Precision Industries v. Qualitech Steel Sbq

• Decision Date: 23 April 2003
• Docket Number: No. 01-2753.,01-2753.
• Citation: 327 F.3d 537
• Court: U.S. Court of Appeals — Seventh Circuit
• Parties: PRECISION INDUSTRIES, INC., and Circo Leasing Co., LLC, Appellees, v. QUALITECH STEEL SBQ, LLC, Appellant. In Re: Qualitech Steel Corporation and Qualitech Steel Holdings Corporation, Debtors-in-Possession.

327 F.3d 537

PRECISION INDUSTRIES, INC., and Circo Leasing Co., LLC, Appellees, v. QUALITECH STEEL SBQ, LLC, Appellant In Re: Qualitech Steel Corporation and Qualitech Steel Holdings Corporation, Debtors-in-Possession.

No. 01-2753.

United States Court of Appeals, Seventh Circuit.

Argued February 15, 2002.

Decided April 23, 2003.

Rehearing Denied May 27, 2003.

Appeal from the United States Bankruptcy Court for the Southern District of Indiana, David F. Hamilton, J.

COPYRIGHT MATERIAL OMITTED

James P. Moloy (Argued), Dann, Pecar, Newman & Kleiman, Indianapolis, IN, for Appellant.

John K. McDavid (Argued), Locke Reynolds, Indianapolis, IN, for Appellees.

Before ROVNER, DIANE P. WOOD, and EVANS, Circuit Judges.

ILANA DIAMOND ROVNER, Circuit Judge.

In this case of first impression at the circuit level, we are asked to reconcile two distinct provisions of the Bankruptcy Code: 11 U.S.C. § 363(f), which authorizes the sale of a debtor's property free of any "interest" other than the estate's, and 11 U.S.C. § 365(h), which protects the rights of the lessee when the debtor rejects a lease of estate property. The bankruptcy court in this case construed a sale order issued pursuant to section 363(f) to extinguish the possessory rights bestowed by a lease of the estate's land. The district court disagreed, reasoning that sections 363(f) and 365(h) conflict and that the more specific terms of the latter provision concerning leaseholds trump those of the former, in this way preserving the lessee's possessory interest even after a section 363(f) sale. Precision Indus., Inc. v. Qualitech Steel SBQ, LLC, 2001 WL 699881 (S.D.Ind. April 24, 2001). We reverse, concluding that under the plain terms of section 363(f), the sale order extinguished the lessee's possessory interest.

I.

The debtors in the underlying bankruptcy proceedings — Qualitech Steel Corporation and Qualitech Steel Holdings Corporation (collectively, "Qualitech") — owned and operated a steel mill on a 138-acre tract of land in Pittsboro, Indiana. Before it entered bankruptcy, Qualitech had entered into two related agreements with appellees Precision Industries, Inc. and Circo Leasing Co., LLC (collectively, "Precision"). A detailed supply agreement executed on June 29, 1998, provided that Precision would construct a supply warehouse at Qualitech's Pittsboro facility and operate it for a period of ten years so as to provide on-site, integrated supply services for Qualitech. The second agreement, a land lease executed on February 25, 1999, specified that Qualitech would lease to Precision the property underlying the warehouse for a period of ten years. In exchange for nominal rent of $1 per year, the lease granted Precision exclusive possession of the warehouse and any other improvements or fixtures it installed on the land for the term of the lease; and in the event of an early termination or default under either the lease or the supply agreement, Precision had the right to remove all improvements and fixtures from the property. Assuming no default, Qualitech had the right at the end of the lease term to purchase the warehouse, its fixtures, and other improvements for $1. In accordance with the two agreements, Precision built and stocked a warehouse on the leased property and Qualitech began purchasing goods from Precision. The lease was never recorded.

Heavily in debt,¹ Qualitech filed a Chapter 11 bankruptcy petition on March 22, 1999. On June 30, 1999, substantially all of Qualitech's assets were sold at auction for a credit bid of $180 million to a group of senior pre-petition lenders that held the primary mortgage on the Pittsboro property.² On August 13, 1999, at the conclusion of a noticed hearing, the bankruptcy court entered an order approving the sale (hereinafter, the "Sale Order"). Precision, which had notice of the hearing, did not object to the Sale Order. That order directed Qualitech to convey its assets to the pre-petition lenders — referred to in the Sale Order collectively as the "purchaser" — "free and clear of all liens, claims, encumbrances, and interests," except for specifically enumerated liens, pursuant to section 363(f), among other provisions of the Code. R. 492 at 6-7 ¶ 2 (emphasis supplied). All persons and entities holding interests other than those expressly preserved in the Sale Order were barred from asserting those interests against the purchaser. Id. at 8 ¶ 6. The pre-petition senior lenders subsequently transferred their interest in the purchased assets to newly-formed Qualitech Steel SBQ, LLC ("New Qualitech"), which assumed the rights of the purchaser under the Sale Order and took title to the Pittsboro property. The Sale Order also reserved for the purchaser the debtor's right to assume and assign executory contracts pursuant to 11 U.S.C. § 365. R.492 at 9 ¶ 9. Although the sale closed on or about August 26, 1999 without assumption of either the lease or the supply agreement with Precision, negotiations toward that end continued and the parties extended the deadline for assumption on four occasions. Those negotiations did not prove successful, however, with the result that Precision's lease and supply agreement were de facto rejected. See 2001 WL 699881, at *9 & n. 8.

By December 3, 1999, Precision had completely vacated and padlocked the warehouse. Shortly thereafter, New Qualitech, without Precision's knowledge or consent, hired a locksmith and changed the locks on the building. New Qualitech's takeover of the warehouse led to a dispute over whether Precision's possessory interest in the leased property, pursuant to section 365(h), survived the bankruptcy sale. Finding itself locked out of the warehouse, Precision filed a diversity suit in the district court contending that New Qualitech was guilty of trespass, conversion, wrongful eviction, breach of an implied contract, and estoppel. New Qualitech in turn asked the district court to refer Precision's complaint — which was premised on the notion that Precision retained a possessory interest in the warehouse under the lease — to the bankruptcy court, and New Qualitech also filed a request with the bankruptcy court asking it to clarify that the Sale Order had extinguished Precision's possessory interest. The district court obliged New Qualitech by referring Precision's complaint to the bankruptcy court, and that court in turn resolved the matter of Precision's possessory interest in New Qualitech's favor.

Based on the terms of both section 363(f) and the Sale Order itself, the bankruptcy court determined that New Qualitech had obtained title to Qualitech's property free and clear of any possessory rights that Precision otherwise might have enjoyed under its lease. In relevant part, the court held that Precision's possessory interest was among those interests extinguished by the Sale Order:

The interest[ ] of Precision as a lessee under the Lease is an "interest" within the meaning of the Sale Order. The sale of the Indiana Facilities pursuant to 11 U.S.C. § 363(b), (f), and (k) was free and clear of all liens, claims, encumbrances and interests [and therefore] acted to convey the Indiana Facilities free and clear of the interests of Precision as lessee under an unrecorded lease.

R. 601 at 5 ¶ 6. The court emphasized that "[t]he Sale Order was unequivocal and not left open to interpretation." Id. at 7 ¶ 11. Implicitly, the bankruptcy court rejected the notion that the provisions of section 365(h) acted to preserve Precision's rights as a lessee in the face of the Sale Order.

[T]he Court is forced to conclude that under the circumstances and the plain language of the Sale Order [New Qualitech] holds the assets acquired from [Qualitech] free and clear of the Lease and all interest of Precision in the ... real estate acquired by the Purchaser from the Debtor. The Lease has been extinguished by the Sale Order and the Sale Order is no longer subject to attack by Precision.

Precision is barred from asserting any interest in the real estate acquired by the Purchaser from [Qualitech].... Precision may take no further action to enforce the Lease against [New Qualitech] or the Indiana Facilities.

Id. at 9-10 ¶¶ 16, 17.

Precision appealed the bankruptcy court's decision, and the district court reversed. The court determined at the outset that the provisions of sections 363(f) and 365(h) were in apparent conflict: "Section 365(h) appears to grant the tenant the right to retain the benefits of the lease, while Section 363(f) appears to allow the [debtor] to divest the tenant of its leasehold." 2001 WL 699881, at *11. Accordingly, the court looked beyond the text of the two statutes. After surveying the legislative history of both provisions along with the divided case law on the subject, the court concluded that the terms of section 365(h) prevail over those of section 363(f) as applied to the rights of lessees.

The focus of Section 365(h)(1)(A)(ii) is very specific — it defines a lessee's post-rejection rights. The statute expressly states that, after rejection of an unexpired lease, a non-debtor lessee may elect to retain possession of the property for the balance of the term and for any enforceable extensions of the term. The available legislative history ... also indicates that Congress intended to preserve the lessee's estate in the event of rejection by a bankrupt landlord. Finally, the statute does not expressly cross-reference any other provision of the Bankruptcy Code by way of limitation. For these reasons, this court holds that the more specific Section 365(h) overrides Section 363(f) in this case.... There is no statutory basis for allowing the debtor-lessor to terminate the lessee's possession by selling the property out from under the lessee, and thus limiting a lessee's post-rejection rights solely to cases where the debtor-lessor remains in possession of its property.

2001 WL 699881, at *14 (emphasis in original). Finally, the district court...