Delaware Bankruptcy Court Adopts the "Time" Approach to Lease Rejection Damages

Background
Filene’s Basement, LLC, Syms Corp., and certain of their affiliates (collectively, the debtors) filed for bankruptcy protection on November 2, 2011. As of the petition date, the debtors owned and operated 46 “off price” retail clothing stores across the country. Many of the stores were located in commercial properties leased by one of the debtors.

The debtors rejected all of their real property leases as a part of their restructuring, giving rise to numerous claims by landlords for rejection damages. Section 502(b)(6) of the Bankruptcy Code caps landlords’ rejection damages claims by providing that a court shall allow such claim in the amount determined by the court, “except to the extent that . . . such claim exceeds—(A) the rent reserved by such lease, without acceleration, for the greater of one year, or 15%, not to exceed three years, of the remaining term of such lease. . . .” 11 U.S.C. § 502(b)(6).

The Split in Case Law Interpreting Section 502(b)(6)
Seizing on a purported ambiguity in section 502(b)(6) and a split in the case law interpreting that section, landlords in Filene’s took various approaches to calculating their “capped” rejection damages claims. Many landlords took the position that the reference to 15 percent in section 502(b)(6) was a measure of the remaining rent under the lease and calculated their capped rejection damages as 15 percent of the total rent reserved remaining for the duration of the lease (the “rent” approach). The rent approach is generally favored by landlords because it often results in a greater capped claim, especially where the lease contains an escalation clause. The debtors contested the rent approach and argued that “15%” in section 502(b)(6) was a reference to the remaining term of the lease. The debtors calculated the capped rejection damages claims by determining the amount of time that constituted 15 percent of the remaining term of the lease and allowing the rent reserved under the lease for that period of time (the “time” approach).

Both the rent approach and time approach have support in case law. Compare In re Heller Ehrman LLP, 2011 WL 635224, at *4 (N.D. Cal. Feb. 11, 2011) (holding that section 502(b)(6) requires the “time” approach), In re Blatstein, 1997 WL 560119, at *14–15 (E.D. Pa. Aug. 26, 1997) (finding that “the 15% applies to ‘time’ remaining [on the lease]”), In re Shane Co., 464 B.R. 32, 39 (Bankr. D. Colo. 2012) (“Fifteen percent of the remaining term of the lease is plainly a reference to an amount of time not money.” (emphasis in original)), In re Connectix Corp., 372 B.R. 488, 491–93 (Bankr. N.D. Cal. 2007) (applying the 15 percent calculation to the time remaining on the lease), In re Ace Elec. Acquisition, LLC, 342 B.R. 831, 833 (Bankr. M.D. Fla. 2005) (“The 15 percent limitation of 11 U.S.C. 502(b)(6) speaks in terms of time, not in terms of rent. . . .”), In re Peters, 2004 WL 1291125, at *6 n.20 (Bankr. E.D. Pa. 2004) (following the decision in Iron-Oak), In re Allegheny Int’l, 136 B.R. 396, 402–3 (Bankr. W.D. Pa. 1991) (finding that the 15 percent cap applied to “the next succeeding term remaining on the lease”), aff’d, 145 B.R. 823, 827–28 (W.D. Pa. 1992), and In re Iron-Oak Supply Corp., 169 B.R. 414, 420 (Bankr. E.D. Cal. 1994) (“The correct interpretation, however, is that the Congress intended that the phrase ‘remaining term’ be a measure of time, not rent.”), with New Valley Corp. v. Corp. Prop. Assocs. (In re New Valley Corp.), 2000 WL 1251858, at *11–12 (D.N.J. Aug. 31, 2000) (finding that the 15 percent cap applies to remaining rent due), In re Andover Togs, Inc., 231 B.R. 521, 545–46 (same), In re Today’s Woman of Fla., Inc., 195 B.R. 506, 507–8 (Bankr. M.D. Fla. 1996) (same), In re Gantos, Inc., 176 B.R. 793, 795–96 (Bankr. W.D. Mich. 1995) (same), In re Fin. News Network, Inc., 149 B.R. 348, 351 (Bankr. S.D.N.Y. 1993) (same), and In re Communicall Central, Inc., 106 B.R. 540, 544 (Bankr. N.D. Ill. 1989) (same).

Although some cases refer to the rent approach as the “majority” view, see, e.g., Connectix Corp., 372 B.R. at 491, the debtors argued that the plain language of section 502(b)(6) and the statute’s legislative history and policy support the time approach. In addition, the debtors noted that deeming the rent approach a “majority” view was misleading, as there was approximately an even split among courts adopting the “rent” approach and the “time” approach.

The Court’s Opinion in Filene’s
Following briefing and oral argument on the question of the proper interpretation of section 502(b)(6) as it applied to the claim filed by Connecticut/DeSales LLC, Judge Carey issued an opinion agreeing with the debtors that section 502(b)(6) requires application of the time approach. As an initial matter, the court refuted the notion that a “majority” view existed, stating that “a review of the case law reveals that courts appear to be evenly split. There is no clear majority of decisions favoring either the ‘rent’ approach or the ‘time’ approach.” In re Filene’s Basement, 2015 Bankr. LEXIS 1350, at *10 n.9.

Moreover, Judge Carey found that the text of section 502(b)(6) unambiguously supported the time approach. Id. at *11–14. Citing Third Circuit precedent explaining that “‘a provision is ambiguous when, despite a studied examination of the statutory context, the natural reading of a provision remains elusive,’” Judge Carey found that the natural reading of section 502(b)(6) supported the time approach for several reasons. Id. at *11 (quoting Price v. Del. State Police Fed. Credit Union (In re Price), 370 F.3d 362, 369 (3d Cir. 2004)). First, as a structural matter, when comparing the greater or lesser of two things (i.e., “one year” or “15%”), the measurements must be parallel—that is, time versus time. Id. (quoting Heller Ehrman LLP, 2011 WL 635224, at *2–3). Second, the court noted that “‘the phrase “term of a lease” commonly refers to the length of a lease based on time rather than rent.’” Id. at *12–13 (quoting Heller Ehrman LLP, 2011 WL 635224, at *2–3). Third, “‘the statute is generally written in terms of time: the calculation of the cap begins following the earlier of two dates, the date of petition or repossession, [and] the maximum cap is worded in terms of time, three years.’” Id. at *13 (quoting Heller Ehrman LLP, 2011 WL 635224, at *2–3). Further, the court reasoned that section 502(b)(6)’s command to calculate rent reserved “without acceleration” supports the time approach because the rent approach would render that phrase superfluous. Id. at *14. Indeed, ‘“[t]aking 15 percent of all the rent for the remaining term, especially where escalation clauses are present, would be tantamount to effecting an acceleration.’” Id. (quoting Iron-Oak Supply Corp., 169 B.R. at 420). For these reasons, the court found that section 502(b)(6) unambiguously supported the time approach and, for that reason, “there is no need to employ other tools of statutory construction.” Id.

In addition to finding that section 502(b)(6) unambiguously supports the time approach, the court explained that the legislative history and policy of section 502(b)(6) offer further support for the time approach. Prior to 1934, landlords were precluded from recovering any future rent because such claims were considered contingent and not capable of proof. Id. at *14–15; see Connectix Corp., 372 B.R. at 491; see also Oldden v. Tonto Realty Corp., 143 F.2d 916, 918 (2d Cir. 1944) (explaining that “[t]he Bankruptcy Act of 1898 as originally enacted was silent as to the provability of claims for rent to accrue in the future. The courts, however, were virtually unanimous in deciding that rent destined to accrue after the filing of a petition was not capable of proof”; collecting cases). Following the 1938 amendments, the Bankruptcy Act provided that a landlord could recover future rent but limited the claims to “the year next succeeding” the date of surrender or reentry, whichever occurred first, in a liquidation case, or “the three years next succeeding” surrender or reentry in a reorganization case. In re Filene’s Basement, 2015 Bankr. LEXIS 1350, at *15; see Bankruptcy Act of 1938 (Chandler Act), ch. 575, 52 Stat. 840, 873, 894 (1938); see also 16 Collier on Bankruptcy ¶ 502.LH[3][a]. When Congress enacted the Bankruptcy Code in 1978, it maintained the limitations on landlord rejection damage claims from the Bankruptcy Act but used a percentage formula to replace the limitation on recovery of three years’ rent in rehabilitation cases. In re Filene’s Basement, 2015 Bankr. LEXIS 1350, at *15–16; see 11 U.S.C. § 502(b)(6)(A); Connectix, 372 B.R. at 492; H.R. Rep. No. 595 at 353. Nothing in the legislative history, however, indicates that Congress intended to depart from calculating the cap based on the rent that would become due within a time period immediately following a statutory trigger date. In re Filene’s Basement, 2015 LEXIS 1350, at *15–16; Heller Ehrman LLP, 2011 WL 635224, at *4–5; Connectix Corp., 372 B.R. at 493; Allegheny Int’l, 136 B.R. at 402–3. To the contrary, the House Report on section 502(b)(6) states that “[t]he damages a landlord may assert from termination of a lease are limited to the rent reserved for the greater of one year or [fifteen] percent of the remaining lease term, not to exceed three years.” In re Filene’s Basement, 2015 Bankr. LEXIS 1350, at *16; H.R. Rep. 95-595 at 353. As a consequence, Judge Carey agreed that “‘[b]ecause there is no clear expression of an intent to change from a time approach to a “total rent” based formula, it cannot be presumed that Congress intended to make that shift.’” In re Filene’s Basement, 2015 Bankr. LEXIS 1350, at *15–16 (quoting Connectix Corp., 372 B.R. at 493).

Further, with respect to the policy of section 502(b)(6), Judge Carey found that the time approach “‘better serves the economic forces Congress was trying to address when it enacted the landlord damage cap.’” Id. at *16–17 (quoting Connectix Corp., 372 B.R. at 494). Specifically, Judge Carey noted that “‘landlords, unlike other general unsecured creditors, have added protection at the termination of a lease arrangement. Landlords get their property back.’” Id. at *17 (quoting Connectix Corp., 372 B.R. at 494). The court rejected the reasoning of other courts that the rent approach is more equitable because it allows landlords to recover damages based on rent increases the parties bargained for when they entered into the lease. Id. at *16–17 (citing Gantos, Inc., 176 B.R. at 795–96; New Valley, 2000 WL 1251858, at *11–12).

The Importance of the Filene’s Decision
As noted above, the Filene’s decision is the first written decision in the District of Delaware interpreting section 502(b)(6)’s “time” versus “rent” question. Especially in light of the recent trend of retail bankruptcy filings, the decision may provide a significant benefit to debtors seeking to invoke section 502(b)(6) to cap landlords’ rejection damages, as the time approach generally results in lower claim amounts than the rent approach. The decision also adds to the growing number of courts that have adopted the time approach.

Keywords: bankruptcy and insolvency litigation, section 502(b)(6); time versus rent, lease rejection, rejection damages