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Capping of Denial of Lease Claims Under the Bankruptcy Code and its Detrimental Effect on Commercial Landlords

When a tenant files for bankruptcy, the commercial landlord is faced with the often worrying prospect that their unexpired lease may be thrown out in bankruptcy proceedings. A tenant’s right to refuse a lease, and therefore disavow future lease obligations, does not exist outside of bankruptcy and often plays an important role in their decision to file for bankruptcy. During the period when the debtor tenant determines whether or not to assume a non-residential lease, the Bankruptcy Code obliges him to timely perform the obligations arising from the lease that arise after the start of bankruptcy proceedings, see 11 USC §365(d)(3)(A). However, this is not the case for lease obligations related to periods of time occurring after the rejection of a lease agreement. The Bankruptcy Code creates a fiction that the dismissal of a lease, although made after the petition, is an offense that occurred immediately before the filing of the bankruptcy petition. See 11 USC §365(g)(1).

Accordingly, if an unexpired commercial lease of real estate is rejected, the landlord will only have a pre-pre-claim unsecured claim to assert in bankruptcy for damages resulting from such rejection and , like other pre-demand unsecured creditors, with the inherent uncertainty of recovering its claim. However, unlike most other unsecured creditors, a business owner is also subject to a limitation on the amount of their claim under section 502(b)(6) of the Bankruptcy Code, even before they reach the stage of recovering their debt. This provision disallows amounts claimed by landlords for damages resulting from the termination of a real property lease that exceed the “rent reserved by such lease, without acceleration, for the greater of one year, or 15%, without exceeding three years, of the remaining term of this lease, whichever comes first: [the petition date and the date the landlord repossessed, or the tenant surrendered, the premises]» plus unpaid rent due under this lease, without forfeiture, to that prior date. See 11 USC §502(b)(6). The formula has proven to be something of a puzzle with courts and commentators delving into, among other things, what constitutes rent for these purposes, as well as how the 15% is calculated.