In re Heller Ehrman, LLP No. 10-CV-03134 2011 WL 635224 (N.D. Cal. Feb. 11, 2011)

In In re Heller Ehrman, LLP, the court analyzed whether the statutory cap imposed on a landlord’s damages resulting from the rejection of a lease should be computed based on the time remaining in the lease, or the full damages resulting from the rejection. While noting a split of authority, the District Court determined that the computation of the cap should be based on a temporal measure to be consistent with statutory language.

When a lease of non-residential real property is rejected, the lease is deemed breached. The landlord has the right to assert damages against the debtor/ tenant resulting from such breach. The Bankruptcy Code establishes a landlord’s damages so as to enable the landlord to have a claim against the tenant, but prohibits a claim so large that it would provide the landlord with a “disproportionate” share of the debtor/tenant’s estate. That calculated limitation, known as the statutory cap, is codified in section 502(b)(6) of the Bankruptcy Code. It provides that the landlord’s damages are limited to the greater of one year’s rent or 15 percent of the remaining term of the lease, not to exceed three years. The question raised by Heller Ehrman is whether the second part of the clause (i.e., 15 percent of the remaining term of the lease not to exceed three years) requires the landlord to compute its damages based on the actual rent that would have been paid for the remainder of the lease limited to 15 percent of such amount (the “gross rent calculation”), or whether the actual amount of time for which the landlord can assert damages is limited by 15 percent of the remaining term of the lease (the “temporal calculation”).

In Heller Ehrman, the landlord computed its statutory cap and used the gross rent calculation. The debtor, on the other hand, asserted that the landlord’s claim was overstated and should be limited to the temporal calculation. In this instance, the difference in calculation was about $2.5 million.

The court analyzed both arguments and concluded that the statutory text of the Bankruptcy Code required that the damages be calculated based on the rent that would otherwise be due during the time that equated to 15 percent of the remaining term of the lease. The court concluded that the statute used “temporal” references throughout, and therefore the computation of the statutory cap based on a time limitation was more consistent with the overall scope of the Bankruptcy Code. Also, the court relied on pre-Code decisions and legislative history to bolster its conclusion.

Since there is a split of authority among various jurisdictions, and understanding that the nuances in calculating the gross rent calculation or the temporal calculation can lead to varying amounts, it is important for landlords to recognize these differences to adequately apply the statutory cap.