Landlord Alert: Limitation On Strategic Bankruptcy Filings By 'Healthy' Companies To Cap Long Term Lease Obligations

Summary

Under Section 502(b)(6) of the Bankruptcy Code, Chapter 11 debtors have a very powerful statutory tool to limit a landlord's recovery under a long term real property lease when the lease is rejected in bankruptcy. Generally, under Bankruptcy Code Section 502(b)(6), a landlord's claim for damages resulting from the termination of a real property lease will be limited to the obligations due under the lease for the greater of (i) one year or (ii) fifteen percent, not to exceed three years, of the remaining term of the lease, plus amounts due under the lease on the earlier of the bankruptcy filing date or the date the property was surrendered. However, two recent judicial decisions, one by the Third Circuit Court of Appeals and the other by a California bankruptcy court, clarify that a lessee may be denied the ability to remain a Chapter 11 debtor when it is solvent and files for bankruptcy relief as a strategic maneuver solely to reject a lease and limit a landlord's lease recovery. Knowledge of this evolving caselaw may impact your ability to protect your rights in certain situations.

In re Integrated Telecom Express

At the time of its Chapter 11 bankruptcy filing on October 9, 2002, Integrated Telecom Express, a supplier of software and equipment to the broadband communications industry, had sufficient cash to pay all creditors in full and had ceased all operations. Prior to that time, while in the process of liquidating its assets, Integrated was unable to negotiate an agreement with its landlord to reduce Integrated's remaining obligations under its long-term real property lease to $8 million instead of $26 million. Thereafter, Integrated filed for Chapter 11 relief in the United States Bankruptcy Court, District of Delaware. The landlord filed a motion to dismiss Integrated's Chapter 11 case as a bad faith bankruptcy filing on the grounds that the sole reason for the filing was to use the limits imposed by Bankruptcy Code Section 502(b)(6) of the Bankruptcy Code to cap the landlord's approximately $26 million rent claim at $4.3 million.

The Delaware bankruptcy court denied the landlord's motion to dismiss the bankruptcy case, citing Integrated's "dramatic" financial losses and noting that Integrated offered a number of reasons for the bankruptcy filing. The denial of the motion was upheld by the U.S. District Court. On further appeal, the Third Circuit Court of Appeals overruled the District Court in In re Integrated Telecom...