The controversy before the 9th Circuit involved interpretation of the cap on landlord claims under section 502 of the Bankruptcy Code. Prior to bankruptcy the leases in question had been terminated and were the subject of arbitration. The debtors claimed that the arbitration fees and attorney fees awarded to the landlords were subject to the cap. The bankruptcy court, as affirmed by the district court, held that the fees were not capped.
Prior to bankruptcy the tenant-debtors stopped paying rent and eventually vacated two commercial properties. The landlords sued the debtors for breach, and the debtors counterclaimed on various grounds, such as breach of contract, breach of good faith and fair dealing, breach of quiet enjoyment, etc. A state court action was stayed pending arbitration.
The arbitrators assessed damages against the debtors for breach of lease, including unpaid past rent and future rent discounted to present value totaling ~$1.3 million, and awarded arbitration fees and attorney fees. They also denied the debtors’ counterclaims. After the debtors filed bankruptcy, the landlords filed a proof of claim for the entire arbitration award, including past due and future rent and the arbitration and attorney fees.
Section 502(b)(6) the Bankruptcy Code provides that a claim is disallowed to the extent that:
such claim is the claim of a lessor for damages resulting from the termination of a lease of real property, [and] 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.
The debtors claimed the entire award was subject to this cap. The landlords responded that the cap applied only to the past and future rent, and not the fees. The bankruptcy court found in favor of the landlords, and the district court affirmed. The only disagreement of the parties was whether the fees were subject to the cap or should be paid in full.
As background, the 9th Circuit reviewed the evolution of landlord claims in bankruptcy.
- “Historically, landlords could not recover future unpaid rent in bankruptcy, on the theory that such claims were contingent” (citing a 1934 Supreme Court decision describing the 1898 bankruptcy act).
- After the Great Depression Congress revisited the issue to reconcile “‘the need for landlords to be able to participate in the bankruptcy claim process and share the assets’ with ‘the need not to allow the debtor’s estate to be depleted through admission of extravagant claims for damages or unearned rent.'”
- This led to 1933 and 1934 amendments to the bankruptcy act that permitted claims for “injury resulting from the rejection by the trustee of an unexpired lease of real estate or for damages or indemnity under a covenant contained in such lease” with the claims limited to unpaid rent plus one year of rent reserved.
- The next significant change was the enactment of the current Bankruptcy Code in 1978. Instead of limiting rejection damages as well as damages under lease covenants, the current cap limits “damages resulting from the termination of a lease.” The court viewed this as a more limited cap.
The court noted that there have been a range of interpretations of this provision. At one end of the spectrum some courts have read the provision “as a kind of subject matter cap on all lease-related damages.” At the other end, some courts have narrowly construed the provision to apply only to claims for future rent and not to collateral damages. The court viewed itself as taking a middle position, focusing on whether a particular claim resulted from termination of the lease.
The 9th Circuit’s simple test as announced in prior case law was: “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?” To address the case of a pre-petition lease termination as opposed to a post-petition rejection, the court modified the test to ask whether the landlord would have the same claim if the lease had not been terminated.
Applying this test to the case before it, the court rejected the all or nothing approach taken by the bankruptcy and district courts. Since the cap on damages applied only to claims for “damages resulting from the termination of a lease,” the fees attributable to litigating claims for future rent were properly capped. However, claims for past rent could be asserted regardless of termination, so related fees were not subject to the cap. A similar analysis needed to be applied to the debtors’ counterclaims.
So, the court remanded the case with the direction that all claims were to be categorized based on whether they resulted directly from termination of a lease or not. Termination related claims were subject to the cap, while the rest more not.
Calculation of a landlord’s claim for rejection damages is not some obscure technicality that comes up once in a blue moon, but rather is a common place issue. It is interesting to note the significant variations in interpretation of the cap that still exist almost 40 years after the current formulation was adopted in the Bankruptcy Code.
Vicki R Harding, Esq.