In In re East Penn Children’s Learning Academy, (Bankr. E.D. Pa. Dec. 3, 2020), the U.S. Bankruptcy Court for the Eastern District of Pennsylvania made clear that Section 502(b)(6) of the Bankruptcy Code provides a statutory limitation—rather than a formula for the calculation—of a  landlord’s actual damages in the event of its tenant’s breach.

Background

East Penn Children’s Learning Academy is a daycare business that filed a Chapter 11, subchapter V bankruptcy petition on Dec. 4, 2020.

Before filing for bankruptcy, East Penn entered into a lease agreement with Robshe Enterprises, LLC. The term of this lease commenced on Sept. 1, 2017, and was set to expire on Aug. 31, 2022. Notably, the lease agreement did not contain an acceleration clause.

On Nov. 6, 2020, just before East Penn’s bankruptcy filing, Robshe obtained a judgment against East Penn in the amount of $40,100 plus 6% interest for unpaid rent. Some months after East Penn’s bankruptcy filing, in April 2021, the court approved Robshe’s post-petition administrative claim in the amount of $12,320 for rental payments owed by East Penn for the months of January 2021 through April 2021. At the same time, the court granted East Penn’s motion to reject its lease with Robshe, and it entered an order requiring East Penn to vacate the leased premises by May 31, 2021, (a subsequent order extended that date to June 30, 2021). About a week later, the bankruptcy court approved Robshe’s post-petition administrative claim for rent from Dec. 4, 2020 (the date of East Penn’s bankruptcy filing) through Dec. 31, 2020.

East Penn vacated the leased premises in accordance with the bankruptcy court’s order.

Robshe filed a third claim against East Penn pursuant to which it sought approval of the sum of $77,725.86 in damages: $43,725.86 for unpaid pre-petition rent and $34,000 in post-petition rental payments through December 2021. East Penn conceded that the pre-petition rental amount of $43,725.86 had been properly calculated and remained owing. East Penn also acknowledged that a portion of the remaining $34,000 claim—$12,320, representing rent due for the period January through April 2021—had already been approved by the court. Its only dispute with Robshe, then, was in connection with Robshe’s claim for approximately $23,000 in rent from May through December 2021, i.e., rental payments purportedly coming due after the date that its lease with Robshe was rejected.

The Court’s Analysis

Robshe based its claim for post-rejection rent on Section 502(b)(6) of the Bankruptcy Code, which is aimed at allowing landlords a “reasonable” amount of damages for lost rent, while preventing landlords’ claims for accelerated rent from eclipsing the claims of other creditors in the bankruptcy case. In general terms, Section 502(b)(6) limits a landlord’s actual claim, as of a date certain, to: the total rent due and unpaid as of that date; plus the greater of: one year’s worth of lease payments, and 15% of the rental due for the balance of the lease term (which is further limited by the statute to three years). Robshe urged that, calculating its damages under Section 502(b)(6), its claim should be allowed in full.

The court began its analysis with a statement that its ruling on East Penn’s objection would hinge on “an understanding of the less than clear rent cap provision outlined in Section 502(b)(6).” Noting that Section 502(b)(6) does not have any impact on the landlord’s actual claim, the court clarified instead that this section allows the parties to determine, for bankruptcy purposes, the allowed amount of that claim. In effect, the court explained that Section 502(b)(6) was never intended to be a method for calculating a landlord’s damages; instead, it was intended to provide the calculation of an amount that would “cap” those damages once they were appropriately calculated under the applicable lease agreement.

The court’s explanation of the intent of Section 502’s framers necessitated a two-step analysis: first, a calculation of Robshe’s actual damages under the lease with East Penn; and second, a 502(b)(6) calculation of the potential “cap” on those damages. Viewed in this light, Robshe’s actual lease damages would be reduced only to the extent they exceeded the Section 502(b)(6) “cap” calculation.  On the other hand, should the Section 502(b)(6) calculation exceed Robshe’s actual lease damages, Robshe would be entitled to no more than its actual damages.

Step One: Robshe’s Actual Damages

The absence of an acceleration provision in the lease proved to be fatal to Robshe’s claim for any rent accruing after East Penn surrendered occupancy of the leased premises. Under Pennsylvania law, if a lease does not contain an acceleration provision, the landlord is only entitled to recover for periodic rental payments as they come due under the lease.  After the landlord retakes possession, it has no claim for future rents.

In this matter, therefore, once East Penn rejected the lease and surrendered the premises as of June 2021, the court was able to calculate Robshe’s actual damages: unpaid prepetition rent in the amount of $43,725.86, plus rent from Dec. 4, 2020, (the date of East Penn’s bankruptcy) through Dec. 31, 2020, in the amount of $2,438.71, plus post-petition rent due from Jan. 1, 2021, through the surrender date of June 30, 2021, (minus two months’ rent already paid by East Penn during this period) in the amount of $12,320, for a grand total of $58,484.57.

Step Two: The Section 502(b)(6) Cap on Robshe’s Actual Damages

The court next calculated the Section 502(b)(6) limitation that might be imposed on Robshe’s actual damages: unpaid prepetition rent in the amount of $43,725.86, plus one year’s rent allowed under the statute in the amount of $33,900, for a grand total of $77,625.86.

Having found that Robshe’s actual lease damages were lower than the damage cap, the court concluded that Section 502(b)(6) did not impact Robshe’s actual damages, and allowed Robshe’s claim in the amount of $58,484.57.

Conclusion

The bankruptcy court crystallized its analysis with the following conclusion: “The conflation of a Bankruptcy Code damages cap and a state law damages calculation leads Robshe to assert that it is entitled to more than would be allowed under the terms of the negotiated lease. Yet the rent cap is not meant as such a gift to landlords.”

Aside from providing insightful analysis of the workings of code Section 502(b)(6), the court’s decision in East Penn provides a simple and obvious lesson for landlords: ensure that your leases contain enforceable default and acceleration provisions. These provisions can be beneficial even after your tenant files for bankruptcy protection, in that your damage calculation will more likely than not be capped by Section 502(b)(6). In such a case, you will find some consolation in knowing that the amount of your claim is as high as it is statutorily permitted to be.

Rudolph J. Di Massa, Jr., a partner at Duane Morris, is a member of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditors’ rights.

Diane J. Kim, an associate with the firm, practices in the area of business reorganization and financial restructuring. Prior to joining the firm. Kim served as judicial law clerk for the U.S. Bankruptcy Court for the District of Delaware.

Reprinted with permission from The Legal Intelligencer, © ALM Media Properties LLC. All rights reserved.