In a recent decision the Ninth Circuit Court of Appeals clarified what damages suffered by a
commercial landlord are subject to the "cap" of Section 502(b)(6) of the Bankruptcy Code. In re Kupfer (9th Cir., 12/29/2016), Case No. 14‑16697.
In Kupfer the debtors leased two commercial properties in Burlingame, California. The leases included arbitration clauses and also clauses for an award of attorney's fees, arbitration fees and costs to the prevailing party.
The debtors stopped paying rent and vacated the premises. The landlord filed an action in state court for breach of lease. The matter was sent to arbitration and the arbitrators assessed damages for past unpaid rent and future rent totaling $1.3 million. In addition, attorneys’ fees of $137,250 and arbitration fees of $56,934.18 were awarded to the landlord.
The debtors subsequently filed bankruptcy and claimed that the attorneys’ fee award as well as the arbitration fee award should be subject to the "cap" in 11 USC 502(b)(6). 502(b)(6) is the section of the Bankruptcy Code which limits a landlord's damages to either 12 months of rent or 15 percent of the remaining term of the lease (up to 3 years). Section 502(b) specifically begins with the qualifier:
“if such claim is the claim of a lessor for damages resulting from the termination of a lease of real property, ...”.
The Ninth Circuit noted that in In re El Toro Materials Co., 504 F.3d 978 (9th Cir. 2007) a land-
lord's claim for environmental damages resulting from 1 million tons of wet clay goo left at a
property by a debtor was not subject to the cap of 502(b)(6). The Ninth Circuit premised its El
Toro holding on the fact that tort claims for waste "do not result from the rejection of the lease —- they result from the pile of dirt allegedly left on the property."
The Ninth Circuit pointed to El Toro as an example of a case where the conditional language at the beginning of Section 502(b) applies— does the claim of landlord "result from the termination of a lease of real property" or is it the claim which would exist irrespective of whether the lease was terminated? In the case of wet goo the damage claim had nothing to do with lease termination.
The Ninth Circuit quoted the test established in El Toro as follows:
"Assuming all other conditions remain constant, would the landlord have the same claim against the tenant if the tenant were to assume the lease rather than rejecting it?"
In Kupfer the lease had already terminated pre-bankruptcy. The Ninth Circuit cited approvingly to an Eighth Bankruptcy Appellate Panel decision which used the following test for leases which terminated prepetition:
"Would the landlord have the same claim against the tenant if the lease had not been terminated?"
Lariat Cos. v. Wigley (In re Wigley), 533 B.R. 267, 270-71 (BAP 8th Cir. 2015).
If the landlord would have had the same claim regardless of termination then the claim did not "result from the termination" and is therefore allowed in bankruptcy.
The Bankruptcy Appellate Panel of the Eighth Circuit in Wigley ruled that damages for unpaid past rent, common area maintenance charges and late fees had accrued before termination of the lease and therefore did not “result from termination of the lease.” For that reason the related attorney's fees and costs as well as interest also did not “result from termination of the lease” and they therefore were not capped by Section 502(b)(6).
Adopting the Wigley analysis, the Ninth Circuit ruled that because the arbitration award at issue involved damages for past rent as well as future rent, it would be necessary on remand to make a proration between the attorneys’ fees associated with the recovery of past rents and attorneys’ fees attributable to the recovery of future rent. As noted by the Ninth Circuit:
"On remand, the district court first must categorize all claims as either directly resulting from termination of leases or not. The former are capped; the latter are not. The Court then must apportion the associated fees and costs accordingly."
This case is largely a victory for commercial landlords. Conceptually it reinforces precedent that 502(b)(6) only limits claims for future rent, leaving claims for waste, pre-petition attorneys’ fees, interest and late charges, as well as past-due rent unaffected by the cap.