8th Circ. Decision clarifies bankruptcy rent ceiling guidelines – Insolvency / Bankruptcy / Restructuring

Only a few bankruptcy practitioners are unaware of Article 502 (b) (6) of the Bankruptcy Code.1

Waves of retail bankruptcies over the past few decades have ensured that this is the case, and the general application of Section 502 (b) (6) limitations on the allocation of owner claims against property assets. bankruptcy is generally uncontroversial.

Less familiar, especially in bankruptcy cases, is the effect of Section 502 (b) (6) on the underlying claim balance of the owner’s substantive right for breach or termination of a lease once that it is reduced by the application of section 502 (b). the cap of (6).

Simple questions, such as whether the balance of the state law claim is viable against other entities outside of the bankruptcy, or if the owner is also bound outside the bankruptcy by the limitations imposed by section 502 (b) (6), are seldom addressed in the bankruptcy case itself – because the discussion of the owner’s claim in bankruptcy usually ends after the application of section 502 (b) (6).

Yet the answers to these important questions, especially those of a circuit court, are very informative and provide practitioners with the information necessary to properly advise their debtor / tenant clients.

In Lariat Cos. Inc. v. Wigley,2 the United States Court of Appeals for the Eighth Circuitaddressed these important questions in one of those unusual cases which dealt with the viability of an owner’s state right claim balance after the application of section 502 (b) (6) in the context a bankruptcy case.3

Wigley’s court, in addition to the issues mentioned above, was faced with a rather unusual argument – namely that the application of Section 502 (b) (6) and the satisfaction of the authorized and capped claim of the owner by a bankruptcy estate, may serve as a defense to an action for discharge brought against the debtor under section 523.4

But first, in order to come to its conclusion, and its rejection of an unusual defense, the Eighth Circuit also provided practitioners with a simple and convincing explanation as to the effect of Section 502 (b) (6) on the state law claim generally; and on the continued viability of the remainder of the state law claim.5

Section 502 (b) (6)

Section 502 (b) (6), as well as its predecessors under the Bankruptcy Code and the Bankruptcy Act,6 were designed to balance the need to compensate homeowners for their losses while simultaneously preventing the same claims from being so large as to prevent other creditors from obtaining meaningful recoveries of a bankrupt estate.seven

Section 502 (b) (6) achieves this balance by limiting the authorized amount of such a claim to the rent reserved for the greater of one year or 15% of the remaining term of the lease, not to exceed three years, depending on the earlier of the request or delivery or possession.8

By providing claimants, debtors and the courts with a clear line – even if this always leads to calculation disputes – bankruptcy courts do not have to struggle and can dismiss claims based solely on fair principles or other principles that are difficult to pin down. .

Rather than guessing when and for how much a landlord can re-let their premises in four years, bankruptcy courts are able to use a formula to determine the appropriate amount of a landlord’s authorized claim against an estate.9

An objection under Section 502 (b) (6) does not attack the merits of the underlying claim in state law. Rather, it seeks to limit the amount of state legal action that can be admitted and collected against a bankruptcy estate.ten The distinction is important.

If a bankruptcy court supports a substantive objection to the merits of a landlord’s state law claim – such as an objection based on breach of the terms of the lease prior to the landlord’s bankruptcy – that decision will have probably an exclusive effect on the whole of the state right claim inside and outside bankruptcy.11

In contrast, an objection based strictly on Section 502 (b) (6), even when supported, should not have an exclusive effect on the balance of the claim under state law. It is on this latter concept that the Eighth Circuit relied when it held that Section 502 (b) (6) is not a viable defense against a request for discharge under the article 523.

Bankruptcy cases

Barbara Wigley’s bankruptcy saga began in February 2014, almost three years before she filed her voluntary Chapter 11 petition, when her husband Michael Wigley filed his own Chapter 11 petition.12

Michael Wigley’s bankruptcy was precipitated by the entry of two important judgments against him.13 The first judgment of over $ 2 million was due to his personal guarantee of a commercial lease to Lariat Cos. Inc.14

The second judgment of $ 780,000 concerned the assets he had transferred to his wife, before she filed for bankruptcy protection, while he was sued as security for a commercial lease, and this judgment expressly concluded that the transfers had been made with the real intention of hindering, delaying and defrauding creditors.15

After Michael Wigley went bankrupt, Lariat filed his claim for $ 2 million plus state law against the estate, which claim was ultimately limited to $ 637,581.07 after the Section 502 limit was applied. (b) (6).16 Lariat’s capped and authorized claim was later satisfied during Michael Wigley’s bankruptcy.17

Barbara Wigley then attempted to overturn the fraudulent transfer judgment against her, based on the theory that satisfying the capped claim in her husband’s bankruptcy case meant she was off the hook – but a Minnesota state court dismissed that petition – prompting it to quickly file its own Chapter 11 petition.18

Lariat then filed its state law claim in the Barbara Wigley bankruptcy case, which claim still exceeded $ 1 million and consisted of the fraudulent transfer judgment and the applicable post-judgment interest.19 Again, because the state law claim of Lariat ultimately arose out of the breach of a lease, Section 502 (b) (6) limited the amount of state law claim allowed. of Lariat against the debtor’s estate at $ 330,886.87, which claim was also satisfied in his bankruptcy.20

But Lariat was not made there.

She also filed an application for discharge against the debtor in the United States Bankruptcy Court for the District of Minnesota, seeking to maintain the balance of the state law claim that was dismissed under section 502 (b) (6) as not releasable under section 523 (a) (2) ( A) as debt obtained by actual fraud.21

The bankruptcy court agreed with Lariat that the balance of the debt under state law was non-dischargeable as debt obtained by fraud, and the debtor appealed.22

On appeal, the debtor argued that the bankruptcy court’s rejection of its defense under section 502 (b) (6) was an error in law, as it was an inappropriate circumvention of the boundaries of the Section 502 (b) (6) cap, while allowing the owner to have an extra-large claim in direct contradiction to the mandate of Section 502 (b) (6).23

The Eighth Circuit disagreed, finding that the application of Article 502 (b) (6) and the subsequent satisfaction of the claim authorized under Article 502 (b) (6) does not constitute not a defense to an action to declare the unauthorized part of the state the law claims to be unreliable.24

As noted above, the Eighth Circuit first explained why and how the Lariat State law claim was viable and could still be invoked against the debtor despite the application of Section 502 (b). (6).25 Specifically, the Eighth Circuit said:

the [state law] the claim is for the total available [claim] under substantive law relating to non-bankruptcy. On the other hand, the [502(b)(6)] the ceiling simply defines the part of the substantial claim that will be “authorized” to be paid by the bankruptcy estate and imposes the “disallowance” of the excess. Taken together, the claim and the ceiling result in the claim “permitted” or “admissible”.26

The Eighth Circuit then declared that the balance of an owner’s state law claim, which had been dismissed against the bankruptcy estate solely on the basis of the bankruptcy principles set out in Section 502 (b) ( 6), even after the satisfaction of the claim authorized under section 502 (b) (6), is not a defense which prevents the remainder of a claim under the law of the State d ” be exempt from discharge under section 523.27

Conclusion

What is most unusual about the Wigley decision is the debtor’s unique, albeit unsuccessful, attempt to use subsection 502 (b) (6) as a defense against an exoneration action.

And to its credit, the Eighth Circuit did not let the unusualness of the argument distract it from the well-established and less new principles that dictated its decision.

Specifically, the Eighth Circuit explained that Section 502 (b) (6) is an objection based solely on the principles of bankruptcy and does not affect the underlying merits of the claim. Accordingly, the answer to the important question of whether Section 502 (b) (6) provides a defense to an action in discharge, under the Eighth Circuit, is “no”.

Footnotes

1.11 USC § 502 (b) (6).

2. About Wigley (Lariat Companies. Inc. v. Barbara A Wigley), 15 F.4th 1208 (8th Cir. 2021).

3. Id.

4. Id. 11 USC § 523.

5. Wigley, 15 F.4e 1208.

6. § 502 (b) (7) was renamed § 502 (b) (6) by the Bankruptcy Amendment and Federal Judgeship Act of 1984 (Pub. L. No. 98-353, 98 Stat. 333 effective on July 10, 1984). See also § 63 (a) (9) of the Bankruptcy Act.

seven. In re Heller Ehrman LLP , 2011 WL 635224, * 4 (NDCal. 2011).

8. 11 USC § 502 (b) (6).

9. “Historically, the limitation of eligible landlord claims was based on two considerations. First, the landlord’s damages in the event of a breach of a land lease were contingent and difficult to prove.” 1 Necklace Pamphlet Edition 2020 (Richard Levin & Henry J. Somme rouge., Mattew Bender), page 339.

10. Wigley at 1212.

11. Id.

12. Id., At 1210.

13. Id.

14. Id.

15. Id.

16. Id.

17. Id, at 1210-1211.

18. Id., At 1211.

19. Id.

20. Id.

21. Id.

22. Id.

23. Id.

24. Id.

25. Id., At 1211-1212.

26. Id., At the end. 3.

27. Id.

Originally posted by Law360

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