July 26, 2021
By: Christopher M. Candon and Jaclyn N. Fisher
For businesses of all sizes, the cost associated with its office or retail space is a significant expense. This reality may be even more accentuated for small businesses that are tied to long-term lease obligations, resulting in the landlord being one of the largest and/or most influential creditors of the business. For the past 16 months, the COVID-19 pandemic has challenged businesses and landlords in navigating never-before experienced economic pressures. Many businesses were forced to shut their doors, unable to meet ongoing rent and other obligations, while others managed to get by and, with respect to rent obligations, negotiated lease modifications to provide some temporary relief. But now as stimulus funds are no longer as readily available, businesses may be faced with mounting pressure to pay postponed rent obligations while staying current on existing monthly rent and all other business obligations. If this burden is too much, businesses may be forced to consider bankruptcy in order to restructure debt and/or reject burdensome leases.
To properly evaluate a bankruptcy filing (or the threat of a tenant bankruptcy filing), both the business tenant and landlord need to understand how the Bankruptcy Code will treat a landlord’s claim resulting from the termination of a lease of real property. Absent such understanding, any pre-bankruptcy negotiations may not be productive.
Under Section 502(b)(6) of the Bankruptcy Code, claims for damages resulting from the termination of a lease (i.e., lease rejection claims) may not exceed the amount of “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….” Not surprisingly, the courts have struggled in applying this formula, largely settling on two approaches – the rent and time approaches.
The Rent and Time Approaches
Courts that have adopted the rent approach permit the landlord to compute the total amount of rent due for the remainder of the lease term and multiply that amount by 15 percent. This results in a capped claim for damages at a maximum of 15 percent of the total rent due for the remainder of the lease term. Although not universally applied, some courts hold that if the 15 percent amount exceeds the total amount of rent due under the lease for the next three years, the three-year amount would be the capped claim. In the alternative time approach, courts view the 15 percent marker as a measure of time remaining under the lease term. In other words, the damages claim would be capped at the amount of rent due for the first 15 percent of the time remaining under the lease, such time period not to exceed three years.
In practical application, the mechanism for calculating the landlord’s capped claim for damages can be summarized as follows:
- Establish the “start date,” which is the earlier of (i) the date the bankruptcy case commenced, or (ii) the date on which the premises were repossessed by the landlord or surrendered by the tenant (herein, the “Cap Commencement Date”).