Skip Page Banner  
Skip Navigation

IHOP Franchisee Subleases Deemed Rejected; Motion for Stay Pending Appeal Denied

Wednesday, October 30, 2013
By Stephanie M. Acree

Oct. 25 -- A group of Chapter 11 debtors operating franchised International House of Pancakes (“IHOP”) restaurants were denied the stay of an order deeming the debtors' subleases rejected Oct. 8 by the U.S. District Court for the Northern District of Illinois (In re A&F Enters., Inc. II, 2013 BL 279511, N.D. Ill., No. 1:13-cv-07020, 10/8/13).

Judge Virginia M. Kendall found that the debtors were unlikely to succeed on the merits of their appeal because the bankruptcy court correctly applied the time period of Section 365(d)(4) of the Bankruptcy Code to the debtors' subleases and that the debtors were not entitled to the longer time period of Section 365(d)(2) to assume the subleases.

Subleases Not Assumed, Deemed Rejected
The debtors were a group of franchisees operating 19 IHOP restaurants in Illinois, Wisconsin, and Missouri. The debtors filed their Chapter 11 cases on Feb. 28, 2013. On Aug. 5, 2013, the bankruptcy court entered an order deeming the debtors' subleases for commercial real property rejected because the debtors had failed to assume the subleases within the 120 time period set out in Section 365(d)(4). The debtors had also failed to seek an extension of the time period for assuming the subleases.

The debtors filed a motion to reconsider the Aug. 5 order, which was subsequently denied by the bankruptcy court. The bankruptcy court also entered an order on Sept. 23, 2013, deeming the franchise agreements and equipment leases expired based on the rejection of the subleases. The debtors filed a emergency motion to stay the enforcement of the orders, which the bankruptcy court denied in an oral ruling. The debtors appealed to the district court, and moved for a stay of the bankruptcy court's orders pending the appeal.

Damaging the IHOP Brand
The debtors argued that the stay was necessary to “prevent a shutdown of their businesses and irreversible damage to their estates and creditors during the appellate period.” The debtors argued that the subleases were “highly interrelated” to the franchise agreements. Furthermore, the debtors argued that the franchise agreements were executory contracts which can be assumed up until the confirmation of a reorganization plan under Section 365(d)(2). The debtor claimed that “[d]ue to the interrelatedness, the [d]ebtors cannot assume the [s]ubleases until they are able to assume the [f]ranchise [a]greements.”

IHOP filed an opposition to the debtors' emergency motion for a stay pending the appeal. IHOP argued that the bankruptcy court had correctly rejected the subleases and denied the stay. IHOP also argued that the debtors had cited no case law to support “a stay pending appeal that would require a trademark owner to allow the use of its marks pending appeal.” IHOP argued that the debtors' continued use of the IHOP trademark was harming the value of the brand.

“Customer complaints and inspections of [d]ebtors' restaurants -- including during the bankruptcy -- have revealed roaches, moldy produce, and improperly refrigerated and prepared food, among other serious issues,” IHOP said.

'Substantial' Likelihood of Success
The court said that in order to grant a stay pending appeal under Rule 8005 of the Federal Rules of Bankruptcy Procedure, the court must consider four factors: “1) whether the appellant is likely to succeed on the merits of the appeal; 2) whether the appellant will suffer irreparable injury absent a stay; 3) whether a stay would substantially harm other parties in the litigation; and 4) whether a stay is in the public interest.” The court said that the debtors must further show a “substantial” likelihood of success on the merits, not the mere possibility of success on the merits, because they must convince the district court that the bankruptcy court committed a reversible error.

Furthermore, the court said that the debtors must make a preliminary showing of the first two factors before the court can move on to balance the relative harms when considering all four factors.

Plain Language Controls
In this case, the court found that the debtors were not likely to succeed on the merits of the appeal because the bankruptcy court had not committed reversible error by determining that Section 365(d)(4) should apply to the debtors' non-residential property subleases.

Section 365(d)(4) allows a debtor 120 days to assume or reject non-residential property leases, with an option for a 90-day extension, which the debtors did not seek. The court rejected the debtors' argument that the subleases should be construed as part of the franchise agreements.

The court said that Seventh Circuit precedent favors following “the plain language of the Bankruptcy Code when that language is unambiguous.” The court said that the cases cited by the debtors in support of their argument were outside the Seventh Circuit, and all but one of them were decided prior to the 2005 amendments to the Bankruptcy Code.

The 2005 amendments changed Section 365(d)(4) from a time period that could be indefinitely extended by the court for cause to the stricter 120-day time period with the option for a 90-day extension. The court said that this amendment “cautions against permitting an equitable end-run around the 210-day period by relying instead on [Section] 365(d)(2).” Therefore, the court found that the debtors were not likely to succeed on the merits.

No Irreparable Harm
The court also found that the debtors had not met their burden of showing they would be irreparably harmed absent a stay. The court said that the debtors' argument that reorganization would be impossible if the subleases were rejected was not a permissible reason to grant a stay. The court said that if it were, then “every bankruptcy debtor that got an unfavorable ruling would have unlimited appeals due [to] a negative effect on the reorganization process.”

“Debtors' second argument, that the companies will lose their franchises and therefore their business, also has no merit,” the court said. “[I]n the context of commercial disputes, the loss of franchises is a commercial loss that can be compensated with monetary damages.”

No Control Over Quality
The court said that it need not address the other factors because the debtors had failed to demonstrate a likelihood of success on the merits or irreparable harm. However, the court said that it was convinced IHOP would suffer irreparable harm if the stay were granted. The court said that if the debtors were permitted to continue operating their restaurants on the subleased properties under the IHOP trademark, IHOP would have no control over the quality of the services provided at those restaurants.

Finally, the court found that the public interest would not be served by granting the stay. The court said that public policy favors following Congress's intent in strictly limiting the time period for assuming commercial leases as well as protecting trademark holders from the involuntary use of their trademarks. Accordingly, the debtors' motion for a stay pending appeal was denied.

To contact the reporter on this story: Stephanie M. Acree in Washington at sacree@bna.com

To contact the editor responsible for this story: Jay Horowitz at jhorowitz@bna.com

To view additional stories from Bloomberg Law® request a demo now