In Re Foamex International, Inc.

Citations: 368 B.R. 383; 2007 Bankr. LEXIS 1694; 48 Bankr. Ct. Dec. (CRR) 83; 2007 WL 1461954Docket: 19-50108

Court: United States Bankruptcy Court, D. Delaware; May 16, 2007; Us Bankruptcy; United States Bankruptcy Court

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Debtors Foamex International Inc. and related entities filed a Supplemental Objection to the claim of Gungor M. Solmaz and Diane M. Solmaz, proposing a reduction of their claim from $793,872.51 to $24,472.51 under Section 502(b)(6) of the Bankruptcy Code. The Claimants contested this reduction, arguing that the limitation does not apply to part of their claim. The Court, presided by Bankruptcy Judge Kevin Gross, granted the Objection in part, with the final claim amount to be determined after further discovery and a hearing.

The Debtors, leading manufacturers of flexible polyurethane and advanced polymer foam products, filed for Chapter 11 on September 19, 2005. An Official Committee of Unsecured Creditors was appointed shortly thereafter. They filed their Original Plan of Reorganization on December 23, 2005, followed by a Second Amended Disclosure Statement and Joint Plan on November 27, 2006, which was confirmed on February 1, 2007. The Second Plan allows for full payment of all allowed claims and retention of ownership interests by shareholders, barring any dilution from a rights offering.

Jurisdiction is established under 28 U.S.C. 1334 and 157(b)(1), categorizing the case as a core proceeding. The factual background includes two leases entered into on April 13, 1995, for nonresidential property in Newton, North Carolina, with ten-year terms extended thereafter. The Debtors terminated these leases effective September 30, 2005, following a notice sent on April 29, 2005, and a subsequent court order granted on October 18, 2005.

Leases impose specific maintenance and repair obligations on both Lessee and Lessor. Under Article 7.1, the Lessee is responsible for maintaining the Demised Premises and making all necessary repairs—both interior and exterior, structural and nonstructural—at its own expense, which includes mechanical, electrical, and other fixtures. Article 7.2 limits the Lessor's obligations to repairs exceeding $5,000, and mandates the Lessor to address any violations of Governmental Laws related to the property’s condition at their expense. 

Claimants, as Lessors, filed a proof of claim on December 1, 2005, for an unsecured amount of $793,872.51, broken down into unpaid rent ($13,477.58), unpaid taxes ($10,994.93), and $769,400.00 related to alleged repair obligations detailed in engineering reports. The Debtors objected to this claim, seeking to reduce it significantly and requesting a cap under Section 502(b)(6) limiting it to no more than one year’s rent. The initial objection was sustained but later vacated due to a service issue. The Court is currently tasked with deciding whether to apply the statutory cap to the Claim, which includes repair costs. The key facts are largely undisputed, leaving only the legal question of the claim's limitation to be resolved.

The legislative history highlights the key differences between Section 502(b)(6) of the Bankruptcy Code and its predecessor, Section 63(a)(9) of the Bankruptcy Act, particularly the omission of a specific phrase in the Code that limits a landlord’s damage recovery. Section 63(a)(9) allowed landlord claims for damages due to lease rejection to be capped at the rent for the year following the lease's termination, plus any unpaid rent accrued. Claimants argue that this omission signifies Congressional intent to exclude certain covenants, like repair and maintenance, from damage caps. In contrast, Debtors assert that the cap applies to all damages arising from lease termination, regardless of type. They reference case law, notably *Kuske v. McSheridan*, which supports the position that lease rejection constitutes a breach of all covenants, thereby triggering the cap. The Bankruptcy Appellate Panel in *McSheridan* concluded that all damages from the breach of lease covenants are subject to the Section 502(b)(6) cap, emphasizing that Congressional intent was to compute damages within the limits of the former statute. Additionally, the *Mr. Gatti's* case reinforced that allowing uncapped damages would disrupt established bankruptcy law.

The court referenced legislative history to clarify that Paragraph (7) of current law limits the damages a landlord can claim from a debtor, ensuring that such claims do not hinder recovery for other unsecured creditors. This provision, rooted in Oldden v. Tonto Realty Corp., is intended to provide landlords compensation without allowing excessive claims based on long-term leases. The legislative history indicates that Section 502(b)(6) derives from the prior Section 63(a)(9) of the Bankruptcy Act, with no indication of a change in intent by Congress in this area. In New Valley Corp., the court affirmed that maintenance provisions are included in the limitations on landlord recoveries under Section 502(b)(6), drawing from precedents like McSheridan and Mr. Gatti's. 

Additionally, the Debtors cited First Bank National Association v. Federal Deposit Insurance Corporation, a non-bankruptcy case that addressed damages tied to a disaffirmed lease under FIRREA. The Third Circuit's decision in First Bank used Section 502(b)(6) to interpret applicable FIRREA provisions, noting that FIRREA's framework mirrors the Bankruptcy Code. The case involved FBNA leasing property to Meritor Savings Bank, which, upon entering receivership, failed to fulfill lease obligations. FIRREA stipulates that if a lease is disaffirmed by the receiver, the receiver is generally not liable for damages beyond specific provisions regarding rent claims, which include conditions under which the lessor can claim unpaid rent and the limitations on damages.

FBNA contended that repair and upgrade costs were distinct from lease termination, thus recoverable. However, the Third Circuit ruled that FIRREA Section 1821(e)(4) limits all damages and cited McSheridan, asserting that breaches of covenants are considered termination damages. Debtors argued that this limitation includes maintenance and repair covenants, suggesting that any claimed damages for breaches of these obligations should be capped under Section 502(b)(6). 

Conversely, Claimants argued that Section 502(b)(6) does not apply because their claims for maintenance, repair, taxes, and rent obligations arose before lease termination. They maintained that such damages are independent of the termination and should not be subject to the cap. Claimants referenced case law, including In re Bob's Sea Ray Boats and In re Atlantic Container Corp., which allowed claims for damages unrelated to lease termination. They emphasized that the legislative intent of Section 502(b)(6) was to compensate landlords for actual losses upon lease termination while limiting speculative future damages. 

Claimants criticized the McSheridan decision, citing In re Best Products, which rejected McSheridan's reasoning and argued that the legislative history of Section 502(b)(6) does not support its restrictive application. The Best Products court concluded that Congress's intent was to allow landlords to receive limited compensation for actual damages rather than speculative future claims. Overall, Claimants contended that their claims for pre-termination breaches should be allowed in full, independent of the termination cap.

Landlords' claims for damages related to maintenance and repairs do not fall under the cap imposed by Section 502(b)(6)(A) of the Bankruptcy Code, as these damages are not considered to arise from the termination of a lease. In the case of Atlantic Container, the court examined whether pre-petition claims for property damage and maintenance expenses should be classified as "future rent" or "lease termination damages." The chapter 7 trustee contended that such damages stemmed from lease termination, which Congress intended to limit under Section 502(b)(6). However, the court clarified that damages resulting from lease termination are limited to those the lessor would have avoided if the lease had not been terminated. Damages related to maintenance and repairs incurred due to the debtor's failure to uphold lease covenants were deemed unrelated to lease termination.

Additionally, the court confirmed that the obligations for repair and maintenance do not constitute "rent reserved" under Section 502(b)(6). Citing the McSheridan test, the court found that the maintenance and repair damages do not meet the criteria to be classified as rent. Specifically, these obligations are not labeled as "rent" in the lease, relate to the use of the premises rather than the property's value, and do not represent fixed, regular, or periodic charges. Thus, the court concluded that the maintenance and repair claims are not subject to the statutory cap as they do not qualify as rent under Section 502(b)(6).

Repair and maintenance charges are not classified as 'rent reserved' under the McSheridan framework because they do not constitute a fixed, regular, or periodic charge. Instead, these obligations are episodic and require prompt performance as issues arise, contrasting with regular charges like common area maintenance. The court determined that only one of the necessary factors for defining an obligation as rent is present in this case.

Following this determination, the impact of lease rejection on these obligations must be considered. Under Section 365(d)(3), the Trustee is required to perform under the lease until it is assumed or rejected. Rejection constitutes a breach of the lease according to Section 365(g), and Section 502(g) allows claims arising from that rejection as prepetition claims. Section 502(b)(6) limits a lessor's claims for damages upon lease termination, applying a statutory cap to any damages from nonperformance of lease obligations. 

The distinction between past obligations and damages due to termination is misapplied, as all damages from nonperformance fall under the statute. Courts generally agree that even if rejection isn't equated with termination, claims must still be limited under Section 502(b)(6). The McSheridan court upheld the bankruptcy court's decision to cap the landlord's damage claim, reinforcing that non-rental charges in a Triple-Net lease must meet a three-part test to qualify as 'rent reserved.' The court emphasized that the rejection of the lease results in a breach of all provisions, including covenants, and that lessors are entitled to a single claim limited by Section 502(b)(6). The reasoning in McSheridan has gained support from subsequent decisions, including one from the Third Circuit.

The single, capped claim applies to all time intervals regarding lease breaches and associated damages, encompassing both prepetition and postpetition issues. The Ninth Circuit Bankruptcy Appellate Panel (BAP) supported its decision on two main points: first, that this interpretation discharges the debtor from future liability related to the lease and provides a more certain remedy for a limited amount, replacing an inefficient old remedy; second, it analyzed legislative history and relevant sections of the bankruptcy code (Sections 365(d)(3), 365(g), 502(g), and 502(b)(6)) as a cohesive framework to justify the ruling. Consequently, it was determined that Section 502(b)(6)(A) covers damages from breaches of all lease covenants upon lease termination. 

The Court concluded that the Claimants' damages related to Debtors' maintenance and repair obligations are subject to a statutory cap. Section 502(b)(6) aims to limit excessive future damage claims by landlords on long-term leases, protecting the bankruptcy estate's value for other creditors. Therefore, the Court partially upheld the Debtors' Supplemental Objection to the Claim of Gungor M. Solmaz and Diana M. Solmaz, allowing an unsecured claim of $13,477.58 for unpaid rent and $10,994.93 for unpaid taxes. An evidentiary hearing will be held to assess whether the Claimants are entitled to additional claims for damages related to repair and maintenance, adhering to the lease terms and the statutory cap under 11 U.S.C. 502(b)(6). An appropriate order will follow this decision.

This Memorandum Opinion presents findings of fact and conclusions of law under Federal Bankruptcy Procedure rules. It addresses the applicability of Section 502(b)(6) of the Bankruptcy Code concerning claims by lessors for damages resulting from lease terminations. The Leases in question are identical, focusing on the interpretation of a $5,000 cap on repairs, which remains unresolved and will be addressed later. Currently, the Court is set to decide the legal issue regarding the Section 502(b)(6) cap, with an evidentiary hearing scheduled for July 18, 2007, to determine alleged damages related to repair and maintenance provisions. 

The opinion notes a distinction in terminology between the Bankruptcy Act and Section 502(b)(6), specifically the use of "rejection" versus "termination." Section 502(b) outlines that claims must be determined in lawful currency, with specific caps for lessor claims tied to unpaid rent and lease term limits. The Court emphasizes its responsibility to independently assess what constitutes "rent reserved," as labels can be misleading. It references case law, including McSheridan, which suggests that costs of repair may be considered additional rent if they are regular and fixed. The Court acknowledges that applying this reasoning broadly could undermine the cap intended by Section 502(b)(6)(A). Lastly, the opinion aligns with the rationale found in prior cases, suggesting support from the Third Circuit regarding the interpretation of these damages.