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Print Page Build Out Recoupment
by Michael Blahy

When Revel Entertainment Group, LLC. (Revel), the owner of Revel Casino in Atlantic City, New Jersey, signed up IDEA Boardwalk LLC (IDEA) to operate a beach club and two nightclubs, they agreed to share the initial “build out” costs. The total cost of the venues was approximately $80 million. Revel was responsible for $48 Million, and IDEA responsible for $16 million. At IDEA’s option, either organization would contribute the remaining $16 million.

On May 12, 2012 the ten year lease, with 15 year option, described by the Bankruptcy Court as a “bloated morass” was signed. The United States Court of Appeals referred to it as “long and neither simple nor direct. Indeed it is an almost impenetrable web of formulas, defined terms, and cross-references”. IDEA was to make monthly rental payments to Revel. In the first four years of the lease, Revel in turn would make what the lease referred to as “recoupment” payments on a venue by venue basis.

Monthly rent was based on cash flow and Revel’s pre-opening “build out” percentage.

Quarterly for the nightclubs and semi-annually for the beach club, “recoupment” payments were calculated for each venue. 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.

Revel entered Chapter 11 and on September 2, 2014, the Revel Casino closed. IDEA continued to operate the three venues on the casino premises. IDEA filed an adversary proceeding in the Bankruptcy Court to protect itself and the lease.

Polo North Country Club, Inc. (Polo) tried to purchase the Revel property and have IDEA’s lease terminated. IDEA took the sale order to the United States Court of Appeals which stayed the first sales order.

On March 20, 2015, Polo made another offer to purchase and shortly afterwards, the Bankruptcy Court granted a long-pending motion by Revel to reject the Lease retroactively to September 2, 2014. IDEA filed a motion to retain its rights under the Bankrupcy Code, and asked the Bankruptcy Court to clarify its rights as a tenant.

In June 2015, the Bankruptcy Court clarified much of the landlord–tenant relationship between IDEA and Polo, but still did not decide on IDEA’s “recoupment” rights. IDEA filed a motion for summary judgment on the claim and was granted by the Bankruptcy Court:

  1. IDEA may “offset (against rent) any damages caused, after rejection, by [Polo’s] nonperformance” under the Lease

  2. 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
Polo appealed the rulings that IDEA may reduce its rent by the recoupment amounts, first to the District Court which affirmed the Bankruptcy Court decision and then to the United States Court of Appeals.

The grounds of the appealed rulings were based on:

  1. the tenant rights that IDEA retained by making an election under section 365(h) of the Bankruptcy Code include the right to reduce its rent obligations by the recoupment amounts

  2. even if section 365(h) did not extend to the recoupment amounts, IDEA would be permitted to reduce its rent obligations under the doctrine of equitable recoupment
Bankruptcy Code Section 365 Subsection (h) says that “[i]f the trustee 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.

The doctrine of equitable recoupment is based on previous legal decisions to deal with two debts arising from a single transaction. It says “that it would be inequitable for the debtor to enjoy the benefits of that transaction without also meeting its obligations.

United States Court of Appeals agreed with IDEA’s contention that the doctrine of equitable recoupment requires the reduction of its rent obligations by Polo’s recoupment obligations. The lease framework “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 the Lease, there is no question the rental obligations and recoupment amounts ‘aris[e] from the same transaction’ ”.

United States Court of Appeals declared “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” concluding, “We therefore affirm, holding that IDEA may reduce its rent obligations by the recoupment amounts provided under the Lease.

(Revel AC Inc v. IDEA Boardwalk, LLC, No. 17-3607 (3d Cir. 2018))

Decided: November, 2018
Published: December, 2018

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