Affirming Bankruptcy Judge Michael E. Wiles across the board, District Judge Mary Kay Vyskocil of New York laid down a set of rules interpreting Section 502(b)(6)(A) to minimize the claims of lessors of commercial real estate.

The chapter 11 debtor was an owner of department stores. A nondebtor affiliate leased real property. The debtor guaranteed the lease and provided a $7.6 million letter of credit to secure the guarantee. After filing, the affiliate vacated the premises and turned the keys over to the landlord.

The landlord refused to accept termination of the lease but drew down the letter of credit. As the months passed, the landlord applied the proceeds to the rent as it was coming due. The landlord filed a $44.4 million proof of claim on the guarantee, to which the debtor objected.

In his decision in February 2023, Bankruptcy Judges Wiles made several important rulings in favor of the debtor. Among other things, Judge Wiles held that the so-called “time approach” is applied to reduce a landlord’s claims under the cap contained in Section 502(b)(6)(A). In re Cortlandt Liquidating LLC, 648 B.R. 137 (Bankr. S.D.N.Y. Feb. 2, 2023). To read ABI’s report, click here.

The landlord appealed but lost on every issue decided by Judge Vyskocil in her March 26 opinion. Judge Vyskocil was a bankruptcy judge in New York from 2016 until her elevation to the district court in late 2019.

The Cap Applies to Lease Guarantors

Most of the issues on appeal turned on the interpretation of Section 502(b)(6)(A). The subsection limits a claim “for damages resulting from the termination of a lease of real property” 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; . . . .” [Emphasis added.]

The landlord argued that Section 502(b)(6)(A) did not apply because it was not making a claim against a lessee but, rather, against a guarantor. Judge Vyskocil conceded that “the statute 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.” [Emphasis in original.]

To decide whether the cap applied to a guarantor of a lease, Judge Vyskocil noted how “the goal behind the statutory damages cap is to compensate a lessor for his damages, while at the same time ensuring that the landlord’s claim is not permitted to be so large that other general unsecured creditors are unable to get recovery from the estate.”

Siding with the “overwhelming majority of courts,” Judge Vyskocil held that “the Section 502(b)(6) Cap applies to a lease guarantor.”

The Lease Was Terminated, to Make Section 502(b)(6)(A) Applicable

The landlord submitted that the cap was not applicable because the cap applies to a “termination of a lease,” and the lease had not terminated under state law.

Judge Vyskocil said there was “no case law” defining the word “termination” as used in Section 502(b)(6). She found no clear error in the bankruptcy court’s finding that the lease was “functionally dead” when the affiliate vacated.

With no binding precedent, Judge Vyskocil held the cap applicable, because “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.”

The ‘Time’ Approach or the ‘Rent’ Approach?

For a claim on a long-term lease, Bankruptcy Judge Wiles ruled that the so-called time approach applies to the calculation of a lessor’s claim. The time approach counts the greater of 15% or three years of rent due after the filing of the petition. The rent approach takes rent escalations into account by computing the greater of 15% or three years of rent over the duration of the lease.

Judge Vyskocil said there was a “clear divide” among district courts in deciding which approach to apply. She cited Collier and other treatises for now adopting the time approach. Saying that Bankruptcy Judge Wiles had written a “well-reasoned decision,” she upheld the time approach in view of the “plain language” of the statute, which “speaks in terms of time and not dollar amounts.”

The LC Reduced the Claim

The landlord argued that the drawdown of the letter of credit should not reduce the claim, after application of the cap.

Judge Vyskocil upheld the bankruptcy court’s finding of “uncontroverted evidence” that the letter of credit had been “satisfied” with estate assets under the chapter 11 plan. If the drawdown did not reduce the claim, she said that a holding to that effect “would lead to duplicate claims against the Debtors from [the landlord] and [the bank that issued the letter of credit].”

Judge Vyskocil held “that the Letter of Credit should be deducted from [the landlord’s] Claim after the Section 502(b)(6) calculation is complete.”

Cleanup Charges Are Subject to the Cap

Part of the landlord’s claim involved cleanup charges after the affiliate vacated. The bankruptcy court made cleanup costs subject to the cap.

Judge Vyskocil explained how Bankruptcy Judge Wiles followed Saddleback Valley Cmty. Church v. El Toro Materials Co. (In re El Toro Materials Co.), 504 F.3d 978 (9th Cir. 2007), where the Ninth Circuit asked whether the landlord would have the same claim had the lease been assumed.

“Finding no controlling case law to the contrary and finding other Southern District of New York cases that have similarly applied the El Toro test,” Judge Vyskocil saw “no error in the Bankruptcy Court’s application of the El Toro test to determine whether certain damages arose ‘from the termination’ of a Lease.”

Because the cleanup costs arose from the termination of the lease, Judge Vyskocil held that the costs were subject to the cap.