Having handed down an opaque, unpublished, non-precedential memorandum in October on an issue where the courts disagree, the Ninth Circuit responded to a request by one of the parties and issued a new opinion on Dec. 29, roughly four times longer than the original decision, holding that the cap on a lease claim under Section 506(b)(6) only applies to damages for future rent and related expenses, but nothing else.
The case involved a tenant that stopped paying rent before vacating the premises. Arbitrators awarded the landlord $1.3 million, representing unpaid past rent and future rent discounted to present value. The lease allowed the prevailing party to recover attorneys’ fees. The arbitrators therefore also awarded the landlord about $200,000 for attorneys’ fees and costs of the arbitration.
The tenant later filed a chapter 11 petition and objected to the landlord’s claim, relying on Section 506(b)(6), which caps “damages resulting from termination of a lease of real property.” The bankruptcy court applied the cap to limit the landlord’s claim for past and future rent but did not cap the claim for attorneys’ fees and arbitration fees. The district court affirmed on the first appeal.
In the Dec. 29 opinion on the second appeal, Circuit Judge Susan P. Graber reversed the lower courts, holding that Section 506(b)(6) “does not cap damages arising from every breach of contract.” Judge Graber said that the cap should not have been applied to past rent. On remand, she also told the lower courts to apportion attorneys’ fees and arbitration costs between claims that were covered by the cap and those that were not.
Judge Graber was bound by the Ninth Circuit’s 2007 El Toro opinion, which held that “damages other than those based on loss of future rental income are not subject to the cap.” El Toro did not address the question of capping claims for associated attorneys’ fees.
In her Dec. 29 opinion that is to be published, Judge Graber conceded that courts are divided on the applicability of the cap. “On one end of the spectrum,” she said, there are courts that interpret the cap “expansively, like a kind of subject matter cap on all lease-related claims.” The Ninth Circuit Bankruptcy Appellate Panel was in that camp until reversed by El Toro.
“At the other end of the spectrum,” Judge Graber cited a Virginia bankruptcy court as “narrowly” interpreting Section 506(b)(6) “to cap claims for future rent, but to exclude all other damages, thereby permitting collateral claims to be asserted in full.”
Taking what she called “the middle ground,” Judge Graber said that El Toro adopted a “simple test” asking whether the landlord would “‘have the same claim against the tenant if the tenant were to assume the lease rather than rejecting it.’”
In the context of pre-bankruptcy termination, Judge Graber followed the approach taken by the Eighth Circuit Bankruptcy Appellate Panel in its 2015 Wigley opinion, holding that unpaid past rent, common area maintenance, and late fees accruing prior to lease termination do not result from termination of the lease and are therefore not subject to the cap. The Eighth Circuit BAP applied the same test to apportioning attorneys’ fees.
Applying the Wigley test, Judge Graber held that attorneys’ fees attributable to the landlord’s claim for future rent would be capped, while fees related to past rent would not be capped because the landlord could assert a claim “independent of termination.”