The following is a case update written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), analyzing a recent decision of interest:
Ruling on an objection filed by a chapter 11 plan administrator to landlords’ claims after lease termination, the Bankruptcy Court for the Southern District of New York (the Court) rejected prior district practice and calculated the amounts due under the rent cap of 11 U.S.C. § 502(b)(6) using the Time Approach rather than the Rent Approach. In re Cortlandt Liquidating LLC, 648 B.R. 137 (Bankr. S.D.N.Y. 2023).
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The plan administrator of a confirmed chapter 11 plan objected to proofs of claim filed by two landlords whose leases had been terminated by a prior court order. The parties’ briefs identified several issues which negotiation had failed to resolve, including: (1) whether the “cap” imposed on such claims by § 502(b)(6) of the Bankruptcy Code should be calculated using the “Time Approach” or the “Rent Approach”; and (2) whether “additional damages” such as store cleanup, mechanics’ liens, window repairs and other miscellaneous repairs arose from the lease termination and therefore were subject to the cap.
The Court ruled that the Time Approach was compelled by a textual analysis of the words of the statute and had been adopted by the majority of courts and relevant treatises in the prior ten years, notwithstanding earlier district decisions which had utilized the Rent Approach. It further held that the store cleanup costs had arisen as a result of the lease termination and therefore were subject to the cap, but the other damages, such as mechanics’ liens and window repairs and other miscellaneous repairs were payable under other provisions of the leases, whether or not they were terminated, and therefore were not subject to the cap.
Section 502(b)(6) places a limit on the allowed amount of an unsecured claim based on the termination of a lease: “(b) Except as provided in subsections (a)(3), (f), (g), (h) and (i) of this section…the court…shall determine the amount of such…as of the date of the filing of the petition, and shall allow such claim…, except 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 exceeds – (A) 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…”
Since the relevant enactment of § 502(b)(6), two approaches to this rent cap calculation have been adopted by bankruptcy courts. The Time Approach imposes a cap that is based on the rents that are specified for the first 15% of the remaining lease term, thereby ignoring rent escalations that might occur in later years. The Rent Approach instead imposes a cap that is based on 15% of all of the rents that are specified for the entire remaining lease term, thereby capturing the effect of later rent escalations. The Court acknowledged that before 2011, bankruptcy courts in the Southern District of New York had utilized the Rent Approach, consistent with the majority of earlier cases and the leading bankruptcy treatise, Collier on Bankruptcy. However, in the past dozen years, that trend had shifted such that both the caselaw and Colliers now favored the Time Approach.
The Court determined that the Time Approach was proper. First, the plain language of the statute makes clear the Time Approach is compelled because the entire phrase is worded in terms of periods of time: “one year” and “three years” which modified the words “of the remaining term of such lease.” If the Rent Approach was correct, then 15% would have not been sandwiched between one and three years. Second, Colliers since 2015 has endorsed the Time Approach, concluding that “[t]he 15 percent limitation of section 502(b)(6) speaks in terms of time, not in terms of rent.” Collier on Bankruptcy ¶ 502.03[c] (16th ed. 2022). Third, better-reasoned decisions have reached the same conclusion, such as the Northern District of California Bankruptcy Court in In re Heller Ehrman LLP¸ 2011 WL 635224 at *3 (Bankr. N.D. Cal. 2011) which concluded that “[b]ecause ‘one year’ is inherently temporal, the phrase ‘remaining term’ necessarily refers to time.” Fourth, the legislative history strongly supports the Time Approach, with amendments as early as the 1930’s which set a three year time limit on landlords’ available damages. Finally, rejecting courts which followed the Rent Approach for equitable or fairness reasons, the Court noted that Congress had struck a balance between terminated lessors and the body of other general unsecured creditors and the Time Approach was consistent with that balance.
On whether other types of damages were subject to the cap, the Court logically looked at whether the costs would only arise when the lease was terminated or were otherwise compelled by terms of the leases. The store cleanup costs would be incurred at the end of the leases. The others would be borne by the estate whether or not the leases were terminated. Therefore, only the cleanup costs were subject to the cap.
This opinion is a useful explanation about the two approaches and why at the present time the Time Approach is favored by the courts and treatises. For the Southern District of New York, it represents a change in the approach by at least one judge from decades-old practices. The second part of the decision about what items are included in the cap represents an area that is more unsettled, with the caselaw varying on the outcome. Normally, the question is resolved by a factual inquiry, tailored to each case reported. The approach of this court, in considering whether the damages or cost would be a liability of the lessee/debtor only upon lease termination or otherwise under lease terms, strike me as a solid approach to the issues.
This review was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.