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The Application of §502 (b)(6) to Nontermination Lease Damages - To Cap or Not

The Application of §502 (b)(6) to Nontermination Lease Damages - To Cap or Not

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TheApplicationof
§
502(b)(6)toNonterminationLeaseDamages:ToCaporNottoCap?
by
MichaelSt.Patric~Baxter*
INTRODUCTIONSection502(b)(6)oftheBankruptcyCode(the"Code")capsacreditor,landlord'sallowedclaimagainstadebtor-tenant'sbankruptcyestate.Specifi-cally,thestatutelimitsalandlord's"damagesresultingfromtheterminationofaleaseofrealproperty"toanamountequaltotherentthedebtor-tenantwouldhavepaidforaperiodofonetothreeyears,dependingontheremain'ingtermofthelease.'Thereisnodisagreementthattheprovisioncapsalandlord'slossofun-realizedfuturepaymentsofrent,taxes,andotherrent'likecharges.Insteadofallowinglandlordstoclaimseveralyearsordecadesoffuturerent,whichmaybemitigatedbyrelettingthepremises,thecapstrikesabalanceandallowslandlordstoclaimonetothreeyearsoffuturerentandrent'likecharges.?
'Partner,Covington
&
BurlingLLP,Washington,D.C.,andProfessorialLecturerinLaw,TheGeorgeWashingtonUniversityLawSchool.Member,JudicialConferenceoftheUnitedStatesAdvisoryCom-mitteeonBankruptcyRules;Conferee,NationalBankruptcyConference;Fellow,AmericanCollegeofBankruptcy;Member,AmericanLawInstitute;FoundingMember,InternationalInsolvencyInstitute;andChair,AmericanBarAssociationSectionofBusinessLawCommitteeonBusinessBankruptcy.Copyright
©
2009byMichaelSt.PatrickBaxter.IamgratefulfortheinsightfulcommentsonanearlierdraftofthisArticlefromThomasB.Bennett,LeifM.Clark,Peter
L.
Borowitz,LuizeZubrow,Michael
L.
Temin,MargaretHoward,GeraldK.Smith,EdwardS.West,NancyB.Rapoport,andCraigGoldblatt.ThankstoChristopherMurrayandMeganB.DoylefortheirassistanceinthepreparationofthisArticle.SpecialthankstoJoshuaD.MeKarcherforhiskeeninsightandinestimableassistanceinthepreparationofthisArticle.Finally,IamindebtedtoJoan,Christian,andSummerformorethancaneverbeexpressedinamerefootnote.TheviewsexpressedinthisArticlearesolelythoseoftheauthor.
III
U.S.C.
§
502(b)(6).Thelandlord'sallowedclaimadditionallyincludesdamagesforunpaidrentoutstandingontheearlierofthedateofthebankruptcyfilingorrepossessionorsurrenderofthepremises.
[d.
§
502(b)(6)(B)."Somemightarguethatthe
§
502(b)(6)capisunnecessarybecauseofthetypicalcontract-lawrequire-mentthatalandlordmitigateitsdamagesresultingfromatenant'sbreach.Theywouldarguethat,ifthelandlordisnotabletomitigatedamages-e.g.,isunabletoreletthepremisesforfiveyearsinsteadofthreeyears-thereisnoreasontoshiftthelossoftwoyears'rentfromthedebtortothelandlordandallowthedebtor,especiallyareorganizingdebtor-in-possession,toavoidtheconsequencesofenteringtheleaseandsubsequentlybreachingit.OthersmightarguethecapreflectsapolicydecisionthattheCode
111
 
112
AMERICANBANKRUPTCYLAWJOURNAL(Vol.83Courtsdisagree,however,onwhethertheprovisioncapsdamagesforpastbreachesofnon-rent(ornon-rent-like)leasecovenants,suchasatenant'scon'tractualobligationtomaintainandrepairthepremises.Ifatenantdestroystheleasedpremisesorleavesequipmentorwasteonthepremises,shouldthelandlord'sclaimfordamagesresultingfromtheseactionsbecapped?Isthelandlord'sclaimfor"damagesresultingfromtheterminationofaleaseofrealproperty'T'Courtsthatapplytheprovisionnarrowlydonotcapdamagesthatthelandlordwouldhavesufferedregardlessofthepremature
terrnina-
tionofthe
lease."
Courtsthatapplytheprovisionexpansivelycapallofalandlord'sdamages,includingdamagesarisingfromthetenant'spastfailuretomaintainorrepairthe
premises."
Theessentialpointsofagreementanddisagreement-andthepracticalconsequences-canbeeasilyillustrated.Forexample,alandlordthatagreestoreconstructaportionofthepremisestoaccommodateanewtenant'sneedsdoessoexclusivelybecausetheformertenantterminatedtheleaseandthelandlordwasforcedtoreletandaccommodateanewtenant.Mostwouldagreethatthecapappliestothesedamages.Alandlordthatmustrebuildseveralinteriorwallsbecauseaformertenantintentionallyremovedtheminviolationofacovenantnottoremovewallsorstructures,however,reconstructsthepremisesmerelytoreturnthepremisestotheiroriginalcon'dition.Althoughterminationmayhaveoccasionedthelandlord'sdiscoveryofthedestruction,theneedtoreconstructthepremisesisnottocustomizeforanewtenantbuttomakethepremisespresentableenoughtoshowtonewtenants(orperhapstomakethepremisesstructurallysound).ThisAr-
provideadefaultmeasureofdamagesforlandlordsinlieuofallowingthemtorecovertraditionalcontractdamages.Stillothersmightarguethatthecapisanachronistic,aholdoverfromthe1930s.Today,forexample,damagesfromtheterminationofanaircraftleasecandwarfthosefromareal-estatelease,buttheformerarepersonal-propertyleasedamagesnotsubjecttoacap.ThisArticleisfocused,notonthesepolicyissues,butontheproperapplicationofthecap.
'11
U.S.C.
§
502(b)(6).
'See,
e.g.,SaddlebackValleyCmty.Churchv.ElTaroMaterialsCo.
(Inre
ElTaroMaterialsCo.),504F.3d978(9thCir.2007);Heck's,Inc.v.Cowron
&
Co.
(Inre
Heck's,Inc.),123B.R.544(SD.W.Va.
1991);Inre
Brown,No.07-34580,2008WL4693197(Bankr.N.D.OhioOct.23,2008);
In
te
BestProds.Co.,229B.R.673(Bankr.E.D.Va.1998);
Inre
Clements,185B.R.895,903(Bankr.MD.Fla.1995)(includingunpaidprepetitionexpensesandmaintenancechargesincalculationofuncappedprepetitionrentdue);
Inre
Farley,Inc.,146B.R.739(Bankr,ND.Ill.1992);
Inre
Bob'sSeaRayBoats,Inc.,143B.R.229(Bankr,D.ND.1992);
Inre
Q-Masters,Inc.,135B.R.157(Bankr.SD.Fla.1991);
Inre
AtlanticContainerCorp.,133B.R.980(Bankr.N.D.Ill.1991);
Inre
McLeanEnters.,Inc.,105B.R.928(Bankr.W.O.Mo.1989);
Inre
StorageTech.Corp.
(Storage'Tech.II),
77B.R.824(Bankr.D.Colo.1986);
Inre
StorageTech.Corp.
(Storage'Tech.I),
53B.R.471(Bankr.D.Colo.1985);Int'lCoins
&
Currency,Inc.v.BarmarCorp.
(Inre
Int'lCoins
&
Currency,Inc.),18B.R.335,338-39(Bankr.D.Vt.1982).
'See,e.g.,
Kuskev.McSheridan
(Inre
McSheridan),184B.R.91(B.A.P.9thCir.1995),
overruledinpart
byEl
'Taro,
504F.3dat982;NewValleyCorp.v.CorporateProp.Assocs.
(Inre
NewValleyCorp.),No.Civ.A.98-982,2000WL1251858(D.N.].Aug.31,2000);
Inre
FoamexInfl,Inc.,368B.R.383(Bankr.D.Del.2007);
Inre
Mr.Gatti's,Inc.,162B.R.1004(Bankr.W.O.Tex.1994).
 
2009)NONTERMINATIONLEASEDAMAGES
113
ticleexploreswhethertheCoderequirestwosuchlandlordstobetreatedidenticallyunder
§
502(b)(6)-or,putdifferently,whetherbothoftheselandlords'claimsaresubjecttothe
§
502(b)(6)cap.Thestakescanbehighfortenants,landlords,andunsecuredcreditorsinbankruptcy.Consideratenantthatconductsminingoperationsandstock,pilesminingwasteinsteadofremovingitastheleaseorenvironmentallawsmightrequire.Orconsideranoffice'buildingtenantthatconductssecretex'perimentsinaninteriorlaboratorythatthetenantstructurallymodifies,con'trarytothelease.Ineithercase,alandlord'scostofrepairandrestoration(notcustomization)beforerelettingcouldexceedseveralmilliondollars.Meanwhile,therentreservedbythelease-andthusthe
§
502(b)(6)capondamages-maybeafractionofthatamount,"Eithertenantmayfileforbankruptcyandrejecttheleaseinanefforttoavoidthemillionsofdollarsindamagestowhichthelandlordmaybeentitled."Ofcourse,thisstrategyiseffectiveonlyif
§
502(b)(6)capsthedamagesthetenantseekstoavoid.Iftheprovisionisreadexpansivelytocapsuchrepairandrestorationdamages,theentirecostoftherepairandrestorationisshiftedfromthetenanttothelandlord.Thetenantescapesliabilityformil,lionsofdollarsitrightfullyowed,whileothercreditors'claimsarenotre-ducedproportionatelybythelandlord'sdamagesclaim.However,iftheprovisionisreadnarrowly,i.e.,nottocaprepairandrestorationdamages,thelandlordcollectsitsproportionateshareoftheestatecommensuratewithotherunsecuredcreditors,"Inthelattercase,though,thedebtor'sotherun-securedcreditorsmayhavetheirrecoveryreducedsubstantiallybecauseofthedilutiveeffectofthelandlord'sclaim.TheissuegarneredattentionmostrecentlyinthedecisionbytheNinthCircuitCourtofAppealsin
Saddlebac~ValleyCommunityChurchv.ElTaroMaterialsCo.(InreEITaroMaterialsCO.).9
The
ElTaro
courtheldthatalandlord'sclaimforanestimated$23millionindamagesfor"waste,nuisanceandtrespass"didnotresultfromtheterminationoftheleasebutfromtortiousactsofthedebtor-tenantinstockpilingtonsofminingwasteon
'E.g.,EI
'foro,504F.3dat980n.2(costofremovalofdebtor-tenant'sminingwastewasestimatedat$23milliononpremisesleasedfor$28,000permonth).
7E.g.,
EIToroMaterialsCo.v.SaddlebackValleyCmty.Church
(Inre
EIToroMaterialsCo.),No.CC,04'1287,slipop.at20(B.A.P.9thCir.July8,2005)(observingthatEITore'sresponsetotheland,lord'snoticeofallegedbreach"wastoseekchapter11relief,andinthatbankruptcycase,torejectthelease"),
rev'd,
EI
'foro,504F.3dat982.
But
see
NMSBPCSLDHB,L.P.v.IntegratedTelecomExpress,Inc.
(Inre
IntegratedTelecomExpress,Inc.),384F.3d108,112(3dCir.2004)(orderingdismissalofdebtor'schapter11caseforbadfaith,wheresolventdebtorsoughtbankruptcyprotectionprimarilytorejectleaseandshiftlossesfromequityholderstothelandlord)."Avoidingthecapdoesnotguaranteethelandlordpaymentof100%ofitsclaim.Theclaimmayonlybepaidinpenniesonthedollar,proratawithotherunsecuredcreditors."SaddlebackValleyCmty.Churchv.EIToroMaterialsCo.
(Inre
EIToroMaterialsCo.),504F.3d978(9thCir.2007).

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