December/January 2012 • the essential resource for today’s ... · December/January 2012 • the essential resource for today’s busy insolvency professional • Vol. XXX, ...

Journala m e r i c a n b a n k r u p t c y i n s t i t u t e

December/January 2012 • the essential resource for today’s busy insolvency professional • Vol. XXX, no. 10

Written by:Harris WinsbergKing & Spalding LLP; [email protected]

When a commercial lease tenant files for bankruptcy, the ten-ant may obtain court approval

to reject the lease pursuant to § 365 of the Bankruptcy Code. If the landlord cannot re-let the property to a new ten-ant or must re-let it at a reduced rent, the landlord may file a claim for damages caused by the tenant’s early termina-tion of the lease. Section 502(b)(6) of the Code, however, caps the amount of damages a landlord may assert due to the termination. While § 502(b)(6) caps damage claims, it does not determine damage claims. Instead, “[a] landlord’s claim for damages is determined by state law and the terms of the lease and then limited by § 502(b)(6).”1

Courts have adopted two methods of cal-culating the cap set forth in § 502(b) (6). Some courts find that the 15 percent cap co r re sponds to the rent accruing for 15 percent of the remaining time under the lease, while other

courts have held that the cap corresponds to the total amount of rent remaining under the term of the lease. This article addresses the two distinct calculations: the most recent case to address the issue, In re Heller Ehrman LLP,2 and the impli-cations of each method of calculation.

The Statute and Calculations Section 502(b)(6) caps landlord damages as follows:

(b) Except as provided in sub-sections (e)(2), (f), (g), (h)

and (i) of this section, if such objection to a claim is made, the court...shall determine the amount of such claim...as of the date of the filing of the peti-tion, and shall allow such claim in such amount, except to the extent that—

(6) 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 ) t h e r e n t reserved by such l e a s e , w i t h o u t acceleration, for the greater of one year, or 15 per-cent, not to exceed three years, of the remaining term of such lease, follow-ing the earlier of—

(i) the date of the filing of the petition; and(ii) the date on which such lessor repos-sessed, or the l e s s e e s u r -rendered, the leased prop-erty; plus

(B) any unpa id r e n t d u e u n d e r such lease, with-out acceleration, on the earlier of such dates.3

The legislative history shows that Congress enacted § 502(b)(6) to com-pensate landlords for actual damag-es while limiting future, speculative damages, which could dilute other creditors’ claims.4 Some courts hold that the 15 percent cap5 corresponds to rent accruing for 15 percent of the remaining time under the lease (“time approach”).6 Under the time approach, a landlord will multiply the remaining time left on the lease by 15 percent and then determine the rent reserved during that specific time period in the lease. Other courts hold the refer-ence to 15 percent corresponds to the total amount of rent remaining under the term of the lease (“rent approach”).7 Under the rent approach, a landlord will multiply 15 percent by the total remain-ing rent due under the lease.

In re Heller Ehrman In Heller Ehrman LLP,8 the land-lord leased office space to the debtor under a lease scheduled to termi-nate in 2018. The debtor obtained court approval to reject the lease in June 2009, and the landlord filed a rejection claim to which the debtor objected as being in excess of the 15 percent cap. Because the lease had approxi-mately 114 months remaining, the 15 percent cap applied to the landlord’s claim. The debtor argued the time

About the Author

Harris Winsberg is a partner at King & Spalding LLP in Atlanta.

On the InsIde: Credit-Bidding issue teed up for supremes • new rules deC. 1 • winter leadership ConferenCe exhiBitor and sponsor direCtory

continued on page 62

Does “Term” Equal “Time”? Calculation of Lease-Damage Claims after Early Termination

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1 See, e.g., Smith v. Sprayberry Square Holdings Inc. (In re Smith), 249B.R.328,334(Bankr.S.D.Ga.2000).

2 No.10-cv-03134,2011WL635224(N.D.Cal.Feb.11,2011).3 11U.S.C.§502(b)(6)(emphasissupplied).

Harris Winsberg

4 H.R.Rep.No.595,95thCong.,1stSess.353(1977),U.S. Code Cong. & Admin. News1978,pages5787,6448.See also Vause v. Capital Poly Bag Inc. (In re Vause),886F.2d794,801(6thCir.1989).

5 As one court explained, the 15 percent cap only applies when theremaining term of the lease beginning with the earlier of the petitiondateor thedateof surrenderor repossession isbetween80and240months. See In re Iron-Oak Supply Corp., 169 B.R. 414, 419 n. 8(Bankr.E.D.Cal.1994).

6 See, e.g., In re Blatstein,CaseNo.97-3739,1997WL560119,at*14-15 (E.D.Pa.Aug.26,1997) (adopting timeapproach); In re Allegheny Int’l Inc., 145 B.R. 823, 828 (W.D. Pa. 1992) (same); In re Connectix Corp.,372B.R.488,493(Bankr.N.D.Cal.2007)(same).

7 See, e.g., New Valley Corp. v. Corporate Property Associates (In re New Valley Corp.), No. Civ. A. 98-982, 2000 WL 1251858, at *11 (D. N.J.Aug.31,2000) (adoptingrentapproach); In re Andover Togs Inc.,231B.R.521,547(Bankr.S.D.N.Y.1999)(same);In re Gantos Inc.,176B.R.793,794-96(Bankr.W.D.Mich.1995)(same).

8 No.10-cv-03134,2011WL635224(N.D.Cal.Feb.11,2011).

62 December/January 2012 ABI Journal

Does “Term” Equal “Time”? Calculation of Lease-Damage Claimsfrom cover

approach, which yielded a future lost rent claim of $12.1 million. The landlord argued the rent approach, which yielded a future lost rent claim of $14.4 million.

Plain Meaning The landlord argued the word “term” in subsection (A) refers to the total rent due under the lease; thus, the one year or 15 percent limitation were alternative ways of calculating the rejection claim. Conversely, the debtor argued the word “term” referred to a measurement of time, which is the remaining time under the lease. The court found when comparing the greater of two things (i.e., one year or 15 percent not to exceed three years), the two things measured should be the same. Because “one year” refers to time, the court concluded the word “term” must be referring to the remaining time under the lease, not the remaining rent due under the lease. The court noted the phrase “term of lease” commonly refers to the length of a lease based on time, not rent.

Legislative History The court noted the statute was sub-ject to different interpretations; thus, the court examined the legislative history of the statute. Prior to 1934, a landlord could not recover on a claim for future rent after the tenant rejected the lease because the landlord’s claim was con-sidered too speculative.9 During the Great Depression, Congress amended the Bankruptcy Act to permit landlords to recover on their rejection claims.10 Section 77B of the Bankruptcy Act lim-ited a landlord’s rejection damages in a reorganization to “an amount not to exceed the rent, without acceleration, reserved by said lease for the three years next succeeding the date of surrender of the premises to the landlord or the date of reentry of the landlord...11 and § 63(a) of the Bankruptcy Act limited a landlord’s rejection damages in a liquidation to “the rent reserved by the lease, without accel-eration, for the year next succeeding the date of the surrender of the premises.”12 Thus, in the Bankruptcy Act, Congress

allowed landlords to recover damages for future rents but limited damages to three years’ rent in reorganizations and one year’s rent in liquidations. In 1978, Congress included a similar provision in the new Bankruptcy Code to allow landlords to recover rejection dam-ages. In enacting the cap, Congress com-bined the two caps into a sliding scale, which removed the words “next suc-ceeding” and added the 15 percent limi-tation.13 Unlike the cap in the Bankruptcy Act, the Bankruptcy Code does not dis-tinguish between a reorganization or liq-uidation case. In Heller Ehrman, the landlord argued that legislative history supports the rent approach. In rejecting this argu-ment, the court noted the cap under the Bankruptcy Act was measured by time, so the court declined to interpret the 15 percent cap in a manner inconsistent with pre-Code practice without clear congres-sional intent.

Equity Finally, the landlord argued that equity favored the rent approach because it takes a sample of the rent negotiated over the term of the lease and more closely satisfies the landlord’s expecta-tion to receive the rent bargained for in the lease. The court noted that the land-lord’s expectancy interest conflicts with the legislative history of § 502(b) (6).14 Because Congress intended to limit rejection claims, the time approach is more equitable as it limits damages to the rent due right after the termination of the lease.

The Implications The method used for the rent cap cal-culation can create different results. The example from New Valley15 illustrates this point:

A chapter 11 debtor rejects a lease with 10 years remaining under the lease. Each of the first [five] years of the remaining lease term requires rental of $80,000 a year, and each of the last [five] years of the remaining lease term

requires rental of $120,000 a year. If the § 502(b) (6) damage cap is calculated as a function of time, 15% of the remaining lease term would be 1.5 years (10 years multiplied by .15), which would make the lessor’s rejection dam-ages $120,000 (1.5 years multi-plied by $80,000 a year for that period of time). If the damage cap is calculated as a function of rent, the lessor would be entitled to $150,000 in damages ($1 mil-lion multiplied by 15%).

...Conversely, assume that the lease requires $120,000 annual pay-ments for the first five years and $80,000 for the remaining five years. If calculated as a function of time, the lessor’s damages would be $180,000 (1.5 years multiplied by $120,000 a year). If calculated as rent, lessor’s damages remains the same—$150,000.

As the example illustrates, the time approach yields different results when the lease payments increase while the rent approach will yield the same result.

Conclusion Section 502(b)(6) should be modified to clarify how the 15 percent cap works and to give courts clearer direction. If Congress intended that courts use the time approach, it could achieve this clar-ity by changing only the word “term.” In that case, modified § 502(b)(6)(A) should read as follows:

(6) 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 accel-eration, for the greater of one year, or 15 percent, not to exceed three years, of the remaining time of such lease...

Similarly, if Congress intended that courts use the rent approach, it could achieve this clarity by changing the word “term” to “rent.” In sum, Congress should clarify the statute. n

9 See Oldden v. Tonto Realty Corp.,143F.2d916,918(2dCir.1944).10 Id.at919-20.11ActofJune7,1934,ch.424,§77(B)(b),48Stat.911,915(empha-

sissupplied).12 Id.at§4(a),48Stat.924(emphasissupplied).

13 H.R.Rep.No.595,95thCong.,1stSess.353(1977),U.S. Code Cong. & Admin. News1978,pages5787,6448;S.Rep.No.989,95thConf.,2dSess.63(1978);124Cong.Rec.H11,094(dailyed.Sept.28,1978).

14 Vause,886F.2dat802.15 2000WL1251858at*11-12.

Copyright 2011 American Bankruptcy Institute. Please contact ABI at (703) 739-0800 for reprint permission.