United States: Landlord Lease Claims: Avoiding the Statutory Cap – Round 2

In re Healthy Hut Inc ., 506 B.R. 526 (Bankr. D. Haw. 2014) –

Prior to bankruptcy the debtor vacated leased space before the end of the lease term. The landlord filed a proof of claim in the bankruptcy. The debtor raised several objections, including an argument that the claim exceeded the statutory cap under Section 502(b)(6) of the Bankruptcy Code.

As a preliminary matter, the debtor argued that the landlord breached the lease by giving notice that it intended to "tent" the building to treat for termites, and alternatively that there was a mutual agreement to terminate the lease when it vacated the premises. However, the court noted that the landlord delayed the termite treatment until after the debtor moved out, and determined that the landlord never agreed to waive its claims for future rent or other damages. Which left the debtor's argument that the landlord claim exceeded the statutory cap.

As discussed in the last blog post ( Landlord Lease Claims: Avoiding the Statutory Cap – Round 1), Section 502(b)(6) provides (emphasis added) that a claim is allowed except to the extent that:

The landlord's claim included lost rent, and payment of its broker's and attorneys' fees. In this case, the parties acknowledged that the applicable limitation was rent reserved for one year. The landlord did not dispute that its claim for lost rent was subject to the cap, but contended that the cap was not applicable to the attorneys' fees or the reletting expenses.

The court applied the 9^th Circuit test that damages "resulting from" termination means claims that the landlord would not have had if the tenant had not terminated the lease. It concluded that in this case all of the damages were attributable to termination of the lease. The landlord would not have a claim for lost rent, broker's fees or attorneys' fees if the debtor had not breached the lease.

The landlord contended that the court should disregard the cap in the interest of fairness, since it was the only creditor in the bankruptcy estate. However, the court found that it was bound by the Bankruptcy Code and did not have discretion to ignore the cap.

The amount of the cap turned on whether particular items were "rent reserved." The debtor argued that the rent reserved should exclude not only the broker's and attorneys' fees, but also the CAM (common area maintenance) expenses. In addition, the cap should be reduced by the amounts of a security deposit, a last rent payment by the debtor, and a new replacement tenant's rent.

The court applied the test from a 9^th Circuit BAP case that in order for an item to be rent reserved, it must be (1)  designated as rent (or be the tenant's obligation under the lease), (2)  related to the value of the property or lease, and (3) a fixed, regular or periodic charge.

Applying this test, the court concluded that CAM charges were rent reserved since they were (1) designated as rent in the lease, (2) related to the value of the property (since they were used to maintain the common areas which the debtor was allowed to use) and (3) a regular or periodic charge (since each month the debtor was obligated to pay its pro rata share). Thus the CAM expenses were included in the base rent for purposes of calculating the cap.

However, the attorneys' and broker's fees were not rent under this test. Even though they were designated as rent in the lease, they related to the landlord's costs of obtaining a judgment and finding a substitute tenant, not the value of the property, and they are not a fixed nor a regular or periodic charge because they are incurred on an ad hoc basis. Thus, the fees were not included in determining the capped amount.

With respect to the debtor's argument that the security deposit and additional debtor rent payment should be deducted from the cap, the court disagreed and determined that they should be applied to the claim for delinquent pre-termination rent. The cap relates only to damages resulting from termination and does not apply to delinquent rent outstanding at the time of termination. The debtor intended to apply the security deposit and its last payment to satisfy its outstanding obligations for rent. Since there was nothing left after payment of the outstanding obligations, there was nothing to apply to the post-termination capped claim.

As for the replacement tenant's rent, the court described the cap calculation as follows: "the court must (1) determine the landlord's gross damages after subtracting any amounts recouped through mitigation; (2) compare the gross damages to the 502(b)(6) cap; (3) subtract any security deposit from the capped amount; and (4) allow a claim in that amount." In this case, the small amount received from the replacement tenant was not enough to bring the gross damages below the cap.

As illustrated by this case, be aware that on the one hand simply characterizing an item as rent does not necessarily mean that it will be treated as rent for purposes of Section 502(b)(6), although on the other hand, the rent characterization may cause an item to be subject to the cap even though the landlord might have been able to argue that it was not.

As a side note, one wonders why this bankruptcy case was not dismissed shortly after it was filed. The schedules filed by the debtor with its Chapter 7 petition show total assets of $161.00 in a bank checking account, and the landlord as the sole creditor with a claim of $58,000.

However, the landlord did not get around to filing a motion to dismiss the case for cause until after this rent cap decision, which was almost 10 months after the case was filed. The Chapter 7 trustee objected, arguing that the landlord was just dissatisfied with a settlement negotiated by the trustee, and the motion should be barred by laches. The bankruptcy court denied the motion.

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