Restructuring

Contributed by Laura Napoli
In a recent case, In re Contract Research Solutions, Inc., Judge Carey of the United States Bankruptcy Court for the District of Delaware had to determine whether an amendment to a lease could be severed from the lease itself.  After Contract Research Solutions and certain of its subsidiaries filed for chapter 11 protection, one of the debtor subsidiaries, Allied Research International, moved to sever and reject an amendment to a real property lease into which it had entered.
Background
Under the original terms of the real property lease, Allied leased space in a building in an office complex in Miami.  The parties later entered into two amendments, both of which related to the same building.  Under a subsequent third amendment to the lease, though, Allied leased space in an unattached, adjacent building in the same complex.
This third amendment—not the entire lease—was the subject of the rejection motion as Allied sought to free itself from the rental obligations for the second building.  Under section 365 of the Bankruptcy Code, a debtor in possession may assume or reject an executory contract or unexpired lease; however, the debtor must assume or reject the lease in its entirety.  This rule prohibits the debtor from “cherry-picking,” accepting the benefits of a lease without taking on its burdens.  Courts, though, have recognized an exception to this universally accepted principle and have allowed debtors to reject only part of a lease or contract if they determine the underlying agreement actually constitutes multiple, severable agreements under applicable non-bankruptcy law.  In Contract Research Solutions, the debtor asked Judge Carey to determine that the lease and the third amendment represented independent agreements that could be treated separately under section 365.
Analysis
The court began by noting that whether an agreement is severable is governed by state law.  In this case, the lease explicitly provided for the application of Florida law.  Under Florida law, the intent of the parties, as determined from the contract itself, determines whether one contract is severable from another.  To determine the parties’ intent, courts ask whether (i) the nature and purpose of the agreements are different; (ii) the consideration for each agreement is separate and distinct; and (iii) the parties’ obligations under the agreement are interrelated.  Judge Carey found that all three factors led to the conclusion that the third amendment was not severable from the main lease.
The first persuasive factor for the court was that the third amendment explicitly stated that the terms and conditions would amend and ratify the lease.  The court viewed this as a clear reflection of the parties’ intent that the third amendment would become part of the lease.  Although the debtor argued that the lease contained a severability clause, the court interpreted the clause only to mean that any portion of the agreement that did not comply with the law could be stricken.  Because the debtor was not challenging the legality of any portion of the lease, the court held that the severability clause was not relevant to its analysis.
The court also was not persuaded by the debtor’s argument that the third amendment related to a different building from the lease and the first two amendments and created separate and distinct rental obligations for the second building.  Other provisions in the amendment related back to the original lease, including an extension of the lease term for all of the premises, a rent abatement for all of the premises, and an overall increase in maintenance charges.  The court also noted that the same entities were parties to the lease and all three amendments and that the third amendment created no separate obligations to any additional third parties.  Notably, in the seminal case dealing with severability of independent obligations in a contract, In re Gardinier, Inc., the Eleventh Circuit (also applying Florida law) severed a contract for the sale of land from a brokerage agreement notwithstanding that the obligations arose under a single agreement into which the parties had entered contemporaneously.  It may be that the debtor’s attempt to characterize the third amendment as a separate agreement, as opposed to the independent agreements contained in the lease that pertained exclusively to the second office building, hindered the debtor’s attempt to fit itself within the exception to the “no cherry-picking” rule.
Perhaps most damaging for the debtor’s cause, though, was that the parties previously had executed a separate lease for office space in yet another building in the same complex.  The landlord used this other lease to argue, successfully, that the parties were capable of creating truly separate agreements.  Based upon the strong evidence from the documents themselves, as well as the existence of a separate lease between the same parties, the court held that the third amendment could not be severed from the main lease for purposes of section 365, and, therefore, the debtor could not retain the space in one of the office buildings and reject its obligations for the space in the other building.