAUM and SYKES, Circuit Judges.

SYKES, Circuit Judge.

Ali Alforookh manages and operates restaurants in Wisconsin, Illinois, and Missouri under franchise agreements with International House of Pancakes (“IHOP”). He created several companies to hold the IHOP franchises he acquired over the years, including A & F Enterprises, Inc. II. Alforookh and his companies (collectively “A & F”) are currently in Chapter 11 bankruptcy proceedings. Their primary assets are 17 separate IHOP franchise agreements and the corresponding building and equipment leases.¹ At this point the central dispute in the bankruptcy is the time limit for assuming these contracts. In general, debtors, in Chapter 11 may assume or reject executory contracts any time before confirmation of a plan. 11 U.S.C. § 365(d)(2). Unexpired leases of nonresidential real property, however, must be assumed within 120 days (210 days if the court grants a 90–day extension). Id. § 365(d)(4). A & F neither assumed the building leases within 120 days nor sought an extension, so IHOP contends that the building leases were rejected, and by way of cross-default provisions, that the franchise agreements and equipment leases expired. A & F believes that because the building leases are just one part of the larger franchise arrangement with IHOP, § 365(d)(2)'s more generous time limit applies to the whole arrangement, including the building leases.

The issue for us on this appeal, however, is slightly different. A & F and IHOP fought this legal battle in bankruptcy court, and A & F lost on the merits. The bankruptcy judge issued orders deeming the building leases rejected and the franchise agreements and equipment leases expired. A & F appealed this decision to the district court. A & F also sought a stay pending appeal, which both the bankruptcy court and the district court denied. Both courts thought that A & F's position lacked merit because the text of § 365(d)(4) contains no exception for leases tied to franchises. A & F filed this appeal seeking review of the district court's order denying the stay and also moved for an emergency stay. We granted the emergency motion and issued a stay order freezing the status quo during the pendency of this appeal. The sole issue for us now is whether the bankruptcy court's orders should be stayed pending resolution of the appeal on the merits, which remains pending before the district court. We find that a continued stay is warranted.

I.

The standard for granting a stay pending appeal mirrors that for granting a preliminary injunction. In re Forty–Eight Insulations, Inc., 115 F.3d 1294, 1300 (7th Cir.1997). Stays, like preliminary injunctions, are necessary to mitigate the damage that can be done during the interim period before a legal issue is finally resolved on its merits. The goal is to minimize the costs of error. See Stuller, Inc. v. Steak N Shake Enters., Inc., 695 F.3d 676, 678 (7th Cir.2012); Roland Mach. Co. v. Dresser Indus., Inc., 749 F.2d 380, 388 (7th Cir.1984). To determine whether to grant a stay, we consider the moving party's likelihood of success on the merits, the irreparable harm that will result to each side if the stay is either granted or denied in error, and whether the public interest favors one side or the other. See Cavel Int'l, Inc. v. Madigan, 500 F.3d 544, 547–48 (7th Cir.2007); Sofinet v. INS, 188 F.3d 703, 706 (7th Cir.1999); In re Forty–Eight Insulations, 115 F.3d at 1300. As with a motion for a preliminary injunction, a “sliding scale” approach applies; the greater the moving party's likelihood of success on the merits, the less heavily the balance of harms must weigh in its favor, and vice versa. Cavel, 500 F.3d at 547–48;Sofinet, 188 F.3d at 707. An unusual twist here is that the stay issue comes to us in the context of a bankruptcy appeal to the district court. But our jurisdiction is secure under 28 U.S.C. § 1292(a). See In re Forty–Eight Insulations, 115 F.3d at 1300. The district judge denied the stay after concluding that A & F was not likely to succeed on the merits; although other aspects of a stay decision are reviewed deferentially, this is a legal conclusion that we review de novo. Id. at 1301.

The contractual relationship between the parties is undisputed. For all but four of the restaurants, there are three separate contracts: a franchise agreement, a building sublease (IHOP leases the buildings from third parties and subleases them to A & F), and an equipment lease, all of which contain cross-default provisions ² A & F may not use the leased buildings for anything other than IHOP restaurants, and the leases cannot be assigned.³ The parties dispute whether the agreements should be viewed as a single integrated contract or as separate-but-interrelated contracts, but they generally agree on the effects of the arrangement. See generally In re FPSDA I, LLC, 470 B.R. 257, 266–72 (E.D.N.Y.2012) (discussing two ways to characterize these arrangements, but concluding that the choice of characterization doesn't affect whether § 365(d)(4)'s time limit applies). A & F has no way to assume the leases without also assuming the franchises; several courts have held that indivisible contractual arrangements must be assumed or rejected in whole, e.g., In re Wagstaff Minn., Inc., No. 11–43073, 2012 WL 10623 (D.Minn. Jan. 3, 2012), but even if A & F were allowed to assume the leases separately, they would be worthless without the franchises since their only permitted use is the operation of IHOP restaurants.⁴ Similarly, A & F cannot assume the franchises without also assuming the leases because the franchise agreements automatically expire if A & F loses the right to occupy the leased buildings. A & F argues that since the leases and franchise agreements must be assumed or rejected in tandem, the longer time limit should apply, while IHOP contends that A & F should be required to assume both within 120 days.

II.

IHOP maintains that the text of § 365(d)(4) plainly controls, leaving no room for an exception for franchise-bound leases. It cites Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, 686 F.3d 372 (7th Cir.2012), in which we warned bankruptcy courts not to create equitable exceptions to clear provisions of the bankruptcy code. But the code is not so clear in this case. While it's undeniable that § 365(d)(4)'s 120–day time limit controls stand-alone leases, it's equally undeniable that § 365(d)(2)' s longer time limit controls stand-alone franchise agreements. When a franchise agreement and a lease are inseparable, one time limit or the other will control both. In the same way that applying § 365(d)(2)'s time limit to the entire arrangement creates an “exception” for certain leases, applying § 365(d)(4)'s time limit creates an “exception” for certain franchises. Granted, the two possibilities are not perfectly symmetrical because one result permits something the code forbids (assuming a lease beyond 120 days) while the other result prevents something the code permits (assuming a franchise agreement beyond 120 days). This is a distinction without a difference, however, because a legal entitlement is lost either way: Either franchisees lose the right to assume franchise agreements at any time before confirmation of a plan, or lessors lose the right to have their leases assumed or rejected within 120 days. Creating an exception is unavoidable, so we have no choice but to look beyond the text.

There are powerful arguments in favor of A & F's position. Chapter 11 is premised on giving debtors a full opportunity to reorganize, and provisions like § 365(d)(4) that limit this opportunity are the exception, not the rule. The franchise agreement is clearly the dominant contract and the focus of the parties' bargaining, so prioritizing the lease lets the tail wag the dog. Furthermore, what little caselaw there is on this precise issue favors A & F's position. Two bankruptcy courts have held on nearly identical facts that § 365(d)(4) does not apply to a lease that is so tightly connected to a franchise arrangement. In re FPSDA I, LLC, 450 B.R. 392 (Bankr.E.D.N.Y.2011), petition for interlocutory appeal denied by470 B.R. 257, 271 (E.D.N.Y.2012) (finding that “there is not a substantial ground for difference of opinion as to whether [§ 365(d)(4) ] is applicable” to a similar franchise-bound lease); In re Harrison, 117 B.R. 570 (Bankr.C.D.Cal.1990). Though we are provisionally persuaded that A & F's position has substantial merit, we emphasize that we aren't deciding the issue today. IHOP leaned heavily on the text, and now that we've indicated that we don't find the text conclusive, IHOP's position may benefit from more extensive briefing on the merits.

Because the legal issue does not have a clear-cut answer, we rest our decision on whether to grant the stay primarily on the balance of potential harms. We don't have the benefit of any factual findings—the bankruptcy judge denied A & F's request for an evidentiary hearing because he concluded that the legal question wasn't even close—but that doesn't preclude us from deciding whether to grant a stay. This analysis is at best a rough estimation, and we are persuaded that A & F has more to lose than IHOP.

A & F fears that it will permanently lose its franchises without a stay. If a stay is denied, IHOP, which wants to sell the franchises, may do so before A & F's appeal has finished. Both parties assume that...