In this installment of “To Cap or Not to Cap,” which was previously featured on Weil’s Bankruptcy Blog in May of 2015 (see here), we reviewed a recent decision from the United States Court of Appeals for the Ninth Circuit. In Kupfer v. Salma (In re Kupfer), the Ninth Circuit vacated the affirmance by the United States District Court for the Northern District of California of the bankruptcy court’s order allowing a claim for breaches of leases and awarding attorneys’ fees and arbitration awards. The Ninth Circuit held that the statutory cap on a landlord’s claims against a tenant in bankruptcy, as set forth in section 502(b)(6) of the Bankruptcy Code, applies only to claims that result directly from the termination of a lease but not to collateral claims.

Relevant Statutory Provisions

Under section 502(a), claims are “deemed allowed, unless a party in interest . . . objects.” 11 U.S.C. § 502(a). If a party objects, the claim is allowed, except to the extent that,

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, following the earlier of (i) the date of the filing of the petition; and (ii) the date on which such lessor repossessed, or the lessee surrendered, the leased property; plus (B) any unpaid rent due under such lease, without acceleration, on the earlier of such dates.

11 U.S.C. § 502(b)(6). In other words, section 502(b)(6) of the Bankruptcy Code sets forth a category of claims that is subject to this cap (i.e., claims of a lessor for damages resulting from the termination of a lease) and then defines the calculation of that cap.

Background

Prior to their chapter 11 filing, the debtors leased two commercial properties pursuant to two separate leases that each ran for ten years. Subsequently, the debtors stopped paying rent and vacated the premises. Pursuant to an arbitration clause contained in each lease, the arbitrators assessed damages against the debtors for breaches of the leases totaling approximately $1.3 million, which included both unpaid past rent and future rent discounted to present value. Additionally, the arbitrators awarded attorneys’ fees of $137,250 plus arbitration fees of $56,934.18 to the landlords.

After the debtors commenced their chapter 11 case, the landlords filed a proof of claim for the arbitration award. The debtors objected to the claim and argued that the entire award, including the attorneys’ fees and arbitration fees, should be limited by the cap in section 502(b)(6) of the Bankruptcy Code. On the other hand, the landlords argued that the cap should apply only to past and future rent, but not to the fee awards.

The bankruptcy court sided with the landlords and allowed the claim in an amount representing the arbitration award of past and future rent as limited by the statutory cap, plus the entire uncapped claim for attorneys’ fees and arbitration fees. The district court affirmed the bankruptcy court’s order and the debtors timely appealed to the Ninth Circuit.

The Ninth Circuit’s Decision

On appeal, the parties did not dispute the bankruptcy court’s calculation of the cap under section 502(b)(6). Rather, they disagreed only as to the legal issue of whether the arbitration and attorneys’ fees must be capped or whether the fees could be claimed in addition to the capped amount of rent. As noted by the Ninth Circuit, courts are divided on how to determine which claims “result from the termination of a lease,” which may in some circumstances include attorneys’ fees and arbitration fees. The Ninth Circuit noted that some courts have interpreted the provision expansively as a cap on all lease-related damages. On the other hand, the court noted that some courts have interpreted the provision narrowly to cap claims for future rent, but not to cap other damages, thereby permitting collateral claims to be asserted in full.

In In re El Toro Materials Co., the Ninth Circuit entered this debate between courts and established a test to determine which claims would be capped under section 502(b)(6): “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 reject it?” In Kupfer, however, the landlords’ claim did not involve the postpetition rejection of a lease, but rather a prepetition termination of a lease. Accordingly, in agreement with a decision from the Bankruptcy Appellate Panel for the Eighth Circuit, the Ninth Circuit applied a modified version of the El Toro test: “Assuming that all other conditions remain constant, would the landlord have the same claim against the tenant had the lease not been terminated?”

Applying this principle, the Ninth Circuit found that the lower courts’ “all-or-nothing” approach was incorrect. Therefore, the Ninth Circuit held that the fees attributable to litigating the landlords’ claims for future rent were capped, because such claims would not exist had the leases not been terminated, but the arbitration fees attributable to damages for past rent, which the landlords could claim independent of termination of the leases, were not capped. The parties also arbitrated the debtors’ numerous counterclaims and, to the extent that the counterclaims concerned ordinary alleged breaches independent of a lease termination, the associated fees and costs were not capped.

Conclusion

The Ninth Circuit’s decision will provide landlords with some clarity as to the applicability and scope of the Bankruptcy Code’s cap on lease termination damages. At least in the Ninth Circuit, a landlord may recover more in a bankruptcy proceeding given that claims not directly resulting from the prepetition termination of a lease, or the postpetition rejection of a lease, are not subject to the cap under section 502(b)(6). The Ninth Circuit’s decision may also provide some ammunition for landlords in other circuits facing similar claim objections.