New York District Court: Cap on Landlord Claims in Bankruptcy Applies to Claims Against Lease Guarantors, and Cap Should Be Calculated Using "Time Approach"

To prevent landlords under long-term real property leases from reaping a windfall for future rent claims at the expense of other creditors, the Bankruptcy Code caps the amount of a landlord's claim against a debtor-tenant for damages "resulting from the termination" of a real property lease. Unfortunately, the language of the provision of the Bankruptcy Code—section 502(b)(6)—that specifies the maximum allowed amount of a landlord's claim for lease termination damages is confusing, and it has led to a number of disagreements among bankruptcy courts regarding application of the statutory cap to claims against debtor-lease guarantors and the proper way to calculate the amount of the statutory cap.

The U.S. District Court for the Southern District of New York recently addressed both of those issues in In re Cortlandt Liquidating LLC, 658 B.R. 244 (S.D.N.Y. 2024). The district court affirmed bankruptcy court rulings that the statutory cap applied to a landlord's claim against a lease guarantor. It also ruled that, based on the plain language of section 502(b)(6), its legislative history, and other recent rulings considering the question, the "Time Approach," rather than the "Rent Approach," represents "the correct view" in calculating the amount of the landlord's lease termination damages.

Statutory Cap on Landlord Future Rent Claims

Section 502(b)(6) of the Bankruptcy Code provides that the maximum allowable amount of the "claim of a lessor for damages resulting from the termination of a lease of real property" is limited to:

(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) (emphasis added). The purpose of this rent cap is to balance the interests of landlords and other unsecured creditors by allowing a landlord "to receive compensation for losses suffered from a lease termination while not permitting a claim so large as to prevent general unsecured creditors from recovering from the estate." Solow v. PPI Enterprises, Inc. (In re PPI Enterprises (U.S.), Inc.), 324 F.3d 197 (3d Cir. 2003); see generally Collier on Bankruptcy ("Collier") ¶ 502.03[7][a] (16th ed. 2024). 

The scope of section 502(b)(6) is limited to lease terminations. Lease damages claims for items such as physical damages to the premises are not subject to the cap. See Kupfer v. Salma (In re Kupfer), 852 F.3d 853 (9th Cir. 2016); Saddleback Valley Cmty. Church v. El Toro Materials Co. (In re El Toro Materials Co.), 504 F.3d 978 (9th Cir. 2007).

Application to Claims Against Lease Guarantors

As noted, section 502(b)(6) provides that the "claim of a lessor for damages resulting from the termination of a lease of real property" is subject to the statutory cap. It does not state, however, that the claim must be asserted by the lessor against a debtor-lessee. For this reason, most courts have concluded that lease termination damages asserted against a debtor-lease guarantor are also capped by section 502(b)(6). See, e.g., In re Arden, 176 F.3d 1226 (9th Cir. 1999); Cutler v. Lindsey (In re Lindsey), 1997 WL 705435 (4th Cir. Nov. 7, 1997); In re Concepts Am., Inc., 621 B.R. 848 (Bankr. N.D. Ill. 2020); Flanigan v. Samalex Trust (In re Flanigan), 374 B.R. 568 (Bankr. W.D. Pa. 2007); In re Henderson, 297 B.R. 875 (Bankr. M.D. Fla. 2003); see generally Collier at ¶ 502.03[f] ("[Section 502(b)(6)] merely results in the limitation of the allowance of damages that a lessor of real property may recover from a bankruptcy estate for termination of a lease, regardless of the identity of the entity that is the debtor…. [T]he cap applies in the bankruptcy of a guarantor."). But see In re Dronebarger, 2011 WL 350479 (Bankr. W.D. Tex. Jan. 31, 2011) (ruling that the cap did not apply to a lessor's claim for damages against the debtors as joint guarantors of a commercial real property lease due to the court's belief, based on its reading of the Fifth Circuit's decision in In re Goforth, 179 F.3d 390 (5th Cir. 1999), that the Fifth Circuit would have concluded that section 502(b)(6) would not apply to a debtor lease guarantor); In re Danrik, Ltd., 92 B.R. 964 (Bankr. N.D. Ga. 1988) (holding that section 502(b)(6) did not limit the lessor's claim against a debtor lease guarantor given the "unusual" facts of the case, where the guarantor debtor was solvent, all other claims have been paid in full, the lessee itself had not filed for bankruptcy, and the claim was not disproportionately large).

Time Approach v. Rent Approach in Calculating Statutory Cap 

The language of section 502(b)(6)(A) (italicized above) has long been a source of consternation among the courts, largely because its perceived ambiguity has created confusion over how it should be applied. See Final Report and Recommendations of the American Bankruptcy Institute Commission to Study the Reform of Chapter 11 (2014) V.A.6, p. 135 (noting that "many courts have confused or misapplied the formula and that, simply stated, the cap should be the rent reserved under the lease for the greater of (i) one year and (ii) the shorter of 15 percent of the remaining term and three years, plus unpaid rents"). Two competing approaches have been applied by courts in determining the maximum allowable amount of a landlord's lease termination claim—the "Time Approach" and the "Rent Approach."

The focus of the Rent Approach is on the dollar amount of rent payable for the entire remaining lease term. According to the Rent Approach, section 502(b)(6) imposes a cap equal to 15% of that amount, provided that it is at least equal to the rent reserved under the lease for one year and does not exceed the rent reserved for the next three years of the lease term. See In re Financial News Network, Inc., 149 B.R. 348, 351 (Bankr. S.D.N.Y. 1993) (applying the Rent Approach without any discussion of the Time Approach); In re Andover Togs, Inc., 231 B.R. 521, 547 (Bankr. S.D.N.Y. 1999) (holding that the Rent Approach is the "logically sounder" approach); In re Rock & Republic Enterprises, 2011 WL 2471000, *20 (Bankr. S.D.N.Y. 2011) (declining to depart from the precedents set in Financial News and Andover and ruling that the Rent Approach should govern).

The Time Approach, by contrast, is anchored to the remaining term of the lease, not the remaining rent payable. According to this approach, section 502(b)(6) imposes a cap equal to the rent reserved under the lease for the time period beginning at lease termination equal to 15% of the remaining lease term, provided that time period is at least one year and no more than three years. See In re Keane, 2020 WL 612296, *2 (Bankr. E.D.N.C. Oct. 14, 2020); In re Filene's Basement, LLC, 2015 WL 1806347, *7 (Bankr. D. Del. Apr. 16, 2015); In re Denali Family Servs., 506 B.R. 73, 83 (Bankr. D. Alaska 2014); In re Shane Co., 464 B.R. 32, 39 (Bankr. D. Col. 2012). The Time Approach would appear to be the majority view among courts that have recently considered the question. See Collier at ¶ 502.03[7][c] (citing cases and noting that the Rent Approach "does not appear to be in accord with the language of the statute").

Because many real property leases contain rent-escalation clauses during the latter stages of the lease, the Time Approach does not take such escalations into account when computing the maximum amount of the landlord's claim, whereas the Rent Approach does, thereby resulting in a higher cap on the landlord's lease‑termination claim. See Collier at ¶ 502.06[7][c] ("The choice of methodology will make a difference only where the remaining rent under the lease is not constant. If the rent is increasing over the remaining term, the latter methodology will impose a lower limit, favoring the estate. If the rent is decreasing, the latter methodology will favor the landlord. If the rent is variable, it will depend on when in the lease the termination occurs."). 

Cortlandt Liquidating

In 2010, C21 1972 Broadway LLC ("C21"), an affiliate of Century 21 Department Stores LLC ("Century 21"), entered into a lease agreement (the "Lease") as tenant with Lincoln Triangle Commercial Holding Co. LLC ("Lincoln") for nonresidential real property located near Lincoln Center in New York City. Century 21 acted as guarantor under the Lease. C21's obligations under the Lease were also secured by a letter of credit ("LC") posted by C21 but funded by Century 21. 

On September 10, 2020, Century 21 and certain affiliates—excluding C21 (collectively, the "debtors")—filed for chapter 11 protection in the Southern District of New York. Shortly afterward, the debtors filed a motion to reject the Lease as well as many other executory contracts and unexpired leases under section 365 of the Bankruptcy Code. Lincoln objected to rejection of the Lease. It argued that C21 did not have the power to reject the Lease because it was not a debtor in bankruptcy. The debtors responded by removing the Lease from the list of leases and contracts to be rejected.

On October 9, 2020—prior to the expiration of the stated term of the Lease—C21 breached the lease by vacating the property and delivering the keys to Lincoln. It also stopped paying rent under the Lease.

Lincoln delivered a written notice to C21 that it refused to accept termination of the Lease. Lincoln then drew down the full amount of the LC (approximately $7.6 million) and held the proceeds as security. Thereafter, it applied those funds to satisfy C21's monthly rent and other Lease obligations.

In December 2020, Lincoln filed a proof of claim against Century 21, as guarantor, in the amount of approximately $44 million for estimated damages resulting from breach of the lease, including: (i) future rent; (ii) future real estate taxes, operating expense escalations, and utilities and repairs; and (iii) actual cleanup and repair expenses, and amounts required to discharge mechanic's liens. 

The bankruptcy court confirmed a liquidating chapter 11 plan for the debtors—thereafter known as Cortlandt Liquidating, LLC—on April 26, 2021. The court-appointed administrator of the debtors' liquidating chapter 11 plan (the "administrator") objected to the claims of various real property landlords with respect to Century 21 store locations, including Lincoln, for damages arising from the termination of their leases. The administrator argued that: (i) section 502(b)(6) capped Lincoln's claim for damages; (ii) Lincoln's damages should be calculated under the Time Approach, rather than the Rent Approach; (iii) the lease termination damages should include only items properly classified as "rent reserved" and should exclude certain maintenance and repair claims; (iv) the projected future "rent reserved" used to calculate Lincoln's claim should reflect reasonable assumptions based on historical data; and (v) the LC should be applied to reduce Lincoln's capped claim for damages.

In an interim order, the bankruptcy court ruled that section 502(b)(6) caps the claims of a landlord against a debtor-guarantor under a terminated lease. It also held that the Lease was "functionally dead" and concluded that "the Court need not reach the question of whether the Lease was terminated pursuant to New York law in order to conclude that, once the Lease was 'functionally dead,' it can be considered 'terminated' for purposes of section 502(b)(6)." In re Cortlandt Liquidating LLC, No. 20-12097 (SCC) (Bankr. S.D.N.Y. May 20, 2022) (Doc. No. 1261) p. 8. In so ruling, the bankruptcy court noted that "termination" is not defined in section 502(b)(6) (or elsewhere in the Bankruptcy Code), and that the term "has a slightly broader meaning than the same term of art under [New York] landlord-tenant law," which requires that both the landlord and the tenant have taken unambiguous actions indicating that they view the lease as having been terminated. 

In addition, the bankruptcy court found that "uncontroverted evidence" established that the LC was satisfied with estate assets under the debtors' liquidating chapter 11 plan and, therefore, that the amount of the LC should be deducted from Lincoln's claim for termination damages after application of the statutory cap. The bankruptcy court declined at that time to rule on the proper calculation of damages under the cap. Id. at p. 9. 

Subsequently, the bankruptcy court ruled in favor of the administrator on the question of the proper approach for calculating the statutory cap. The court wrote that it did not "lightly depart" from precedent to the contrary in Financial News, Andover and Rock & Republic, but that it was "convinced that the Time Approach represents the correct view." In re Cortlandt Liquidating LLC, 648 B.R. 137, 141 (Bankr. S.D.N.Y. 2023), aff'd, 2024 WL 1301429 (S.D.N.Y. Mar. 26, 2024).

"First and most importantly," the bankruptcy court explained, the plain language of section 502(b)(6) "makes clear that the Time Approach is the correct one" because the entire phrase "for the greater of one year, or 15 percent, not to exceed three years, of the remaining term of such lease" is "worded in periods of time" rather than the dollar amount of rent. If lawmakers had intended the Rent Approach to apply, the court noted, section 502(b)(6) "would have stated that the allowable rejection damages would not exceed '15 percent of the rent reserved for the remaining term of such lease, provided that such amount will not be less than the rent reserved for the next year of the lease term, and shall not be more than the rent reserved for the next three years of the lease term.'" Id. According to the bankruptcy court, those are not the words of section 502(b)(6) "and they cannot reasonably be derived from the language that does appear." Id.

Next, the bankruptcy court explained that the Time Approach is supported by the legislative history of section 502(b)(6), which indicates that, in enacting the provision in 1978 (then designated as section 502(b)(7)), lawmakers did not clearly express the intention to change from the Time Approach employed in cases under the former Bankruptcy Act to a "total rent"-based formula. Id. at 142–43 (citing Filene's, 2015 WL 1806347, at *6; In re Connectix Corp., 372 B.R. 488, 493–94 (Bankr. N.D. Cal. 2007)). 

The bankruptcy court disagreed with courts that have ruled that: (i) considerations of equity or fairness favor the Rent Approach over the Time Approach; and (ii) the former better implements lawmakers' intent or the purposes of section 502(b)(6). According to the judge, the plain intent of section 502(b)(6) was to limit landlords' claims and to "strike a balance between the interests of landlords and the interests of other creditors." However, it emphasized,"[i]dentifying that general intent is of no help in deciding whether Congress intended that the Rent Approach or the Time Approach would be used." Id. at 143. The bankruptcy court further noted that considerations of fairness and equity are not instructive in determining which approach should be employed.

The bankruptcy court accordingly ruled that, in accordance with the Time Approach, the section 502(b)(6) cap with respect to the landlords should be "calculated by reference to the rents reserved under the relevant leases for the first 15 percent of the remaining lease terms, provided, that such amounts shall not be less than the rents reserved for the first remaining year of the relevant lease terms, and shall not be greater than the rents reserved for the first three remaining years of the relevant lease terms." Id. at 144.

Finally, addressing the remaining disputes before it, the bankruptcy court held that: (i) because "the statutory cap applies only to damages that are attributable to the fact that the term of the lease has come to an end," the store cleanup costs incurred by Lincoln were subject to the cap because they arose from the termination of its lease; (ii) Lincoln's claim for mechanic's liens placed on the leased premises by unpaid contractors engaged by Century 21 was not subject to the cap because "any damages associated with mechanic's liens plainly would have existed regardless of whether the lease was terminated"; (iii) Lincoln's claim for repairs required under the terms of its lease did not arise from the termination of the lease and was not subject to the cap; and (iv) although real estate taxes and certain operating expenses were properly included in calculating the "rent reserved" under Lincoln's lease as well as the amount of the section 502(b)(6) cap, the absence of certain facts regarding projected future rent assumptions precluded the court from ruling on that issue.

Lincoln appealed the bankruptcy court's rulings to the district court.

The District Court's Ruling

The district court affirmed the bankruptcy court's rulings.

U.S. District Court Judge Mary Kay Vyskocil concluded that the section 502(b)(6) cap applies to a lessor's claim against a debtor-guarantor under a lease. She explained that "[b]y its terms, [section 502(b)(6)] does not explicitly address whether it applies with respect to a claim against a guarantor/debtor of a lease as opposed to a tenant/debtor." According to Judge Vyskocil, although the Second Circuit has not addressed the question, "by its terms, the statute simply does not distinguish among types of debtors." Cortlandt Liquidating, 658 B.R. at 250. 

The district court noted that, to achieve section 502(b)(6)'s goal of overcompensating lessors at the expense of other general unsecured creditors, the provision "speaks not to a particular debtor entity, but rather to the amount of damages recoverable from the estate." Id. (citing In re Episode USA, Inc., 202 B.R. 691, 695 (Bankr. S.D.N.Y. 1996)). For this reason, Judge Vyskocil wrote, "[t]he overwhelming majority of courts that have considered the issue have found" that the statutory cap applies to lease termination claims against debtor-guarantors. Id. at 252.

Next, the district court agreed with the bankruptcy court that the Lease was terminated for purposes of section 502(b)(6). Judge Vyskocil found no error in the bankruptcy court's conclusion that the term "termination" has a broader definition under the provision that it does under New York law, and that the Lease was "functionally dead" after the debtors intentionally abandoned the premises to the landlord, "similar to rejection." Id. She also agreed with the bankruptcy court's reasoning that "it would be antithetical to the purpose of Section 502(b)(6) to allow a landlord to avoid application of the damages cap by seizing on a technicality in state law to refuse to accept a surrender of the premises after the lessee has intentionally abandoned the premises." Id. at 253. 

The district court did not fault the bankruptcy court's conclusion that the section 502(b)(6) cap should be calculated under the Time Approach. Judge Vyskocil acknowledged that "[c]ourts throughout the country uniformly recognize the two competing approaches." She also noted that the bankruptcy court and the parties acknowledged that "there is a clear divide in district court opinions on the proper approach to the 'Cap.'" Id. at 254. 

According to Judge Vyskocil, the bankruptcy court did not lightly depart from prior Southern District of New York precedent in ruling that the Time Approach was the correct one to calculate the statutory cap, but decided to do so in part because, in the 12 years since the last district court in the Southern District of New York addressed the issue in Rock & Republic Enterprises, "the weight of the relevant authorities throughout the country has shifted very strongly in favor of the Time Approach." Id. at 255. Guided by that authority, the district court wrote, the bankruptcy court "conducted [its] own, independent analysis of Section 502(b)(6)'s statutory language and legislative history, and ultimately came to the well-reasoned decision that the Time Approach was the correct interpretation of Section 502(b)(6)." Id. The district court found no error with the bankruptcy court's reasoning or its conclusion.

Similarly, for the reasons articulated by the bankruptcy court, the district court ruled that the bankruptcy court correctly held that the proceeds of the LC should be applied to reduce Lincoln's claim, as capped by section 502(b)(6), and that store cleanup costs were subject to the damages cap. 

Outlook

In Cortlandt Liquidating, the district court adopted the majority position regarding both the application of the statutory cap on lease termination claims to claims against debtor-lease guarantors and the calculation of the cap in accordance with the Time Approach—the latter departing from long-standing precedent that the court viewed as outdated. 

Key takeaways from the decision include:

• Section 502(b)(6) does not on its face distinguish between debtor-lessees and debtor-lease guarantors in limiting a lessor's claims for damages arising from the termination of a real property lease.
• The definition of "termination" in section 502(b)(6) may be broader than the meaning of the term under applicable state landlord-tenant law.
• Parties to real property leases should know which approach has historically been employed by the courts in a district where the debtor-tenant or guarantor files (or is likely to file) for bankruptcy.
• While bankruptcy and appellate courts sometimes disagree on the proper approach, the Time Approach is trending as the appropriate way to calculate the statutory cap. In light of that, historical practice in the jurisdiction may not guarantee future outcomes.

Read the full Business Restructuring Review here.