The Ninth Circuit Court of Appeals recently provided landlords dealing with a rejected lease with further guidance on the size and basis of their claims against a tenant’s bankruptcy estate.  Kupfer v. Salma (In re Kupfer), No. 14-16697 (9th Cir. Dec. 29, 2016).  The Ninth Circuit held that the statutory cap – 11 U.S.C. § 502(b)(6) – on a landlord’s claims against a tenant arising from lease rejection in bankruptcy applies only to claims that result directly from the lease termination; the cap does not apply to collateral claims.

The Statutory Cap in Bankruptcy Code Section 502(b)(6)

Bankruptcy Code Section 502(b)(6) caps a landlord’s claim for damages for a lease terminated before or during the tenant’s bankruptcy to (a) the greater of (i) one year’s worth of rent or (ii) 15%, not to exceed three years, of the remaining lease term; plus (b) any unpaid rent due under the lease as of the earlier of (x) the date the bankruptcy case was initiated (commonly called the “petition date”) or (y) the date the landlord repossessed the property or the tenant surrendered it.  The cap is designed to prevent landlords from pursuing large claims arising from terminated long-term leases, when in reality the landlord will likely be able to re-let the space at some point in the future.

Many courts have considered how broadly the statute should be construed and what type of damages are subject to the cap.   (Other cases have dealt with other idiosyncracies of Section 502(b)(6), such as whether the “15%” means 15% of the remaining rent (escalating over time under the lease), or 15% of the remaining lease months at the current rent.  For a recent post on this arcane “15% of what” issue, see here.)   In Kupfer, the Ninth Circuit specifically considered whether Section 502(b)(6) caps a landlord’s entire claim for attorney’s fees and costs, if some of such amounts arose from other lease breaches, and not the lease termination.

Factual Background And Lower Court Rulings

Two related tenants had leased two commercial properties, each lease running for ten years and containing an arbitration clause and a prevailing party attorney’s fees, arbitration fees, and costs provision.  Tenants stopped paying rent and eventually vacated the premises.   Landlords won in arbitration, obtaining a $1.3 million damages award against Tenants for unpaid past rent and the present value of future rent.  Landlords also received an attorney’s fees, arbitration fees, and costs award of almost $200,000.

Tenants subsequently filed Chapter 11 cases.  Landlords filed a proof of claim for the entire arbitration award.  Tenants objected, arguing that Section 502(b)(6) applied to the entire arbitration award, including past rent, future rent, and the fee award.  Landlords argued that the statutory cap should only apply to the past and future rent award, not the fee award.  The bankruptcy court agreed with Landlords and the District Court affirmed.  Tenants appealed to the Ninth Circuit.

The Ninth Circuit Decision

In ruling, the Ninth Circuit considered public policy, legislative history behind the statutory cap, and various cases, including its prior ruling in In re El Toro Materials Co., 504 F.3d 978 (9th Cir. 2007) (damages arising from tort claims for waste, trespass and nuisance were not subject to statutory cap because they would have existed regardless of lease termination).  In El Toro Materials, the Ninth Circuit held that the statutory cap in Section 502(b)(6) only applies to damages directly resulting from lease termination.  (For a contrary ruling that the cap encompasses virtually every form of damages a landlord could suffer, even a breach of the contractual duty to repair and maintain the premises, see the Mr. Gatti’s decision out of Texas, here.)

Extending its reasoning in El Toro Materials, the Ninth Circuit partially reversed the lower court rulings and held the statutory cap only extends to the portion of Landlords’ fee award attributable to litigating Landlords’ future rent claims.  Accordingly, Landlords’ award for attorney’s fees and costs related to claims for unpaid past rent and defending against counterclaims were not subject to the statutory cap.  The Ninth Circuit remanded the case for determining which portion of the fee award related to lease termination – and is therefore included in the cap and hence disallowed – and which portion of the fee award did not arise from the lease termination, and thus would be an additional allowed claim free from the cap of Bankruptcy Code section 502(b)(6).

Conclusion

In the Ninth Circuit, Bankruptcy Code section 502(b)(6) only caps landlord damages directly resulting from lease termination – including attorney’s fees and costs awards to the extent they are attributable to lease terminations.  Thus, a landlord’s claim is not limited if its damages would have existed regardless of a tenant’s lease terminations.