Mary Santiago Julie Platner for The Wall Street Journal

The state’s highest court weighed in Tuesday on a dispute over a plan by a bankruptcy trustee to sell the rent-stabilized apartment of an 80-year-old East Village woman to her landlord.

Arguments before the Court of Appeals focused on whether such leases were considered transactions like any leases, or public benefits conferred by the state legislature that should be protected from bankruptcy court.

Some judges on the Court of Appeals sharply questioned a lawyer for Mary Santiago, the East Village woman. He argued that a state law that listed exemptions from bankruptcy for “public-assistance benefits” meant to include rent-stabilized leases, though the law doesn’t specifically mention them.

Several judges seemed sympathetic to another argument, raised by lawyers for Attorney General Eric Schneiderman and Mayor Bill de Blasio, that rent stabilized leases couldn’t be considered property at all, since they couldn't be legally bought and sold by tenants.

Under a bankruptcy court ruling, Ms. Santiago would have been permitted to live in her apartment at the same rent for the rest of her life but would give up the right to pass the apartment to her son. Ms. Santiago appealed.

The state court was asked by the Second U.S. Circuit Court of Appeals to step in and examine the state law setting exemptions for state residents from bankruptcy.

Tenant advocates say the fear of being forced out of rent-regulated apartments—many with below-market rents and succession rights—have deterred thousands of tenants from seeking protection federal bankruptcy courts.

The chief judge, Jonathan Lippman, wondered aloud whether rent rules that freeze rents paid to a landlord is “different from the concept of a benefit” paid out by the government.

“You don’t have to be in poverty” to have rent—stabilized leases, said Judge Eugene F. Pigott Jr. He suggested that the phrase “public benefit” was meant to cover welfare payments for the poor.

But Ronald J. Mann, a professor at Columbia Law School who argued on behalf of Ms. Santiago, said the legislature had used public-assistance benefits “in a lot of contexts that do not apply strictly to the poor.”

Judge Jenny Rivera said: “I don’t understand the distinction between the government sending you a check and what you have here” under government-mandated rent regulation.

The judges also focused on whether rent-protected leases are property at all. Although many tenants move out of apartments in exchange for payments from landlords, the courts sometimes have found that tenants can’t legally sign away their rights under the rent laws. Lawyers for the city and state say that raises a question about whether the leases have value as property.

Judge Robert S. Smith asked whether Ms. Santiago would be willing to “do what the trustee did” and give up her lease if she were offered enough money.

J. David Dantzler Jr., a lawyer for the bankruptcy trustee, John Pereira, argued that in prior decisions the federal appeals court already had concluded that rent-stabilized leases were considered property.

He said it was impossible “for this court to conclude that the legislature intended for” these leases to be included in the state bankruptcy exemptions. He said the issue should be left to the legislature.

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