Any property owner which has experienced the bankruptcy of a tenant is doubtless keenly aware of the limitation on damages which the Bankruptcy Code imposes on the landlord. A new decision by the Ninth Circuit bolsters the position of landlords in this long-running tussle.
Section 502(b)(6) Cap Refresher
Before getting 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 struggled with is how broadly to interpret the statute.
In other words, what sorts of “damages” sustained by a landlord are actually limited to the cap amount, i.e., is it only rent? What about clean-up or other charges? Amounts owing for tenant improvement allowances? Commissions? Attorneys’ fees?
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 (in what would be a termed a debtor-tenant “friendly” way) by including within its scope all damages incurred by the landlord. Other courts have read it more narrowly, finding, for example, that not all such damages are the result of lease termination and are thus not subject to a cap, in effect a much more “landlord friendly” rule.
The Ninth Circuit Addresses the Extent of the Cap
Last week, the Ninth Circuit issued a decision which was technically in favor of a debtor-tenant but actually gave landlords more clarity on what damages are not subject to the bankruptcy cap in courts in the Ninth Circuit—which includes all of California as well as Washington, Oregon, Montana, Idaho, Nevada, Arizona, Alaska and Hawaii. In a case called Kupfer v. Salma (In re Kupfer) (14-16697), US Court of Appeals – Ninth Circuit, December 29, 2016 — 2016 DJDAR 12730 http://cdn.ca9.uscourts.gov/datastore/opinions/2016/12/29/14-16697.pdf, the Ninth Circuit reversed an order of the District Court that an arbitrator’s award of attorneys’ fees in favor of a landlord did not fall under the statutory cap. However, in its opinion, the Ninth Circuit clarified that the cap on landlord claims only applies to a limited subset of the attorneys’ fees—namely those fees which are attributable to litigating the landlords’ claims for future rent. Because the Ninth Circuit found that those claims would not arise but for lease termination, they were capped under section 502(b)(6). Conversely, because damages for past rent were independent of termination and thus not capped, any attorneys’ fees attributable to litigating the landlord’s claim for past rent were also not capped. The Ninth Circuit remanded the case for a categorization of all claims asserted by the landlord as either “directly resulting from termination of leases, or not. The former are capped; the latter are not” said the Ninth Circuit.
The facts of the case were that the tenant had sued the landlord, claiming breach of two leases and the landlord countersued. The case was then sent to arbitration and an arbitrator found in favor of the landlord and against the tenant. Damages were assessed against the tenant for nearly $1.3 million, plus attorneys’ fees of $137,250 and arbitrator’s costs of $56,934. The tenant filed a chapter 11 bankruptcy case and the landlord filed a proof of claim for the full amount of the arbitration award. The Debtor objected to the claim, arguing that the entire arbitration award, including attorneys’ fees should be limited by the cap of section 502(b)(6). The Bankruptcy Court and District Court found that the landlord’s claim for rent was limited by the cap, but held that attorneys’ fees were not.
The Debtor appealed, claiming that the entire arbitration award should be subject to the limitations of section 502(b)(6). Based upon its reading of the statute and policy considerations, as well as its own 2007 decision in In re El Toro Materials Co, 504 F.3d 978 (9th Cir. 2007), the Ninth Circuit interpreted the statute to mean that only damages that were a direct result of lease termination were limited by the statute and thus subject to the cap.
The Ninth Circuit reasoned that the purpose of the cap was to strike a balance between compensating the landlord for its loss while also protecting other creditors from a huge landlord claim which would result from the somewhat unique long term nature of leases. In El Toro, the Ninth Circuit had held that tort claims such as waste, trespass and nuisance were not subject to the cap even when they were part of a damage claim arising from the rejection of a lease. Because the claim would have existed whether the lease was assumed or rejected, the claim was not capped. The Ninth Circuit extended its reasoning in its earlier decision to attorneys’ fees claims, capping only those that related to litigation of claims that were capped, but allowing an unlimited attorneys’ fee award for fees attributable to uncapped claims.
The Kupfer decision solidifies a landlord’s right to assert uncapped claims based upon damages that would have existed even in the absence of a lease termination. Landlords may now more comfortably pursue claims for past rent without concerns over whether attorneys’ fees incurred will be subject to the statutory cap in bankruptcy. However, other circuits around the country have taken different views, and therefore California landlords should proceed with some caution in recognition of the possibility that a tenant organized elsewhere may file for bankruptcy outside of the Ninth Circuit.