Chapter Five Calculating the Landlord's Lease-Rejection Damages Claim

• Jurisdiction: United States

Chapter Five Calculating the Landlord's Lease-Rejection Damages Claim

I. The Landlord's Claim for Lease-Rejection Damages

The landlord of a commercial tenant may have different economic claims and rights against the estate of a debtor in bankruptcy if a lease is rejected. When a lease is rejected, the terminology of these various entitlements, and the amount that may be recovered, is sometimes confusing and subject to inconsistent judicial rules. One way to understand the landlord's various entitlements after rejection is to view them as essentially being split into three different groups: (1) a general unsecured claim for pre-petition rent; (2) a general, unsecured post-rejection claim for future rent and termination damages; and (3) in some cases, damages for pre-rejection injury that are not "rent" claims. Remember, the claim for pre-rejection rent is a priority claim under § 365(d)(3) and is discussed earlier in this book.

First, the landlord will have a general, unsecured claim for "unpaid rent" that was "due" on the earlier of the date of the filing of the petition or the date on which the landlord obtained possession of the premises. This portion of the claim is allowed under § 502(b)(6)(B). Litigation has arisen over what is embraced within the term "unpaid rent," as well as when certain obligations, such as rent and real estate taxes, became "due." This claim is not subject to the statutory cap that applies to future rent claims. The amount of the claim should be determined by reference to state law principles of contract interpretation.³³¹ However, some courts limit this claim to items that fall within the definition of "rent reserved."

Second, if the tenant rejects the lease, the landlord may also have a general, unsecured pre-petition claim for all damages caused by the termination, which may include future rent for the period during which the tenant does not occupy the space. This claim is said to arise as if the breach had occurred prior to the filing of the petition and is governed by § 502(b)(6)(A); it is also subject to an express "cap" or limit. It cannot exceed the greater of one year's rent or 15 percent of the remaining term, not to exceed three year's rent (or 15 percent of the remaining rent, according to some cases). The cap pertains to "rent reserved," and here again the courts are split on whether monetary damages other than rent are allowable at all or, conversely, are subject to the limits of § 502(b)(6)(A).

Third, some courts separately consider pre-rejection claims that are not "for rent" or "rent reserved" and have suggested variations from the above rules. The ABI Report noted the importance of this issue in calculating rejection claims: "Notably, courts are split regarding the application of the section 502(b)(6) cap to non-termination damages relating to the lease, which could constitute millions of dollars and significantly impact unsecured creditors' pro rata share of estate assets."³³²

II. The Pre-Petition Cl aim: Unpaid Rent Due on Petition Date

A. Introduction

The first component of a landlord's claim arises under § 502(b)(6)(B) and covers compensation for the rent that was due as of the date of the filing of the bankruptcy petition. The amount due is determined without reference to any right of acceleration that might otherwise be provided for in the lease. The landlord's damage claim under this section may be confined to "rent reserved," although the courts are divided on this issue. This claim for unpaid rent, unlike the claim for future rent, is not subject to any monetary cap, although the limitation imposed by the term "rent" may prove to be significant. As discussed below, the landlord may still have an additional claim for the post-petition period prior to rejection, as well as a claim for future rent that became due after the filing of the petition and for the period during which the tenant does not occupy the space.

B. Statutory Authority: § 502(b)(6)(B)

Section 502(b)(6)(B) states:

(b) [T]he court ... shall determine the amount of such claim ... as of the date of the filing of the petition, 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 termination of a lease of real property, such claim exceeds —

(B) any unpaid rent due under such lease, without acceleration, on the earlier of the date of the filing of the petition; and the date on which [the] lessor repossessed, or the lessee surrendered, the leased property[.]³³³

C. One View: No Limit on Pre-Petition Damages

In the event a debtor rejects a lease, the first "element" of damages is "any unpaid rent due under such lease" on the date that the petition was filed or that the lessee surrendered possession, pursuant to § 502(b)(6)(B). This claim is first calculated by reference to normal state law notions, except that an "acceleration" clause will not be honored.³³⁴ One issue that typically arises is whether the monies sought were "due" on, or before, the date of the petition. If so, the claim may be allowed as a general unsecured claim and paid pro rata with other unsecured creditors. A second issue is whether the claim for "unpaid rent" due under the lease includes all elements of damage that would be permitted under state law.

The general rule for claims under § 502(b)(6)(B) is that there is no cap on such claims provided that the damages are for "rent" or encompass factors similar to rent. "Under § 502(b)(6)(B), unpaid rent due, without acceleration, on the earlier of the bankruptcy petition date or the date of repossession or surrender of the leased property, is fully allowed as part of the damage claim."³³⁵

For example, in In re MDC Systems Inc.,³³⁶ the court stated, "Section 502(b)(6)(B) provides for the allowance of the full amount of the [pre-petition rent]; there is no limitation."³³⁷

The general rule is summarized in Colliers as follows:

There is no limit on amounts owing under the lease as of the petition date. Hence, if a debtor lessee is delinquent on payments as of the petition date, that amount is allowed as an amount "due" under such lease under section 502(b)(6)(B) and is not subject to the limitation of the prior subsection.
Congress intended, through subparagraphs (A) and (B) of section 502(b)(6), to provide lessors with actual damages for past rent and to place a limit on damages for speculative future rent payments in long-term leases, so in section 502(b)(6)(B) the word "due" should be interpreted to mean "owing" rather than "payable." Thus, section 502(b)(6)(B) does not bar a landlord from claiming significant unpaid prepetition rent as past damages under a lease. In one case, this resulted in a nearly one-year deficiency for past due rent where the chapter 11 debtor filed its petition four days before the scheduled annual rent payment.³³⁸

An example of a court applying the "no limit" rule to the pre-petition claim can be found in In re Clements.³³⁹ There, the landlord argued that it was entitled to "all damages" that arose pre-petition, including taxes, maintenance, insurance and attorneys' fees. The court held that such damages were not limited to rent, stating that "case law supports the idea that the landlord's claim is not merely the rent under the lease."³⁴⁰ However, the court also noted and appeared to be at least partially persuaded by the fact that the lease was a "triple net lease" in which the debtor had agreed to pay all expenses, and that defined the expenses involved as "additional rent."³⁴¹

D. Contrary Rule: Limit on Pre-Petition Damages

Despite the general rule discussed above, some cases have held that the pre-pe-tition portion of a claim may be limited by the definition of what is included within the term "unpaid rent." One such case is Smith v. Sprayberry Square Holdings Inc.,³⁴² which held that a landlord's pre-petition uncapped claim could only include "rent due" and that the term "rent due" is to be analyzed in the same manner as the term "rent reserved" under § 502(b)(6)(A). The court recognized that other cases have held that there is no limit, other than state law, on the pre-petition portion of the claim. Nevertheless, the court held that "total damages" does not mean "all damages."³⁴³ "Here, the Code has stated that claims by a lessor for pre-petition damages by a lessor are disallowed if they exceed 'unpaid rent.'"³⁴⁴

The Smith court adopted the definition of "rent" from Kuske v. McSheridan (In re McSheridan).³⁴⁵ In McSheridan, the Bankruptcy Appellate Panel adopted a three-part test that must be met for a lease charge to constitute "rent-reserved" under § 502(b)(6)(A):

1) The charge must (a) be designated as "rent" or "additional rent" in the lease; or (b) be provided as the tenant's/lessee's obligation in the lease;
2) The charge must be related to the value of the property or the lease thereon; and
3) The charge must be properly classifiable as rent because it is a fixed, regular or periodic charge.³⁴⁶

The court in Smith acknowledged that the test adopted in McSheridan was focused on the definition of "rent reserved" for purposes of determining the cap for a claim for future rent under § 502(b)(6)(A). Nevertheless, the court held that the same test should apply to the pre-petition period, and hence acts as a limit on this claim. Given this test for what constitutes "rent," the court in Smith disallowed various items of the landlord's claim. First, the court disallowed recovery of "excused rent," which was free rent that was due and payable only upon default:³⁴⁷

Excused rent only became due on default, when it was levied as a one-time lump sum charge. It does not have the rent characteristic of being a fixed, regular or periodic charge. If [the d]ebtor had never defaulted, [the l]andlord never would have received any [e]xcused [r]ent monies. Therefore, [e]xcused [r]ent is a penalty for default.³⁴⁸

Second, the court disallowed the landlord's claim for the...