When a tenant files for bankruptcy and rejects its lease, the Bankruptcy Code limits a landlord’s rejection claim to the amount of any unpaid rent and rent-related charges accrued prior to the tenant’s bankruptcy plus future rent and rent-related charges (e.g., common area maintenance charges, real estate taxes) reserved under the lease (without acceleration) for the greater of one year or 15 percent, not to exceed three years, of the remaining term of the lease. (You would need a remaining lease term of 6 years and 8 months to have a future rent claim exceeding one year’s rent.) Tenants in bankruptcy and bankruptcy trustees have been largely successful in arguing that all of a landlord’s damages associated with the lease and the leased premises are limited by this so-called cap. For retail landlords with long term leases, in particular, this has often meant having no recourse against a bankrupt tenant’s estate for physical damage to the abandoned leased premises. If a retail tenant is leasing multiple locations from the same landlord, the potential lost damages as a result of the cap may be significant. However, recent decisions from bankruptcy courts in Michigan and Pennsylvania suggest that the cap has a much narrower application and only limits damages that “result from” termination of the lease. Whether these decisions signal an emerging trend in commercial tenant cases remains to be seen. Accordingly, retail landlords, with the assistance of counsel, should seek to identify and document not only damages resulting from a tenant’s rejection of the lease (e.g., the remaining rent under the lease), but also any additional damages unrelated to the lease termination.
In In re Energy Conversion Devices, Inc., a Michigan bankruptcy court denied a motion to disallow a landlord’s claim that included not only a year’s rent, but also claims based on the tenant’s breach of lease provisions requiring it to maintain and repair damage to the premises. The trustee argued that the claim for maintenance and repair damages was subject to the cap, while the landlord asserted that the additional damages did not arise from the lease being terminated, and therefore the cap did not apply.
Relying on the plain meaning of the statute, as well as legislative history of the Bankruptcy Code, the court denied the trustee’s motion. The court noted the absurdity that could result if the Code were construed to preclude a landlord from asserting a damage claim wholly unrelated to the debtor’s rejection of the lease — for example, where a debtor caused major damage to the leased premises. The Court reasoned that leaving the landlord with no recourse in such a situation was a result Congress could not have intended.
In a more recent decision, In re MDC Systems, Inc., a Pennsylvania Bankruptcy Court refused to disallow a portion of a landlord’s claim for attorney’s fees incurred by the landlord in a state court action brought against the tenant-debtor. Similar to the Energy Conversion Devices court, the court narrowly construed the cap to apply only to damages resulting from the termination of the lease and concluded that the obligation to pay attorney’s fees arose independently from the lease’s termination.
Both cases cite favorably to the California Bankruptcy Court’s decision in In re El Toro Materials Co., Inc. In that case, the court framed a simple test to determine whether a certain portion of a landlord’s claim should be subject to the cap: “Assuming all other conditions remain constant, would the landlord have the same claim against the tenant if the tenant were to assume [i.e., continue performing under] the lease rather than rejecting it?” If yes, the landlord may have a claim for damages in addition to its capped claim. Claims for repairs to the premises (as in Energy Conversion Devices), pre-rejection attorney’s fees (as in MDC Systems), environmental cleanup, indemnification or other claims which arise under the lease, but arise irrespective of assumption or rejection of the lease would appear to fit the bill. In the case of a tenant bankruptcy, a retail landlord should seek to identify, document and recoup all categories of damages accruing under the lease, not simply lost rent resulting from the termination of the lease.
