Daily Development for Tuesday, January 4, 2005
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
BANKRUPTCY; LEASES; DAMAGES: Bankruptcy cap on lease damages also caps claims by bankrupt lessee’s assignor, whether or not claims arise under lease or under indemnification agreement or as a consequence of assignor’s separate lease obligations, triggered by bankrupt’s termination of lease.
In re Regal Cinemas, Inc. 2004 Westlaw 2952728 (6th Cir. 12/22/04)
Capitol was a tenant for ten movie theaters. It sold the theaters and assigned the leases to Regal. In the assignment agreement, Capitol specifically guaranteed Regal’s performance, but as the court notes, Capitol was liable for the performance of the leases anyway because it was the original tenant.
Regal went bankrupt and terminated its lease payments on one of the theaters. Apparently the theater could not be relet and there were potentially substantial damages - in excess of $6 million. The landlord filed a claim in bankruptcy for the total amount of its damages as “capped” by the provisions of 11 USC Sec. 502(b)(6), which limits landlord’s claims against tenants in bankruptcy for “damages resulting from the termination of a lease of real property” to: “(A) 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--i) the date of the filing of the petition; and(ii) the date on which such lessor repossessed, or the lessee surrendered, the leased property; plus (B) any unpaid rent due under such lease, without acceleration, on the earlier of such dates.” The capped amount was $860,000.
Capitol also filed a claim in the bankruptcy court for contingent liabilities in excess of $5 million, representing liabilities to which it was exposed as a consequence of Regal’s failure to perform the lease.
The bankruptcy court rejected Capitol’s claim in its entirety, invoking 502(e)(1), which provides as follows:
“ Notwithstanding subsections (a), (b), and (c) of this section and paragraph (2) of this subsection, the court shall disallow any claim for reimbursement or contribution of an entity that is liable with the debtor on or has secured the claim of a creditor, to the extent that--
(A) such creditor's claim against the estate is
(B) such claim for reimbursement or contribution is contingent as of the time of allowance or disallowance of such claim for reimbursement or contribution; or
(C) such entity asserts a right of subrogation to the rights of such creditor under section 509 of this title.”
Capitol appealed, urging the notion that at least some of the contingent claims that it was asserting were not claims disallowed under 502(b)(6) because they were not rent claims, but other items, such as payment of real estate taxes, attorney’s fees, and maintenance costs. The appeals court rejected this argument, indicating that the broad language of 502(b)(6) capped all claims arising as a consequence of the termination of the lease. Although the “cap” was determined by reference to the amount of rent, this does not mean that only rent claims are capped.
Further, the court noted that in any event the other disjunctive sections of 502(e)(1) would bar Capitol’s claim anyway. These claims were either subrogation claims that Capitol had a right to make as a surety or they were contingent reimbursement or contribution claims. The court rejected Capitol’s argument that the claims arose under separate contractual provisions - the assignment agreement. As they arose only in the context of Capitol’s liability as original lessee/assignor or as guarantor of the lease, which liability occurred solely as a consequence of Regal’s termination of the lease, they necessarily were “reimbursement or contribution claims” and it did Capitol no good to style them as separate contract claims. “The language of the provision is broad enough to encompass any type of liability shared with the debtor, whatever its basis, including claims based on a contractual relationship."
Comment: The result here is not surprising, and is consistent with the analysis contained in other cases reported on DIRT dealing with caps on claims where guarantors are present.
But it nevertheless represents an object lesson to parties who are engaged in assignment of leases, especially leases, such as theater leases, involving premises that may be hard to relet if the operating tenant cannot make a profit on the location and goes bankrupt.
What might the assignor have done? If possible, it might have obtained personal guarantees or other security in assets not owned by Regal to protect its claims against Regal should Regal go bankrupt. Or it might have tried to “buy out” of the contingent obligations with the landlord in some way, such as offering security for some of the contingent obligations and obtaining releases for the rest. It is difficult however, to offer landlords sufficient incentives in such cases to induce them to give up their claims against a solvent surety.
Another approach, of course, is for Capitol to now become aggressive in assisting the landlord in mitigating the damages claim. Particularly in a “no duty to mitigate” jurisdiction, it might find itself actually paying out all those millions over time. Even if the landlord has a duty to mitigate, as noted, many theater buildings are “purpose built” with many yards of concrete under the seats, and it is very difficult to lease to anyone but another theater. Changes in technology and markets can often make even a relatively new theater building obsolete or unmarketable.
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