Damages arising from the rejection of a lease by a tenant in
bankruptcy are subject to a cap under Section 502(b)(6) of the
Bankruptcy Code. In this case the landlord managed to find a way to
characterize part of its claim so that it was not subject to the
Section 502(b)(6) provides that a claim will be disallowed 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
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
the date of the filing of the petition; and
the date on which such lessor repossessed, or the lessee
surrendered, the leased property; plus< BR>
any unpaid rent due under such lease, without acceleration, on
the earlier of such dates.
In addition to asserting a claim for prepetition rent and a
Section 502(b) claim equal to one year's rent, the landlord
asserted an "Additional Damages Claim" for the costs of
removing equipment and other personal property of the tenant, and
for various other items, including damage to the roof, parking lot
and HVAC system, environmental damage and liabilities, and other
costs for restoring the property to the condition required by the
The court noted a split in case law regarding the scope of
claims subject to the cap:
The bankruptcy trustee relied on cases holding that a
debtor's rejection of a lease constitutes a breach of all of
the covenants, so that all damage claims are subject to the
In contrast, the landlord argued for a narrower reading that
the cap applies only to those claims arising as a result of lease
termination. Under the narrower view, the cap would not apply to
claims that the landlord would have even if the tenant assumed
rather than rejected the lease.
In analyzing the issues, the ECD court quoted
extensively from a Ninth Circuit case, In re El Toro Materials
Co., Inc., 504 F.3d 978 (9th Cir. 2007). That case
provided an interesting history of this section. Prior to 1934,
landlords were not able to recover for future lease payments
because they were considered contingent and not provable in
bankruptcy. However, the Great Depression created pressure for
change after it led to a number of bankruptcies that left landlords
with broken leases and empty buildings, and no way to recover from
the former tenants. The Bankruptcy Act of 1934 balanced (i) the
interest in allowing a landlord to claim lost rent in order to
reduce the harm done by a breach against (ii)
"extravagant" claims that could deplete the estate to the
detriment of other creditors by allowing a claim for back rent to
the date of abandonment plus damages no greater than one year of
future rent. When the Bankruptcy Act was overhauled in 1978,
existing law was carried forward.
The Ninth Circuit analyzed the scope of the cap as follows: The
structure of the cap, which is measured as a fraction of the
remaining term and refers to damages "resulting from"
lease termination, suggests that damages other than those based on
the loss of future income are not subject to the cap.
Further, extending the cap to cover collateral damage to the
premises would allow a post-petition but pre-rejection tenant to
cause any amount of damage to the premises – either
negligently or intentionally – without fear of liability
beyond the cap. If the tenant's debt to the landlord already
exceeded the cap then there would be no deterrence against even the
most flagrant acts in violation of the lease, possibly even to the
point of the tenant burning down the property in a fit of pique.
Absent clear statutory language supporting such an absurd result,
we cannot suppose that Congress intended such an absurd result.
Based on this and other similar analyses, the ECD court
adopted the narrower view and allowed the landlord to proceed with
its "Additional Damages Claim" without regard to the
There are merits to both sides of the argument. However, the
test offered for distinguishing between those claims subject to the
cap and claims for collateral damage that are not is far from a
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In almost every out-of-court workout situation, when the negotiations get tough and the debtor does not like the terms proposed by the creditor, it is more than common for the debtor to state: "Well, we will just see you in bankruptcy court."