Court Opinion

ID: 4346129
Source: CourtListenerOpinion
Date Created: 2018-11-30 18:00:17.892516+00
Date Added: 2024-06-11T10:15:36.896697
License: Public Domain

PRECEDENTIAL

UNITED STATES COURT OF APPEALS
     FOR THE THIRD CIRCUIT
        ________________

               No. 17-3607
            ________________

      In re: REVEL AC INC., et al.,
                     Debtors

       IDEA BOARDWALK, LLC

                     v.

REVEL ENTERTAINMENT GROUP, LLC;
 POLO NORTH COUNTRY CLUB, INC.

         Polo North Country Club,
                        Appellant
           ________________

Appeal from the United States District Court
        for the District of New Jersey
  (D.C. Civil Action No. 3-16-cv-08683)
District Judge: Honorable Michael A. Shipp
             ________________

        Argued September 26, 2018
               Before: AMBRO, CHAGARES,
           and GREENAWAY, JR., Circuit Judges

             (Opinion filed: November 30, 2018)

Stuart J. Moskovitz        [Argued]
4400 Route 9 South, Suite 1000
Freehold, NJ 07728

       Counsel for Appellant

Jeffrey A. Cooper        [Argued]
Barry J. Roy
John H. Harmon
Rabinowitz Lubetkin & Tully
293 Eisenhower Parkway, Suite 100
Livingston, NJ 07039

       Counsel for Appellee
                    ________________

                OPINION OF THE COURT
                    ________________

AMBRO, Circuit Judge

       We determine whether the operator of two nightclubs
and a beach club at the Revel casino in Atlantic City, New
Jersey, may reduce its outstanding rent obligations based on
“recoupment” payments that the initial owner of the casino—
Revel AC, Inc.—agreed to make under a complex commercial
lease before it filed for Chapter 11 bankruptcy. The
Bankruptcy Court and District Court both held that the
nightclub operator is permitted to reduce its rental obligations

                               2
under a tenant-protective provision of the Bankruptcy Code, 11
U.S.C. § 365(h), and the doctrine of equitable recoupment. We
affirm on both grounds.
I.     Background
       A. Facts and Procedural History

       When Revel entered Chapter 11 in 2014, one of its
tenants, plaintiff-appellee IDEA Boardwalk, LLC, continued
to operate two nightclubs and a beach club on the casino
premises. As Revel worked through its bankruptcy, IDEA
sought to protect its right to continue operating on the casino
premises under a long-term lease (the “Lease”) by filing an
adversary proceeding in the Bankruptcy Court. IDEA initially
filed against Revel as the owner, but defendant-appellant Polo
North Country Club, Inc., became the defendant in the
proceeding (and IDEA’s landlord under the Lease) when it
purchased Revel’s assets, including the casino, for a small
fraction of the casino’s building cost per a purchase agreement
dated March 20, 2015 (the “Purchase Agreement” or
“Agreement”). The Bankruptcy Court approved the sale
shortly thereafter (the “Sale Order”).

        The Purchase Agreement provided that Polo would
purchase Revel’s assets free and clear of all liabilities except
for those listed in the Agreement. As relevant here, it stated
that Polo’s only surviving liability with respect to the Lease
would be a potential liability to IDEA for an administrative
expense claim up to a specified maximum amount. (Purchase
Agreement § 2.3(f).) The Agreement also stated that Polo
would acquire certain legal claims Revel may have against
IDEA with respect to the Lease (id. § 2.1(m)), which the
parties understand to include any rent payments that IDEA may
still owe under the Lease.

                               3
        The Sale Order generally authorized Polo’s purchase of
Revel’s assets “free and clear of all liens, claims,
encumbrances and other interests of any kind” under § 363(f)
of the Bankruptcy Code, 11 U.S.C. § 363(f). (Sale Order ¶ 6.)
In light of prior litigation concerning the rights of tenants on
Revel’s properties,1 the Sale Order also contained two carve-
out provisions that expressly preserved certain rights relating
to IDEA’s continued use of the casino premises under the
Lease. The first carve-out preserved “[a]ny rights (including
rights of setoff and recoupment), claims and defenses of IDEA
. . . with respect to [IDEA’s adversary proceeding against
Revel].” (Id. ¶ 14.) The second reserved “any rights elected
to be retained by [IDEA or other tenants] pursuant to section
365(h) of the Bankruptcy Code” after Revel’s rejection of the
governing tenancy agreements, including, in IDEA’s case, the
Lease. (Id. ¶ 18.)
       The Sale Order’s carve-out of these tenant rights set the
stage for further litigation between IDEA and Polo concerning
IDEA’s rights and obligations as Polo’s tenant under the Lease.
Shortly after entering the Sale Order, the Bankruptcy Court
granted a long-pending motion by Revel to reject the Lease
retroactively to September 2, 2014, the date on which the Revel
casino closed its doors. In response to that order, IDEA filed a
notice of its election to retain its rights as a tenant under §
365(h) of the Code, as expressly allowed by the Sale Order.
IDEA also asked the Bankruptcy Court to clarify its rights as a

1
  Polo first tried to purchase Revel’s assets under a sale order
that would have extinguished IDEA’s possessory rights under
the Lease. That order was stayed by our Court in a prior
decision, see In re Revel AC, Inc., 802 F.3d 558, 575 (3d Cir.
2015), and superseded by the Sale Order we now review.

                               4
tenant after Revel’s rejection of the Lease and sale of the casino
to Polo.

        In an omnibus order in June 2015, the Bankruptcy Court
clarified major aspects of the post-petition landlord–tenant
relationship between IDEA and Polo. That order substantially
narrowed the litigation between IDEA and Polo but left open
an important question about the rights IDEA retained under the
Lease—namely, whether IDEA is permitted to deduct from its
outstanding rent obligations certain “recoupment” amounts
owing to IDEA under the Lease. To seek the Bankruptcy
Court’s clarification on this point, IDEA filed a motion for
summary judgment on one of its pending claims in the
adversary proceeding. The Bankruptcy Court granted in part
IDEA’s motion for summary judgment, declaring that:
(i) IDEA may “offset (against rent) any damages caused, after
rejection, by [Polo’s] nonperformance” under the Lease; and
(ii) it may “apply and setoff the Recoupment Amount, as
defined in the Lease, for both the period prior to [Polo’s]
acquisition of title and after.”
       The Bankruptcy Court’s ruling that IDEA may reduce
its rent obligations by the recoupment amounts under the
Lease, which is the only aspect of the Bankruptcy Court’s
summary judgment order on appeal, gave two independent
grounds: (1) the recoupment provisions of the Lease “fall
within the ambit of rights preserved under Code
§ 365(h)(1)(A)(ii),” In re Revel AC, Inc., 2016 WL 6155903,
at *11 (Bankr. D.N.J. Oct. 21, 2016); and (2) IDEA could
deduct amounts based on the equitable doctrine of recoupment.
Id. at *11–12. Polo appealed to the District Court the
Bankruptcy Court’s grant of summary judgment, which
affirmed on the same two grounds. It now appeals to us.

                                5
       B. The Lease
        The Lease is long and neither simple nor direct. Indeed
it is an almost impenetrable web of formulas, defined terms,
and cross-references—a “bloated morass,” in the words of the
Bankruptcy Court. We accordingly do not recite the Lease
provisions verbatim, but instead summarize its relevant
provisions, which relate to capital contributions, rent
obligations, and recoupment obligations.2

       Capital contributions. The Lease contemplated that
both Revel and IDEA would make capital contributions to
“build out” the IDEA venues before opening them. (Lease
§ M(a).) The total budget for this build-out was roughly $80
million, with Revel responsible for about $48 million and
IDEA bound for $16 million. (Id.) The remaining $16 million
would either be contributed by IDEA (at IDEA’s option) or by
Revel if IDEA did not make the contribution. (Id. § M(b).)
These capital contributions—and, in particular, the relative
proportions of capital contributed by IDEA and Revel—were
the foundation for rent and recoupment calculations under the
Lease (described below).

       Rent obligations. The Lease contemplated that IDEA
would pay rent to Revel each month on a venue-by-venue
basis. IDEA’s capital contribution was apportioned among its

2
  We make one clarification concerning our use of the term
“recoupment.” We use “recoupment amounts” to describe
Revel’s contractual obligation under the Lease to make certain
recoupment payments because the Lease itself uses the term
“recoupment.” However, this contractual obligation is not the
same as the concept of “equitable recoupment,” which is an
equitable doctrine from the common law (as we discuss
below).

                              6
three venues based on certain percentages specified in the
Lease. (Id. Ex. K.) Then, each month, the rent for a given
venue was calculated to be the distributable cash flow from that
venue multiplied by the percentage share of capital contributed
to that venue by Revel as part of the pre-opening build-out.
(Id. § C.1(a)(i).)
        Recoupment obligations. Under the Lease, Revel would
make certain “recoupment” payments to IDEA in the first four
years of the Lease term. These occurred every three months
for IDEA’s two nightclubs and twice a year for the beach club.
(Id. § C.1(d)(vi).) On each of the calculation dates, IDEA and
Revel would determine (a) whether the venue in question had
reached a certain threshold in gross sales, and (b) whether it
had registered a positive return on capital investment, as
measured by comparing the venue’s year-to-date distributable
cash flow (as defined in the Lease) to the portion of IDEA’s
capital contribution allocated to that venue for the time period
in question using a straight-line depreciation over four years.
(Id. §§ C.1(a)(i)(1), C.1(d).) For each of these calculation
dates, if the venue met the applicable gross-sales threshold but
did not have a positive return to capital net of depreciation,
Revel would refund to IDEA the amount necessary to cause the
latter to break even for that period. (Id.)

II.    Jurisdiction and Standard of Review
       The District Court had jurisdiction under
28 U.S.C. § 158(a). In re Truong, 513 F.3d 91, 93 (3d Cir.
2008) (per curiam). We have jurisdiction per 28 U.S.C.
§ 158(d)(1) and exercise the same standard of review as did
the District Court. In re Heritage Highgate, Inc., 679 F.3d
132, 139 (3d Cir. 2012). It reviewed the Bankruptcy Court’s
grant of summary judgment de novo. See In re Klaas, 858
F.3d 820, 827 (3d Cir. 2017). We do the same.

                               7
III.   Discussion
        The Bankruptcy Court and the District Court both ruled
that IDEA has a right to reduce its rent obligations to Polo by
the amount of Polo’s recoupment obligations under the Lease.
Both Courts based this ruling on two independent grounds:
First, the tenant rights that IDEA retained by making an
election under § 365(h) of the Bankruptcy Code include the
right to reduce its rent obligations by the recoupment amounts.
Second, even if § 365(h) did not extend to the recoupment
amounts, IDEA would be permitted to reduce its rent
obligations under the doctrine of equitable recoupment.
       A. Section 365(h) Election
        Section 365 of the Bankruptcy Code governs a debtor’s
rejection of executory contracts and unexpired leases during
bankruptcy. Subsection (h) protects a tenant whose landlord
files for bankruptcy and then rejects the tenant’s lease. In
relevant part, it provides that

       [i]f the trustee[3] rejects an unexpired lease of real
       property under which the debtor is the lessor . . .
       [and] the term of such lease has commenced, the
       lessee may retain its rights under such lease
       (including rights such as those relating to the
       amount and timing of payment of rent and other
       amounts payable by the lessee and any right of
       use, possession, quiet enjoyment, subletting,
       assignment, or hypothecation) that are in or

3
 With narrow exceptions not relevant here, rights and powers
given to a trustee under Chapter 11 of the Code may be
exercised as well by a debtor in possession (here Revel, as the
debtor) when no trustee is appointed for the debtor’s estate.
See 11 U.S.C. § 1107(a).

                                 8
       appurtenant to the real property for the balance
       of the term of such lease . . . .

11 U.S.C. § 365(h)(1)(A)(ii).
        In the Sale Order approving Revel’s sale of assets to
Polo, the Bankruptcy Court expressly preserved “any rights
elected to be retained by [IDEA or other tenants] pursuant to
section 365(h) of the Bankruptcy Code” after the debtor’s
rejection of the governing tenancy agreements, including the
Lease. (Sale Order ¶ 18.) And IDEA preserved those rights
by making an election under § 365(h) when the Bankruptcy
Court approved Revel’s motion to reject the Lease.
        Under subsection (h), the rights IDEA reserved under
the Lease include those “relating to the amount and timing of
payment of rent and other amounts payable by the lessee.”
11 U.S.C. § 365(h)(1)(A)(ii).       As we have explained
previously, a tenant who makes an election under this
provision is “entitled to remain under the same rental terms as
are set forth in the lease.” Megafoods Stores, Inc. v. Flagstaff
Realty Assocs. (In re Flagstaff Realty Assocs.), 60 F.3d 1031,
1034 (3d Cir. 1995) (quoting In re TM Carlton House
Partners, 97 B.R. 819, 823 (Bankr. E.D. Pa. 1989)).
        There is no doubt the “rental terms” under which IDEA
leased the venue premises include the right to receive
recoupment payments under the Lease. Although it contains
distinct provisions addressing “rent” and “recoupment,” they
are inextricably related and combine to establish IDEA’s rental
terms under the Lease. In their net effect, the rent and
recoupment provisions ensured that IDEA would pay rent in
the first four years of the Lease term only when an IDEA venue
turned a profit (as measured by the year-to-date distributable
cash flow from the venue and accounting for the depreciation
of capital that IDEA contributed to that venue). To render the

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“recoupment” component of this framework inoperative, while
still calculating the “rent” component using the same formulas,
would upend the rent framework established in the Lease and
deny IDEA’s statutory right to remain in possession of the
premises under the same “rental terms.” Flagstaff, 60 F.3d at
1035. Accordingly, by virtue of its election under § 365(h),
IDEA is permitted to reduce its rent obligations by the
recoupment amounts applicable under the Lease for the
balance of the term of the Lease after the date of rejection—
i.e., after September 2, 2014.4
       B. Equitable Recoupment
       The doctrine of equitable recoupment “is not codified
in the Bankruptcy Code, but has been established through
decisional law.” In re Anes, 195 F.3d 177, 182 (3d Cir. 1999)
(quoting Flagstaff, 60 F.3d at 1035). When a claim against a
debtor qualifies for equitable recoupment, the claim “avoids
the usual bankruptcy channels,” in that it receives full value in
the netting of obligations between a creditor and the debtor
without regard to the bankruptcy priority of the claim—“thus,
in essence, [the claim] is given priority over other creditors’

4
  We note that, in addition to the general tenant protections in
§ 365(h)(1)(A)(ii), another provision addresses a tenant’s right
to reduce its rent obligations under a rejected lease based on
the landlord’s nonperformance of its obligations under the
lease after the rejection. See 11 U.S.C. § 365(h)(1)(B).
Although we need not rest our decision on this particular
provision, we note that it appears to provide another basis on
which IDEA could reduce its rent obligations based on the
recoupment amounts under the Lease, assuming, as the record
suggests, that Revel ceased to perform its recoupment
obligations after moving to reject the Lease.

                               10
claims.” Flagstaff, 60 F.3d at 1035; see also In re Anes, 195
F.3d at 181–82 (discussing equitable recoupment).5

        Recoupment means “the setting up of a demand arising
from the same transaction as the plaintiff’s claim or cause of
action, strictly for the purpose of abatement or reduction of
such claim.” In re Univ. Med. Ctr., 973 F.2d 1065, 1079 (3d
Cir. 1992) (quoting 4 COLLIER ON BANKRUPTCY § 553.03, at
553-15 to -17 (emphasis added by Univ. Med. Ctr.)). For
purposes of equitable recoupment, “a mere logical relationship
is not enough: the ‘fact that the same two parties are involved,
and that a similar subject matter gave rise to both claims, . . .
does not mean that the two arose from the same transaction.’”
Id. at 1081 (quoting Lee v. Schweiker, 739 F.2d 870, 875 (3d
Cir. 1984)). “Rather, both debts must arise out of a single
integrated transaction so that it would be inequitable for the
debtor to enjoy the benefits of that transaction without also
meeting its obligations.” Id.
       IDEA contends that the doctrine of equitable
recoupment requires reducing its existing rent obligations by
Polo’s recoupment obligations. We agree. As summarized
above, the rent and recoupment provisions created a rental
framework that ensured IDEA would pay rent in the first four
years of the Lease term only when a venue made profit as
measured by a formula set out in the Lease. To give effect to
this framework, the recoupment provisions of the Lease
performed a periodic downward adjustment to IDEA’s rent
obligations under the Lease. Given this countervailing relation
between the rent obligations and recoupment amounts under

5
   For this reason, we have pointed out that equitable
recoupment, “as a non-statutory, equitable exception to the
automatic stay, should be narrowly construed.” In re Univ.
Med. Ctr., 973 F.2d 1065, 1081 (3d Cir. 1992).

                               11
the Lease, there is no question the rental obligations and
recoupment amounts “aris[e] from the same transaction,” Univ.
Med. Ctr., 973 F.2d at 1079 (citation and emphasis omitted),
for purposes of equitable recoupment. In this context, we also
have no trouble concluding it would be inequitable to require
IDEA to pay the full amount of its rental obligations without
applying the countervailing downward adjustments
contemplated by the recoupment provisions. See Flagstaff, 60
F.3d at 1035 (ruling that tenant could reduce its rent under the
doctrine of equitable recoupment based on the cost of making
repairs the bankrupt landlord was obligated to make, because
“[b]oth the claim for repair costs and the rent arise from the
lease, and it would be inequitable for the landlord to receive
rent without compensating [the] tenant for undertaking
repairs”).
        That Polo obtained Revel’s assets “free and clear of all
liens, claims, encumbrances and other interests of any kind” in
a sale under Code § 363(f) does not change the result. The Sale
Order expressly preserved “[a]ny rights (including rights of
setoff and recoupment), claims and defenses of IDEA . . . with
respect to [IDEA’s adversary proceeding against Revel].”
(Sale Order ¶ 14.) That preserved IDEA’s assertion of
equitable recoupment here. Further, as we have explained in
prior cases, the doctrine of equitable recoupment is an
affirmative defense, and the sale of assets “free and clear” of
liens, encumbrances, and interests “does not include defenses
to claims.” Folger Adam Sec., Inc. v. DeMatteis/MacGregor,
JV, 209 F.3d 252, 257, 258–64 (3d Cir. 2000); accord In re
Trans World Airlines, Inc., 322 F.3d 283, 289 (3d Cir. 2003)
(“[A] right of recoupment is a defense and not an interest and
therefore is not extinguished by a § 363(f) sale.” (quoting
Folger, 209 F.3d at 261)).
      In short, IDEA is entitled to reduce its rent obligations
by the recoupment amounts under the Lease based on the

                              12
doctrine of equitable recoupment. We also clarify that
equitable recoupment applies to rent and recoupment amounts
under the Lease regardless whether they arose before or after
Revel filed its bankruptcy petition and regardless whether they
arose before or after Revel rejected the Lease.6

                 *      *      *      *      *
       When IDEA agreed to operate two nightclubs and a
beach club at the Revel casino, it agreed under the Lease to pay
rent only when its venues met certain financial benchmarks.
Section 365(h) of the Bankruptcy Code and the doctrine of
equitable recoupment entitled IDEA to continue paying rent on
those same terms even after its landlord filed for bankruptcy
and rejected the Lease. Nothing in the agreements or court
orders governing third-party Polo’s purchase of the casino in
bankruptcy changes this result. We therefore affirm, holding
that IDEA may reduce its rent obligations by the recoupment
amounts provided under the Lease.

6
  For the avoidance of any doubt, we do not hold that IDEA is
entitled to recover affirmatively any recoupment amount from
Polo. Rather, IDEA’s rights under § 365(h) and the equitable
recoupment doctrine are limited to giving IDEA the right to
reduce its rent obligations to Polo. Nothing in this opinion
should be construed to allow IDEA to recover any additional
monies from Polo (such as for the recoupment of capital
contributions) beyond the reduction of rent that IDEA owes to
Polo under the Lease.

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