Second Circuit: Bankruptcy Code's Lease Assumption and Assignment Provisions Apply Only to "True Leases"

The ability of a bankruptcy trustee or chapter 11 debtor-in-possession ("DIP") to assume and assign executory contracts and unexpired leases is an invaluable tool for generating value for a bankruptcy estate to pay creditor claims and provide funding for a chapter 11 plan. However, the provisions of the Bankruptcy Code governing assumption and assignment of unexpired leases apply only to "true" or "bona fide" leases, as distinguished from many financing arrangements commonly utilized in real estate transactions. See In re PCH Associates, 804 F.2d 193, 198 (2d Cir. 1986). The U.S. Court of Appeals for the Second Circuit examined this issue in MOAC Mall Holdings LLC v. Transform Holdco LLC (In re Sears Holdings Corp.), 2024 WL 5113165 (2d Cir. Dec. 16, 2024). The court of appeals affirmed a district court ruling that the Bankruptcy Code's deadline for assuming or rejecting a nonresidential real property lease did not apply to a shopping center "lease" because the agreement was not a true lease, and neither the debtor nor the purported assignee of the agreement waived or forfeited the argument that the lease was not bona fide. 

Assumption, Rejection, and Assignment of Unexpired Leases in Bankruptcy 

A bankruptcy trustee or DIP generally has the right to "assume" (reaffirm) or "reject" (disavow, resulting in breach) unexpired leases under section 365(a) of the Bankruptcy Code. 11 U.S.C. § 365(a). Moreover, most assumed leases can be assigned as a means of creating value for the bankruptcy estate. See 11 U.S.C. § 365(c) and (f).

Section 365(d)(4) provides that a nonresidential real property "lease" under which the debtor is the lessee "shall be deemed rejected, and the trustee shall immediately surrender that nonresidential real property to the lessor," if the trustee or DIP does not assume or reject the lease by the earlier of 120 days after the bankruptcy petition date or the date of confirmation of a plan, unless the court grants a 90-day extension "on the motion of the trustee or lessor for cause." 11 U.S.C. § 365(d)(4).  

The Bankruptcy Code itself does not define the term "lease" in the context of section 365(d)(4) or otherwise. Many courts, however, including courts in the Second Circuit, have interpreted section 365(d)(4) to apply only to "true" or "bona fide" leases. See In re PCH Associates, 804 F.2d at 198; accord Int'l Trade Admin. v. Rensselaer Polytechnic Inst., 936 F.2d 744 (2d Cir. 1991) ("RPI"); see generally Collier on Bankruptcy ¶ 365[3] (16th ed. 2025) (noting that "courts have been vigilant to limit the application of section 365 to true leases, not disguised financing arrangements …. [and that] [e]very appellate court, other than the Third Circuit, that has considered the issue holds that substance controls and that only a 'true lease' counts as a 'lease' under section 365"). 

In determining whether an agreement is a true lease, many courts apply an "economic substance test" to ascertain whether, notwithstanding the labels used in the agreement, "the parties intended to impose obligations and confer rights significantly different from those arising from the ordinary landlord/tenant relationship." PCH Associates, 804 F.2d at 200. 

Second Circuit courts consider various factors in determining whether a particular transaction is a true lease pursuant to section 365(d)(4), including: 

(i) whether the "rental" payments were calculated to compensate the lessor for the use of the land, or rather were structured for some other purpose, such as to ensure a particular return on an investment; (ii) whether the purchase price was related to the fair market value of the land, or whether it was calculated as the amount necessary to finance the transaction; (iii) whether the property was purchased by the lessor specifically for the lessee's use; (iv) whether the transaction was structured as a lease to secure certain tax advantages; [and] (v) whether the lessee assumed many of the obligations normally associated with outright ownership, including the responsibility for paying property taxes and insurance. 

In re Hotel Syracuse, Inc., 155 B.R. 824, 838–39 (Bankr. N.D.N.Y. 1993) (citing PCH Associates, 804 F.2d at 200–01; In re Wingspread Corp., 116 B.R. 915, 923 (Bankr. S.D.N.Y. 1990)). Lease provisions that permit or require the lessee to purchase the premises for a nominal sum at the end of the term of the lease are also relevant. In re Hotel Syracuse, Inc., 155 B.R. 838-39 (citing Wingspread, 116 B.R. at 923); In re Opelika Mfg. Corp., 67 B.R. 169, 171 (Bankr. N.D. Ill. 1986). Other indicia "that a lease is a financing vehicle include: (i) an option price bearing little resemblance to fair market value; (ii) an option price that is minimal in comparison with total payments; and (iii) rental payments equal to or greater than the selling price." Wingspread, 116 B.R. at 923 (citation omitted). 

Sears Holdings 

Iconic retailer Sears filed for chapter 11 protection in the Southern District of New York in October 2018. In February 2019, the bankruptcy court approved the sale of substantially all of Sears's assets for $5.2 billion to Transform Holdco LLC and an affiliate (together, "Transform"), companies created and controlled by former Sears CEO Eddie Lampert and several other former Sears executives.  

The sale transaction gave Transform the right, following assumption by Sears, to assign 660 Sears store leases, including a lease with MOAC Mall Holdings LLC ("MOAC") for premises located in the Mall of America (the "MOAC Lease"). Signed in 1991, the MOAC Lease was atypical in the retail industry. It included a term of 100 years and, because Sears constructed the premises at its own expense, an annual rent obligation of only $10, which Sears prepaid until 2021. The MOAC Lease and a related operating agreement did not require Sears to pay a "percentage rent." However, the MOAC Lease's terms did require Sears to pay taxes, common area charges, and insurance at the rate of approximately $1.1 million annually.  

In connection with the sale of Sears's assets to Transform, the bankruptcy court initially approved Transform's assumption and assignment of all Sears's leases except the lease with MOAC, which objected to the proposed assignment. MOAC objected, arguing that Sears failed to provide "adequate assurance" of Transform's future performance, as required by section 365(b)(3) of the Bankruptcy Code, which specifically governs the assignment of shopping center leases. In re Sears Holdings Corp., 613 B.R. 51, 60 (S.D.N.Y.), vacated on reh'g, 616 B.R. 615 (S.D.N.Y. 2020), vacated and remanded, 2023 WL 7294833 (2d Cir. Nov. 6, 2023); see also 11 U.S.C. § 365(b)(3). During the litigation over MOAC's objection, the parties stipulated several times to extend the 120-day deadline for assumption or rejection of the MOAC Lease specified in section 365(d)(4) of the Bankruptcy Code. Sears also stipulated to the existence of a shopping center lease subject to section 365(b)(3). 

The bankruptcy court overruled MOAC's objection and entered an order approving assumption and assignment of the MOAC Lease as part of the sale transaction. MOAC appealed to the district court and sought a stay of the bankruptcy court's assignment order. The bankruptcy court denied MOAC's request for a stay pending appeal, reasoning that authorization to assign a lease—as distinguished from approval of a sale or a lease—did not fall within the scope of section 363(m) of the Bankruptcy Code, which provides that, unless a party challenging an order authorizing a bankruptcy sale or lease is stayed pending appeal, reversal or modification of the order on appeal does not affect the validity of the sale or lease to a good faith purchaser (commonly referred to as "statutory mootness"). 

The bankruptcy court confirmed a chapter 11 plan for Sears in October 2019. The plan, which became effective in October 2022, established a liquidating trust to administer Sears's vestigial assets. Shortly before the effective date of the plan, the court approved a settlement in which Transform and Sears agreed that in the event that the assumption and assignment of the MOAC Lease were overturned, Sears would take any actions necessary either to effect assignment of the MOAC Lease to Transform or to give Transform the economic benefit intended by the transaction. 

In the appeal of the bankruptcy court's adequate assurance ruling, the district court agreed with MOAC and initially vacated the bankruptcy court's assumption and assignment order. However, Transform argued for the first time in its motion for rehearing that the appeal was mooted by section 363(m) because MOAC failed to obtain a stay pending appeal of the sale order. Constrained by applicable precedent, the district court ultimately vacated its initial decision and ruled that the assignment of the MOAC Lease to Transform qualified as a "sale" and, because MOAC never obtained a stay pending its appeal, MOAC's appeal must be dismissed as moot on jurisdictional grounds under section 363(m). 

MOAC appealed to the Second Circuit, which affirmed in a summary order. In its ruling, the Second Circuit explained that because MOAC's appeal was moot under section 363(m), the district court lacked jurisdiction to hear it. See In re Sears Holdings Corp., 2021 WL 5986997 (2d Cir. Dec. 17, 2021). 

MOAC appealed the ruling to the U.S. Supreme Court, which vacated the Second Circuit's ruling and remanded the case below. See MOAC Mall Holdings LLC v. Transform Holdco LLC, 598 U.S. 288 (2023). The Court unanimously rejected Transform's argument that the appeal was moot because "no legal vehicle remains available for undoing" the lease assignment and MOAC could not "possibly obtain any effectual relief," regardless of the Court's decision. "Our cases," the Court wrote, "disfavor these kinds of mootness arguments." Id. at 295.

The Court also held that section 363(m) of the Bankruptcy Code is not a jurisdictional "precondition to relief" because there is no "clear statement" in the text of the provision indicating that Congress intended for it to be jurisdictional. Id. at 298–302. 

On remand from the Supreme Court, the Second Circuit agreed with the district court that Transform had failed to satisfy section 365(b)(3) (establishing adequate assurance of future performance requirements for the assignment of shopping center leases). It accordingly remanded the case to the district court for it to determine a "remedial course." In re Sears Holdings Corp., 2023 WL 7294833, at 1 (2d Cir. Nov. 6, 2023). 

On remand to the district court, MOAC argued that section 365(d)(4) of the Bankruptcy Code required that the MOAC Lease be deemed rejected and immediately surrendered to MOAC because the MOAC Lease had not been timely assumed or rejected under section 365(d)(4) of the Bankruptcy Code (and the parties' stipulations to extend the 120-day period stated therein). Transform countered that section 365(d)(4) did not apply because the MOAC Lease was not a "true lease."

The district court agreed with Transform, holding that section 365(d)(4) did not apply, and finding that that Transform and Sears had not waived or forfeited that argument. It accordingly vacated the assumption and assignment of the MOAC Lease and directed that it be returned to the Sears liquidating trust.

MOAC appealed to the Second Circuit. 

The Second Circuit's Ruling 

A three-judge panel of the Second Circuit affirmed the district court's ruling in a unanimous opinion. 

The Second Circuit agreed with the district court that the MOAC Lease was not a true lease in accordance with the "economic substance" analysis applied by the court in RPI (which originated from the court's earlier decision in PCH Associates). The Second Circuit noted that RPI was "on all fours" with the case before it. Sears Holdings, 2024 WL 5113165, at *3. It explained that RPI involved a 99-year ground lease with a base rent for the entire term that was prepaid over the initial three years of the lease, and the tenant was obligated to pay taxes, assessments, utility charges, and other fees. Based principally on these lease terms, and its finding that the tenant "assume[d] and discharge[d] many of the risks and obligations ordinarily attributed to outright ownership of property, such as the payment of property taxes," the Second Circuit in RPI concluded that the purported lease was not a true lease. Id. (quoting RPI, 936 F.2d at 749). It also emphasized that a contrary conclusion would give the landlord an inequitable windfall. Id. (quoting RPI, 936 F.2d at 751).

Mindful of the equities at stake, the Second Circuit in Sears Holdings likewise found that permitting the landlord MOAC to recapture the leased premises more than 60 years before the expiration of the MOAC Lease would amount to a windfall, the gross inequity of which bolstered its conclusion that section 365(d)(4) did not apply to "this unusual transaction." Id. In weighing the inequities, the court emphasized how unfair it would be to revert the MOAC Lease to MOAC more than 60 years before the expiration of the MOAC Lease, despite MOAC having "'received the substance of its bargained for consideration.'" Id. The Second Circuit accordingly held that the MOAC Lease was not a true lease governed by section 365(d)(4), and "there was no basis for the MOAC Lease to revert to MOAC once the district court vacated the assumption and assignment of the lease to Transform." Id. at *4. 

The Second Circuit also determined that Sears and Transform neither waived nor forfeited the argument that the MOAC Lease was not a true lease governed by section 365(d)(4). According to the court, Sears and Transform did not intentionally and unequivocally relinquish their right to make the argument by referring to the MOAC Lease as a "lease" in the stipulations extending the 120-period to assume or reject. Instead, the Second Circuit attributed their conduct to "at most … oversight" or "thoughtlessness." Id. at *5.  

The Second Circuit also agreed with the district court's finding that there was no forfeiture because "there was no earlier phase in the litigation in which it would have been necessary—or even appropriate—for Transform or Sears to assert that the MOAC Lease was not a 'true lease' and thus not subject to § 365(d)(4)." Id. (citation and internal quotation marks omitted). Specifically, the Second Circuit explained the issue "only became live" after remand to the district court, and Sears and Transform were not obligated to "raise every possible alternate ground upon which the lower court could have decided an issue." Id. (citation and internal quotation marks omitted).  

Outlook 

On March 17, 2025, Transform and the liquidating trustee filed a petition asking the Supreme Court to review the Second Circuit's ruling. Although not precedential, the Second Circuit's ruling in Sears Holdings is significant for a number of reasons. First, it reinforces the principle that section 365 of the Bankruptcy Code applies only to true or bona fide leases. Consequently, agreements denominated as lease transactions that are actually financing arrangements are not subject to the strictures of section 365, and may therefore not be assumed or assigned in accordance with the procedures and requirements set forth in the provision. The Second Circuit reaffirmed this principle even though the purported lessee stipulated to the existence of a "lease" several times. Second, the decision is instructive in illustrating that a bankruptcy court should examine the economic substance of an agreement rather than the labels given to it by the signatories in determining whether the agreement is a true lease. 

Sears Holdings is a bitter pill to swallow for MOAC. Despite having prevailed in the Supreme Court on the statutory mootness dispute (on an important issue of bankruptcy law), MOAC now confronts the reality that, because the assumption and assignment of the MOAC Lease was void ab initio, the lease now belongs to the Sears liquidating trust, which is no longer in bankruptcy and therefore not subject to the strictures of section 365 (even if it applied). Presumably, in accordance with the settlement agreement between Sears and Transform, the liquidating trustee will either assign the MOAC Lease to Transform or take whatever steps are necessary to allow Transform to obtain the equivalent economic benefit of assignment.