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On Bankruptcy Alert

January 23, 2017

Limits Placed on Landlord Claims in Bankruptcy

By Shane G. Ramsey

On December 29, 2016, the Ninth Circuit issued its decision in In re Kupfer, holding that the statutory cap on a landlord's claims against a tenant in bankruptcy, as set forth in 11 U.S.C. § 502(b)(6), applies only to claims that result directly from the termination of a lease, but not to collateral claims.  This decision has significant implications regarding the scope of section 502(b)(6) claims­—an area of bankruptcy law already significantly in flux.  Knowledge of how to navigate the ever-changing landscape of section 502(b)(6) claims can improve outcomes for landlords confronted with a tenant that has filed for bankruptcy protection.

Section 502(b)(6)

Before turning to the Ninth Circuit’s recent opinion, here is a quick review for those who have not confronted the issue recently: Bankruptcy Code section 502(b)(6) generally “caps” a landlord’s claim for “damages” against a bankrupt tenant when a lease is terminated before or during the bankruptcy case to (a) the greater of the next year of rent due, or 15% of all the remaining rent due up to 3 years of the remaining term, and (b) any unpaid rent owing as of the date of the bankruptcy, or the date the tenant lost possession of the premises if prior to bankruptcy.  Fairly or not, the policy justification for the cap is that large claims of landlords, which are by their nature long-term and hard to calculate, should not overwhelm the claims of other trade creditors.

Many issues have arisen regarding the interpretation of section 502(b)(6), and one of the issues that courts have particularly struggled with is how broadly to interpret the statute's "cap".  In other words, what “damages” sustained by a landlord are actually limited to the cap amount? Are damages limited simply to rent, or does the cap extend more broadly to tenant improvement allowances, real estate taxes, clean-up costs, attorneys' fees, and other such items.

Bankruptcy courts around the country have read section 502(b)(6) in a variety of ways when confronted with this issue. Some have read it broadly, including within its scope all damages incurred by the landlord.  Other courts have read it more narrowly, finding, for example, that not all damages a landlord sustains are the result of the lease termination and, as such, are not subject to section 502(b)(6)'s cap. 

The Ninth Circuit's Decision

The Ninth Circuit's decision arose out of a dispute regarding whether or not certain pre-petition arbitration awards were subject to the 502(b)(6) cap.  Konstantin and Margarita Kupfer (the "Debtors") entered into two, ten-year commercial property leases with Karim and Roberta Salma, as Trustees of the Salma Trust, Lindsey S. Bruel, Riyad R. Salma, and Laith Salma (collectively, the "Creditors").  Each lease included an arbitration clause that provided for an award of attorney fees, arbitration fees, and costs to the prevailing party.  At some point, the Debtors stopped paying rent under these leases and the Creditors filed suit in California state court.  The case was stayed pending arbitration, wherein the arbitrators assessed liability against the Debtors for breaching the leases, totaling nearly $1.3 million in unpaid past and future rent.  In addition, the arbitrators awarded attorneys' fees of $137,250 and arbitration fees of $56,934 to the Creditors. 

Shortly after conclusion of the arbitration, the Debtors filed a petition under Chapter 11 of the Bankruptcy Code and the Creditors filed a proof of claim for their arbitration award.  The Debtors objected to the proof of claim and argued that the entire arbitration award—both the unpaid rents and the attorney/arbitration fees—was subject to, and limited by, section 502(b)(6)'s cap.  The Creditors countered that the cap applied only to the unpaid rent, and not to the award of attorney and arbitration fees. 

The primary question in this case was whether the arbitration awards "result[ed] from the termination" of the two leases.  Both the bankruptcy court and the district court sided with the Creditors and held that section 502(b)(6) applied only to the unpaid rents and did not limit the awarded attorney and arbitration fees. 

The Ninth Circuit rejected the lower courts' "all-or-nothing" approach to these awards, and instead held that the test to determine whether certain costs "result from" a pre-petition lease termination requires answering the following question: "Assuming that all other conditions remain constant, would the landlord have the same claim against the tenant had the lease not been terminated?"  If the answer is "yes," then the claim did not "result from" the termination of the lease and is not, therefore, subject to the cap; if the answer is "no," then the claim did "result from" the termination and is subject to the cap.

The Ninth Circuit's approach in In re Kupfer is a middle-of-the-road approach to a currently-divided area of bankruptcy law.  Some circuits include all lease-related damages within the section 502(b)(6) cap, while others narrowly apply the cap to only unpaid future rent.  For companies contemplating filing a Chapter 11 petition that have significant real estate holdings, this case adds another layer of analysis in determining the appropriate venue to file.  Until the Supreme Court provides guidance as to the proper interpretation of section 502(b)(6), courts will remain split on how to calculate claims under this provision.

To discuss how the Kupfer opinion might affect your business practices, contact Shane Ramsey, 615-664-5355, or any member of the Nelson Mullins Bankruptcy and Financial Restructuring Practice Group.