Pursuant to section 365 of the Bankruptcy Code, a commercial lease tenant is entitled to reject a lease of non-residential real property. The landlord’s resulting claim for the termination of the lease is capped by section 502(b)(6) of the Code up to the rent reserved by the lease for:
- the greater of 1 year; or
- 15%, not to exceed 3 years, of the remaining term of such lease.
The landlord is also entitled to claim for any unpaid rent due on the lease.
The Bankruptcy Code is ambiguous, however, in describing how the 15% of the remaining term of the lease works. As a result, some courts hold that the 15% cap corresponds to rent accruing for 15% of the remaining time under the lease (the “time approach”). See, e.g. In re Blatstein, 1997 WL 560119 (E.D. Pa, 1997); In re Connectix Corp., 372 B.R. 488, 493 (Bankr. N.D. Cal. 2007).
Other courts hold that the 15% corresponds to the total amount of rent remaining under the term of the lease. See, e.g. New Valley Corp. v. Corporate Property Associates (In re New Valley Corp.), 2000 WL 1251858 (D.N.J. 2000); In re Andover Togs, Inc., 231 B.R. 521, 547 (Bankr. S.D.N.Y. 1999). Under the “rent approach,” a landlord will simply multiply 15 percent by the total remaining renT due under the lease to calculate his damages claim.
The following illustration shows the potential impact by using each approach. If a chapter 11 debtor rejects a lease with 10 years remaining, and the first five years requires $80,000.00 in annual rent, and the last five years requires $120,000.00 annual rent, under the time approach, 15% of the remaining term is 1.5 years (15% of 10 = 1.5), which would make the landlord’s rejection damages claim $120,000 (1.5 x $80,000). Under the rent approach, the landlord would be entitled to $150,000 ($1,000,000 x 15%) claim. Conversely, assume that the lease requires $120,000 annual payments for the first five years and $80,000 for the remaining five years. Under the time approach, the landlord’s damages claim is $180,000 (1.5 years x $120,000). Under the rent approach, the landlord’s claim remains at $150,000. As this example demonstrates, the time approach yields different results when the lease payments increase, while the rent approach yields the same result.
Unfortunately, the Legislative history of section 503(b)(6) does not provide clear guidance. Under the Bankruptcy Act, as amended during the Great Depression, landlords could recover damages for future rents, but the Act limited damages to three years’ rent in reorganization cases and one year’s rent in liquidation cases. Under the 1978 Bankruptcy Code, Congress conformed the two time caps to 3 years and added the 15% limitation.
In the recent case of In re Heller Ehrman LLP, 2011 WL 635224 (N.D. Cal. 2011), the court found that the Legislative history suggested that the time approach had historically been used under the Bankruptcy Act and it was not clear that the Bankruptcy Code changed such approach. Thus, in that case, it was left up to bankruptcy court to determine the appropriate formula for the 15% cap under section 502(b)(6).
The Fifth Circuit Court of Appeals has not yet adopted an approach. Thus, courts and practitioners within the Fifth Circuit will need to rely on the opinions of other courts outside this jurisdiction in determining rejection damages claims by landlords.