April 14, 2008 Case Update Below:
On October 1, 2007, the United States Court of Appeals for the Ninth Circuit issued a decision significantly improving a landlord's ability to recover claims in bankruptcy cases. See Saddleback Valley Community Church v. El Toro Materials Company, Inc. (In re El Toro Materials Company, Inc.), 504 F.3d. 978 (9th Cir. Oct. 1, 2007). Under the Bankruptcy Code, a landlord's claim for "damages resulting from the termination of a lease of real property" is limited to rent for "the greater of one year, or 15 percent, not to exceed three years, of the remaining term of such lease," plus any rent that was owed when the bankruptcy case was filed. See section 502(b)(6) of the Bankruptcy Code. Certain courts previously interpreted this statutory cap to limit virtually all types of claims that a landlord would be able to assert in a bankruptcy case, whether or not the claims were based on lost future rent. The Ninth Circuit disagreed.
In the El Toro Materials case, the debtor (a mining company) rejected its land lease. When the debtor vacated the premises, it left behind approximately one million tons of wet clay "goo" -- byproducts from its sandwashing operations -- as well as mining equipment and other debris. The landlord brought a lawsuit against the debtor, claiming $23 million in damages for the cost of removing the mess, under theories of waste, nuisance, trespass, and breach of contract.
On the debtor's motion for summary judgment, the bankruptcy court found that the landlord's recovery on its tort claims was not limited by the statutory cap. On appeal, the Bankruptcy Appellate Panel ("BAP") reversed, holding that all of the landlord's damages would be capped. The BAP reached this conclusion because it considered itself bound by its precedent in the case of Kuske v. McSheridan (In re McSheridan), 184 B.R. 91 (B.A.P. 9th Cir. 1995).
The landlord appealed to the Ninth Circuit, which reversed the BAP decision, stating "to the extent that McSheridan holds section 502(b)(6) to be a limit on tort claims other than those based on lost rent, rent-like payments, or other damages directly arising from a tenant's failure to complete a lease term, it is overruled." The Ninth Circuit thus held that the landlord’s clean-up expenses are not limited by the statutory cap on damages and can be allowed as a separate and additional claim in the bankruptcy case.
The debtor and the chapter 11 trustee then filed a petition for writ of certiorari to the Supreme Court of the United States, which the landlord opposed. On April 14, 2008, the Supreme Court entered an order denying the petition, thus solidifying the landlords’ victory.
This decision is a big win for landlords. The Ninth Circuit presented the outcome in terms of general principles of bankruptcy law, so the case is likely to have a substantial ongoing impact. Following the El Toro Materials case, landlords may have capped rent claims, but their claims for tort and contract claims unrelated to lost rent, rent-like payments, or other damages directly arising from a tenant's failure to complete a lease term, will be uncapped.
Rutan & Tucker, LLP partners Robert C. Braun and Roger F. Friedman represented Saddleback Valley Community Church in the appeal and the underlying litigation. They can be reached by telephone at (714) 641-5100.