Recent SDNY Bankruptcy Court Opinion Lowers Cap On Commercial Real Estate Lease Rejection Damages

• Published date: 02 May 2023
• Subject Matter: Real Estate and Construction, Insolvency/Bankruptcy/Re-structuring, Insolvency/Bankruptcy, Real Estate
• Law Firm: Morrison & Foerster LLP
• Author: Mr Mark S. Edelstein, Theresa A. Foudy and Martha E. Martir

In a departure from prior precedent in the United States Bankruptcy Court for the Southern District of New York (SDNY), a recent opinion by Judge Michael E. Wiles in In re Cortlandt Liquidating LLC,¹ effectively lowered the Bankruptcy Code section 502(b)(6) cap on rejection damages that a commercial real estate landlord may claim, by holding that the cap should be calculated using the "Time Approach," rather than the "Rent Approach."

Calculation of Lease Rejection Damages

When a debtor-tenant rejects a real property lease of "non-residential real property" (e.g., a ground lease or a space lease), section 502(b)(6) of the Bankruptcy Code provides for a statutory "cap" on the amount of a landlord's unsecured rejection damages claim in an amount equal to:

1. 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'
   1. the date of the filing of the petition; and
   2. the date on which such lessor repossessed, or the lessee surrendered, the leased property; plus
2. any unpaid rent due under such lease, without acceleration, on the earlier of such dates.

11 U.S.C. ' 502(b)(6) (emphasis added).², ³ This "damage cap" is, in essence, social policy enacted by Congress to prevent commercial lease rejection damage claims from dwarfing all other unsecured claims and has been codified in the Bankruptcy Code since 1934. See In re Connectix Corp., 372 B.R. 488, 491-92 (Bankr. N.D. Cal. 2007) (citing Oldden v. Tonto Realty Corp., 143 F.2d 916, 918 (2d Cir. 1944)).

Courts are divided on how to interpret "fifteen percent, not to exceed three years, of the remaining term of such lease" in section 502(b)(6)(A).

• A majority of courts have adopted the "Time Approach," wherein the lease rejection damages are capped at the rent that is specified for the first 15% of the remaining lease term, so long as that time period is at least one year and no more than three years.
• A minority of courts, which had included SDNY, have adopted the "Rent Approach," wherein lease rejection damages are capped at 15% of the total dollar amount of the rent that would be payable for the entire remaining term of the lease, so long as that amount is at least equal to the rent reserved for the next one year and does not exceed the rent reserved for the next three years of the lease term.

Because rents under a commercial real estate lease generally escalate over time, the "Rent...