/>iThe number of corporate bankruptcy filings has increased significantly over the past several years. In 2024, there were 688 chapter 11 filings by private companies with either assets or liabilities greater than $2 million or public companies with assets or liabilities greater than $10 million—the highest number of such chapter 11 filings in 15 years. 2025 has already seen the highest total of such filings for the first half of the year since 2010 with 371 total filings—with 127 filings in May and June.[1]
In these cases, it is not unusual for companies to use the bankruptcy process to “reject” unwanted leases to lessen corporate footprints and improve liquidity. As a result, landlords often find themselves in a dispute with a debtor-tenant over the resulting damages from such rejection. With the increasing number of corporate bankruptcies, and the resulting impact on landlords, this article offers an overview of considerations landlords should contemplate when they are notified that their leases have been rejected in bankruptcy.
The Power to Reject
The Bankruptcy Code empowers a debtor-tenant to “reject” an unexpired lease. Rejection is considered a breach, not a termination, of the lease, but the effect is that the debtor-tenant vacates and surrenders the leased premises. As a result of the rejection, a landlord is entitled to assert a claim against the debtor-tenant for rejection damages. The claim, however, is treated as a general unsecured claim, which means landlords will only receive payment after a debtor-tenant’s secured claims, administrative claims, and priority unsecured claims are paid in full—and even then payment will be a pro rata distribution with all other general unsecured claims. Moreover, even if a lease contains provisions detailing how damages are to be calculated, a landlord’s allowed claim for rejection damages is capped by the Bankruptcy Code.
The Rejection Damages Cap
Under Section 502(b)(6) of the Bankruptcy Code, a landlord’s damages claim from a debtor-tenant’s lease rejection is limited to the greater of gross rent due for (i) one year or (ii) 15% of the remaining lease term as of the bankruptcy filing (not to exceed three years).[2] In interpreting Section 502(b)(6), courts have included rent-like obligations, including taxes, insurance, and common area maintenance, in the calculation of the capped claim.[3] While simple in theory, this statute has been the source of significant controversy regarding (i) the mechanics of the calculation, (ii) whether certain landlord claims are subject to the cap, and (iii) the impact of security deposits and letters of credit.
Rent Approach v. Time Approach
Since its inception, there has been debate as to whether the “15% percent” in Section 502(b)(6) refers to 15% of the rent due over the course of the remaining lease term (the “Rent Approach”) or to the rent due for 15% of the remaining lease term (the “Time Approach”). Whether the Rent Approach or the Time Approach applies can significantly impact a landlord’s recovery.
For example, assume “Debtor-Tenant” files for bankruptcy at a time when it has 10 years remaining under its lease with “Landlord” with the following rent schedule:
- Years 1-3 – $500,000/year ($1,500,000 total)
- Years 4-7 – $750,000/year ($3,000,000 total)
- Years 8-10 – $1,000,000/year ($3,000,000 total)
Under the Rent Approach, Section 502(b)(6) would cap Landlord’s claim at $1,125,000 (15% of $7,500,000, i.e. the remaining rent due under the lease). Under the Time Approach, Landlord’s claim is capped at $750,000 (rent due for 15% of the remaining term, i.e. 1.5 years).
While many courts have adopted the Rent Approach, there has been a recent shift favoring the Time Approach. Indeed, in In re Cortlandt Liquidating LLC, 658 B.R. 244, 254-55 (S.D.N.Y. 2024), the Southern District of New York turned away from its prior support of the Rent Approach, noting that “the weight of the relevant authorities throughout the country has shifted very strongly in favor of the Time Approach.”
Claim Types
Section 502(b)(6) caps only those damages “resulting from the termination of a lease.” A claim that exists irrespective of whether the debtor-tenant rejects the lease, therefore, is not subject to Section 502(b)(6). In the Ninth Circuit, courts have adopted a “simple test” to determine whether damages result from the rejection of a lease – “[A]ssuming all other conditions remain constant, would the landlord have the same claim against the tenant if the tenant were to assume the lease rather than rejecting it?”[4] Thus, for example, unpaid rent owing under a lease prior to rejection will not be subject to the cap under Section 502(b)(6).
Security Deposits and Letters of Credit
In the event a landlord holds a security deposit, a debtor-tenant can request that the landlord’s allowed claim under Section 502(b)(6) be reduced by the amount of the security deposit—and that any amount exceeding the cap be turned over to the debtor-tenant.
In the example above, if Landlord held a $1,000,000 security deposit, and the court applied the Rent Approach that capped its claim at $1,125,000, Landlord’s claim would be reduced to $125,000. If, however, the court applied the Time Approach and the claim was capped at $750,000, Landlord would be required to return $250,000 of the security deposit to Debtor-Tenant.
Landlords have attempted to avoid this outcome by requiring letters of credit in place of typical security deposits. However, while letters of credit are not generally considered assets of a debtor-tenant estate, courts have nevertheless found that letters of credit are intended to serve as a security deposit where, for example, the letter of credit is described in the “Security Deposit” provision of a lease.[5]
A letter of credit, however, may still offer some protection against the application of Section 502(b)(6) provided it is not treated as a security deposit. A landlord wishing to hold a letter of credit, therefore, should ensure that the lease contains clear language that the letter of credit is not intended to constitute a security deposit.
Conclusion
The use of Section 502(b)(6) to cap a landlord’s claim resulting from the rejection of a lease is a powerful tool available to debtor-tenants. As more companies seek to use the Bankruptcy Code as a means of “righting the ship,” landlords can expect that debtor-tenants will use the Bankruptcy Code to reject leases and cap the resulting damages. The application of Section 502(b)(6), however, can be complicated and requires careful analysis of the underlying lease, the landlord-tenant relationship, and the laws of the applicable jurisdiction.
[2] See 11 U.S.C. § 502(b)(6)(A), which states in relevant part, “the court . . . shall allow such claim in such amount, except to the extent that if such claim is the claim of a lessor for damages resulting from the termination of a lease of real property, such claim exceeds 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 the lease . . . .”
[3] See, e.g., In re Fifth Ave. Jewelers, Inc., 203 B.R. 372, 381 (Bankr. W.D. Pa. 1996); In re Andover Togs, Inc., 231 B.R. 521, 541-42 (Bankr. S.D.N.Y. 1999); In re Denali Family Servs., 506 B.R. 73, 80 (Bankr. D. Alaska 2014).
[4] In re El Toro Materials Co., Inc., 504 F.3d 978, 981 (9th Cir. 2007).
[5] See, e.g., In re Stonebridge Techs., Inc., 291 B.R. 63 (Bankr. N.D. Tex. 2003) (where the lease defined “security deposit” to include the letter of credit at issue, the court ruled that the letter of credit constituted part of the security deposit subject to section 502(b)(6)); In re PPI Enter. (U.S.), Inc., 324 F.3d 197 (3d Cir. 2003) (finding the parties intended their letter of credit to serve as a security deposit and affirming the bankruptcy court’s decision to reduce the landlord’s damages claim by the letter of credit); In re Connectix Corp., 372 B.R. 488 (Bankr. N.D. Cal. 2007) (applying draws on a letter of credit against the landlord’s capped claim).
