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Our attorneys stay on top of changes in legislation, agency regulations, case law, and industry trends—then craft timely legal alerts to keep clients up to date on legal developments important to their business.

April 12, 2022

Feeling Rejected by the Cap? Lease Rejection Damages Explained

Tenants filing for bankruptcy protection generally have the ability to reject their real property leases. This is akin to a termination and allows tenants to avoid performing their future lease obligations. It leaves landlords with only “claims” against the tenant’s bankruptcy estate that may not have meaningful value. The power of rejection, which does not exist outside of bankruptcy, is an important tool for tenants and often the primary purpose of a retailer’s filing. This may be true regardless of whether the tenant intends to remain in business.

A landlord may file proofs of claim—official bankruptcy forms used by creditors to assert amounts owed—for rent they’re owed under a real property lease with the bankruptcy court. Specifically, landlords are entitled to a claim for damages resulting from the rejection of a lease. A claim like this, which is typically unsecuredi and therefore lower in priority than most other classes of claims, is artificially capped by the US Bankruptcy Code, a cap that has been in place since the code’s enactment. It’s important for landlords to understand this limitation, especially since COVID-19-related rent relief may be a thing of the past and could result in increased tenant bankruptcies. Under section 502(b)(6) of the US Bankruptcy Code, landlords’ rejection claims are capped at the rent for the greater of (i) one year or (ii) 15 percent of the remaining lease term (which cannot exceed three years). The calculation begins from the earlier of the date of the bankruptcy filing and when the landlord repossessed or the tenant surrendered the premises. Landlords are also entitled to a claim for any unpaid rent due under the lease on the earlier of these dates.

Bankruptcy courts have weighed in on various issues regarding the rejection damages calculation. For example, they have reached different conclusions on whether the 15 percent is a function of the remaining rent (calculated by dollars) or the remaining time (calculated by the term) under the lease. There have also been many decisions on what charges constitute “rent reserved,” which typically encompasses fixed, periodic, or regular charges that the lease defines as rent or additional rent, but may include other charges as well.

The rejection damages cap is a product of Congress’s intent to limit landlords’ claims to prevent them from receiving a windfall at the expense of other creditors. For instance, the rejected lease may have significant rent and term remaining following rejection, while a vendor in the case may hold a claim for specific product sold to the debtor before the filing. Both creditors may be sharing from the same cash available to pay their claims, and Congress felt the landlord, who may be able to mitigate at least some portion of its damages, would unduly benefit if its claim was not limited.

Barclay Damon’s Restructuring, Bankruptcy & Creditors’ Rights Practice Area issues alerts on an ongoing basis to keep clients and friends up to date on important developments in the insolvency space. If you have any questions regarding the content of this alert, please contact the authors, Kevin Newman, partner, at knewman@barclaydamon.com, or Scott Fleischer, counsel, at sfleischer@barclaydamon.com; Jeff Dove or Janice Grubin, co-chairs of the Restructuring, Bankruptcy & Creditors’ Rights Practice Area, at jdove@barclaydamon.com and jgrubin@barclaydamon.com, respectively; Robert Wonneberger, partner, at rwonneberger@barclaydamon.com; or Frank Heller, partner, at fheller@barclaydamon.com.

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