In re Lefrak
| Decision Date | 14 August 1998 |
| Docket Number | Adversary No. 98-8154A.,Bankruptcy No. 96 B 43478 (SMB) |
| Citation | 223 BR 431 |
| Parties | In re Joseph S. LEFRAK, Debtor. Alexander SCHACHTER, as Trustee of the Estate of Joseph S. Lefrak, Plaintiff, v. Susan LEFRAK, Defendant. |
| Court | U.S. Bankruptcy Court — Southern District of New York |
Rosenman & Colin LLP, New York City, A. Peter Lubitz, Melissa A. Hager, of counsel, for Plaintiff.
Law Offices of Ian J. Gazes, New York City, Ian J. Gazes, of counsel, for Defendant.
Under section 365(d)(1) of the Bankruptcy Code, a chapter 7 trustee must assume or reject a debtor's unexpired lease within sixty days of the order for relief. If he fails to do so, and if the court does not grant him additional time to decide, the lease will be deemed rejected. The primary issue before the Court is whether the debtor-shareholder's proprietary lease in a cooperative apartment building is a lease for purposes of section 365. The Court holds that it is not, and for the reasons set forth below, directs the occupant of the apartment, the debtor's non-debtor wife, the defendant Susan Lefrak ("Susan"), to turn over possession to the trustee. In addition, the trustee is entitled to payment of postpetition use and occupation in an amount to be determined in a subsequent hearing.
This adversary proceeding represents the second round in a dispute between the trustee and the Lefraks. The first culminated in a decision that the estate owns the entire interest in the subject cooperative apartment (the "Apartment"), see Schachter v. Lefrak (In re Lefrak), 215 B.R. 930 (Bankr.S.D.N.Y. 1998), and the trustee subsequently commenced this suit to compel its turnover and to recover use and occupation from Susan. The relevant facts have been determined in the previous litigation or are not in dispute.
The debtor, Joseph S. Lefrak ("Joseph"), and Susan married in September 1952, and moved into the Apartment (14D), located at 983 Park Avenue in Manhattan, in 1976. In 1982, the building converted to cooperative ownership. Joseph acquired the shares (the "Shares") representing an interest in the corporation that owned the building (the "Corporation"), and entered into a proprietary lease (the "Lease") with the Corporation to occupy the Apartment. Joseph was the sole owner of the Shares and the sole lessee under the Lease.
The prior litigation concerned the ownership of the Shares and Lease.1 The Lefraks contended that Joseph conveyed a 50% joint interest in the Shares and Lease to Susan in 1984. Thereafter, pursuant to a 1994 oral separation agreement, Joseph conveyed the remaining 50%. Prior to but certainly no later than the oral separation agreement, Joseph moved out, and Susan became (and has remained) the sole occupant of the Apartment. The Lefraks argued that as a result of these transactions, Susan owned the Shares and Lease, and they never became property of Joseph's estate when he subsequently filed his chapter 7 petition in 1996.
The trustee challenged the transfers. He commenced the first adversary proceeding to avoid them and to obtain a judicial declaration that the estate owned 100% of the interest in the Apartment. Following a trial, the Court held that both transfers were ineffective. As a consequence, the entire interest in the Apartment became property of the estate. In re Lefrak, 215 B.R. at 938.2
The ruling did not address Susan's continued occupancy; she has lived in the Apartment, rent free, during the entire case. The parties agree that the unpaid postpetition maintenance is approximately $35,000.00, and continues to accrue at the monthly rate of about $2,500.00. The unpaid maintenance is secured by the interest in the Shares. .) In addition, the Shares and Lease secure Joseph's loan from Dime Savings Bank, and this loan has not been satisfied. As a result, the failure to make monthly maintenance or mortgage payments eats away at the estate's equity.
Following the first decision, the trustee commenced this adversary proceeding to compel Susan to turn over the Apartment and to recover postpetition use and occupation charges of approximately $140,000.00. Susan did not answer, and the clerk entered her default. See Fed R. Civ. P. 55(a). Susan subsequently moved to vacate her default, and the trustee opposed the motion. He argued that she had failed to show a meritorious defense to the turnover application. It became evident that the dispute raised purely legal issues, and accordingly, the Court, with the parties' consent, vacated the default, accepted Susan's proposed answer and treated the submissions as cross-motions for summary judgment.
In response to the trustee's turnover application, Susan makes two arguments.3 First, Susan challenges the trustee's standing. The trustee failed to assume the Lease within sixty days following the judgment in the first adversary proceeding, and Susan argues that the Lease has been deemed rejected under 11 U.S.C. § 365(d)(1). The rejection, she maintains, results in an abandonment of the estate's interest in the Lease to Joseph, and the trustee has no right to evict her. Second, she contends that under the 1994 oral separation agreement, Joseph gave her a possessory interest in the Apartment which is superior to the estate's title. The parties have made other arguments as well, but in light of the Court's disposition, it is unnecessary to reach them.
To the extent relevant here, section 365 permits a chapter 7 trustee to assume or reject an unexpired lease. The purpose of this section is to benefit the estate by permitting assumption of beneficial leases and rejection of burdensome ones. See Liona Corp. v. PCH Assocs. (In re PCH Assocs.), 804 F.2d 193, 200 (2d Cir.1986). The Code further provides that a lease is deemed rejected if the trustee does not move to assume it, or to extend his time to decide, within sixty days of entry of the order for relief. 11 U.S.C. § 365(d)(1).
It is well-settled that section 365 applies only to "true" or "bona fide" leases, see International Trade Admin. v. Rensselaer Polytechnic Inst., 936 F.2d 744, 748 (2d Cir.1991); In re PCH Assocs., 804 F.2d at 198-99,4 and its applicability presents a question of federal law. Barney's, Inc. v. Isetan Co. (In re Barney's, Inc.), 206 B.R. 328, 332 (Bankr.S.D.N.Y.1997). Thus, while state law may treat the agreement as a lease,5 this does not mandate the application of section 365. In re Moreggia & Sons, Inc., 852 F.2d 1179, 1182-83 (9th Cir.1988); In re KAR Dev. Assocs., L.P., 180 B.R. 629, 638-39 (D.Kan.1995); Hotel Syracuse, Inc. v. City of Syracuse Indus. Dev. Agency (In re Hotel Syracuse, Inc.), 155 B.R. 824, 838 (Bankr. N.D.N.Y.1993).
Instead, courts consider the economic substance of the transaction, see International Trade Admin., 936 F.2d at 748; In re PCH Assocs., 804 F.2d at 200, and whether "the parties intended to impose obligations and confer rights significantly different from those arising from the ordinary landlord/tenant relationship." In re PCH Assocs., 804 F.2d at 200; see In re Moreggia & Sons, Inc., 852 F.2d at 1184. Typically, the reported cases address the distinction between "true" leases and financing arrangements, and apply criteria that focus on that distinction. These include whether the "rent" reflects compensation for the use of the property or is structured as a return on an investment, whether the purchase price is based on the market value of the land or the amount necessary to finance the transaction, whether the property was purchased specifically for the lessee's use, whether the transaction is structured as a lease for tax reasons, whether the lessee assumes the obligations normally associated with outright ownership and whether the lessee can acquire the property at the end of the term for a nominal payment. See, e.g., In re PCH Assocs., 804 F.2d at 200-01; In re KAR Dev. Assocs., L.P., 180 B.R. at 639; In re Barney's, Inc., 206 B.R. at 334; In re Challa, 186 B.R. 750, 757 (Bankr. M.D.Fla.1995); In re Hotel Syracuse, Inc., 155 B.R. at 838-39; see S. Rep. No. 95-989, at 64 (1978). Other relevant considerations are the length of the lease, International Trade Admin., 936 F.2d at 749-50, and whether the lease is part of a larger agreement. In re TAK Broadcasting Corp., 137 B.R. 728, 731, 733-34 (W.D.Wis.1992).
The Lease in question is clearly not a financing device. The Corporation, the landlord under the Lease, did not lend Joseph any money, and there is no debt to secure. It does not follow, however, that because the Lease fails the test of a disguised security agreement it must therefore be a "true" lease. Rather, the issue is whether the Lease created a typical residential landlord-tenant relationship, or instead, conferred the risks and rewards of home ownership. The inquiry remains the same — the economic substance or reality of the transaction — and many of the criteria used to distinguish leases from security arrangements are germane.
In the usual landlord-tenant relationship, a landlord acquires a building for his own benefit, and then rents apartments to his tenants at a profit, subject to the effects of the various rent control laws. The residential tenant does not fund the landlord's acquisition, and, aside from a security deposit, does not make an initial payment. The tenant receives a relatively short lease, and pays a fixed rent. He does not assume any of the obligations associated with ownership; he has no liability for operating costs beyond the payment of rent. Similarly, he does not face the risks or enjoy the rewards of fluctuating values in the real property market. While the tenant has the right to use and enjoy the premises during the term of his...
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