On November 30, 2018, the United States Third Circuit Court of Appeals upheld rulings of U.S. Bankruptcy Judge Michael Kaplan and U.S. District Judge Michael A. Shipp in favor of RLT’s client IDEA Boardwalk, LLC (“IDEA”), the former operator of the highly successful HQ Nightclub and HQ Beachclub at the Revel Casino. The Third Circuit ruled that when a bankrupt landlord rejects a tenant’s lease, § 365(h) of the Bankruptcy Code and the doctrine of equitable recoupment will allow the tenant to offset its damages, even if it means that the tenant remains in possession without paying rent.
IDEA’s lease contained what it characterized as a recoupment provision. In his opinion for the Third Circuit, Judge Thomas L. Ambro summarized the provision as meaning that the tenant would pay no rent unless the nightclubs turned a profit. The bankruptcy and district courts agreed that the recoupment provision was enforceable, effectively meaning that IDEA was not liable for rent.
Polo North, Country Club, Inc., the purchaser of the Revel, appealed to the Third Circuit and lost again. The Third Circuit said there was “no doubt” that the recoupment clause was one of the rental terms that remained enforceable after rejection under Section 365(h)(1)(A)(ii). “To render the ‘recoupment’ component . . . inoperative, while still calculating the ‘rent’ component using the same formula, would upend the rent framework established in the Lease and deny [the tenant’s] statutory right to remain in possession of the premises under the same ‘rental terms,’” Judge Ambro said.
The Third Circuit also sided with IDEA on an independent ground. It ruled that IDEA also had a common law right of recoupment, sometimes referred to as equitable recoupment, which offsets obligations arising between the same parts in the same transaction. Judge Ambro said there was “no question” that the rental obligation and the tenant’s recoupment rights arose from the same transaction. He said it would be “inequitable” if IDEA were required to pay rent without the offsetting reductions afforded by the recoupment provision. In short, Judge Ambro said that IDEA “is entitled to reduce its rent obligations by recoupment amounts under the Lease based on the doctrine of equitable recoupment.”
IDEA was represented in the Third Circuit appeal by Barry J. Roy, Jeffrey A. Cooper, and John J. Harmon.
If you have any questions regarding this matter, please do not hesitate to call Barry J. Roy or Jeffrey A. Cooper at (973) 597-9100.