Landlord Claims: Calculating Capped Future Rent Claims Should Be A Simple Matter of Arithmetic – Right?

In re MDC Systems, Inc., 488 B.R. 74 (Bankr. E.D. Pa. 2013) –

A chapter 7 debtor’s landlord filed a proof of claim for ~ $1 million.  An unsecured creditor objected on the basis that (1) the lease was terminated prepetition, so the landlord did not have any claim for rent, and (2) to the extent that it did have a claim, it was subject to the statutory cap on lease claims.  Resolving this objection required the bankruptcy court to examine various aspects of lease claims under the Bankruptcy Code.

Under Section 502(b)(6) of the Bankruptcy Code, allowance of a landlord’s damage claim is limited to the extent that:

If such claim is the claim of a lessor for damages resulting from the termination of a lease of real property, such claim exceeds –

(A)  the rent reserved by such lease, without acceleration, for the greater of one year, or 15 percent, not to exceed three years, of the remaining term of such lease, following the earlier of –

(i)  the date of the filing of the petition; and

(ii)  the date on which such lessor repossessed, or the lessee surrendered, the leased property; plus

(B)   any unpaid rent due under such lease, without acceleration, on the earlier of such dates.

This case called into question both the proper date for evaluation of the rent cap, and the scope of claims subject to the cap.

In this case:

  • The debtor (which was the tenant under the lease) relinquished possession to a related entity – supposedly pursuant to an assignment, although the assignment was not approved by the landlord – sometime in 2004 or 2005.
  • In mid-2005, the landlord sued the debtor for payment defaults.
  • After the matter went to trial in 2007, the state court entered judgment in favor of the landlord for ~$1million.
  • In fall of 2007 the landlord also began an ejectment action against the affiliate on the basis that it was an illegal occupant/subtenant.
  • The affiliate vacated the premises and turned over the keys to the landlord December 29, 2007.
  • The landlord subsequently obtained two new tenants after incurring costs in connection with reletting the space.
  • The debtor filed bankruptcy on July 23, 2008.

In response to the creditor’s argument that the ejectment action terminated the lease under state law so that the landlord did not have a claim for rent, the court noted that (a) the ejectment action was not brought against the tenant, but rather its “illegal” subtenant, and (b) there was nothing in the record to support a finding that the landlord had terminated the lease.

In considering the effect of Section 502(b)(6), the court began by noting that the purpose of the rent cap is to balance the interest of landlords and unsecured creditors by allowing a landlord to receive some compensation for losses without allowing a claim so large that it prevented unsecured creditors from receiving any recovery.  According to the court, the threshold requirements for a claim under Section 502(b)(6) are “The claim must be:  (1) of a lessor (2) for damages arising from the termination of a lease, (3) of real property.”

In determining the appropriate date for calculation of the rent cap, the critical question was whether the property was surrendered for purposes of Section 502(b)(6)(A)(ii) before the bankruptcy case was filed.  The creditor contended that the property was surrendered on December 29, 2007.  However, under applicable state law a landlord must accept for a surrender to occur.  So the landlord contended there had not been a surrender, and thus the rent cap date was the date the bankruptcy was filed.

While acknowledging a majority view that the meaning of “surrender” is governed by state law (as with many other provisions relating to rights of affected parties), the court did not agree and instead used a “more ordinary, dictionary-like definition” so that the debtor’s voluntary delivery of possession constituted surrender regardless of whether the landlord agreed.

It found several arguments persuasive, including: (1) if Congress meant lease termination (i.e., in this case surrender by the tenant that was accepted by the landlord), it would have said so; (2) the statute appears to characterize surrender in terms of acts by the tenant and repossession in terms of acts by the landlord, so it would be inappropriate to define surrender as requiring action by the landlord; and (3) Section 365(d)(4) requires a trustee to “surrender” property to the landlord in the context of a rejected lease; the term should be used consistently – which means it cannot require the landlord’s acceptance.

In determining the “rent reserved” after the rent cap date, the court adopted the view that the charge generally must be designated as rent, relate to the value of the property or lease, and be a fixed, regular or periodic charge.  In this case, the court agreed that basic rent, pass-through CAM (common area maintenance) charges and storage space rent were included in the “rent reserved.”   The court allowed ~ $175,000 as rent reserved subject to the cap.

Unpaid rent due up through the rent cap date (without acceleration) is included in an allowed claim under Section 502(b)(6)(B) and is not subject to the cap.  The court allowed ~ 141,000 for unpaid rent.

The court declined to include any costs for reletting the space to new tenants, concluding that mitigation as a whole should not be considered under Section 502(b)(6) so that (a) costs incurred by the landlord were not allowed and (b) no credit was given for rent received from the new tenants.

Finally, the landlord also requested attorney fees and costs that had been included in the state court judgment.  While agreeing that the attorney fees and costs were not “rent,” the court decided that Section 502(b)(6) restricted only rent and damages resulting from the termination of the lease, and not other claims.  Turning to a 9th Circuit case for guidance, it asked the question: “Assuming all other conditions remain constant, would the landlord have the same claim against the tenant if the tenant were to assume the lease rather than rejecting it?”  Since the attorney fees arose prior to surrender of the property and did not relate to termination, they would have been part of any cure amount.  So, the court allowed ~$83,600 in fees for a total allowed claim of ~$400,000.

While at first blush the rent cap provision might appear to be a simple question of arithmetic, as this case illustrates, there are a variety of nuances that can provide a fertile ground for argument.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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