The Seventh Circuit Court of Appeals decided a case that affects the rights of a tenant with respect to a bankruptcy of its landlord. The question addressed by Precision Industries, Inc. v. Qualitech Steel SBQ, LLC (7th Cir., 2003) is whether the possessory interest of a tenant survives a sale of property by the bankruptcy trustee.

Qualitech Steel owned and operated a steel mill on land in Pittsboro, Indiana. Precision leased a portion of the land from Qualitech and built a warehouse and other improvements. Qualitech subsequently filed a Chapter 11 bankruptcy petition and all of its assets were sold by the trustee. The Court approved the sale, free and clear of all liens, claims, encumbrances and interests. When Precision and the purchaser failed to come to agreement on a new lease, the Court deemed the existing lease to be rejected by the purchaser’s failure to timely assume the lease. The Court of Appeals ruled that the possessory interest of a tenant may be extinguished by a sale free and clear of all interests. The Court ruled that the protection provided to a lessee under a rejection of the lease may not apply to a sale by the trustee.

As a result, tenants should object to bankruptcy sales and request adequate protection. While the Court did not specify what would constitute adequate protection, tenants should be aware that the failure to request relief may result in forfeiture of their leasehold estate. Tenants should also review their leases for appropriate notice and bankruptcy protection language.

Lenders should also review their leasehold mortgages and related loan documents in light of the Precision Industries decision. In addition to common leasehold mortgagee protection provisions typically found in the leasehold mortgage, leasehold mortgagees should seek additional protections by requiring notice of pleadings and schedules in connection with any bankruptcy proceeding by or against the lessee or lessor, and should be granted the right to act on the lessee’s behalf in such a proceeding.