In the United States Bankruptcy Court

for the Northern District of Iowa


ARMSTRONG'S, INC. Bankruptcy No. L-90-01908C
Debtors. Chapter 11
Claim No. 1518

Ruling Re: Kennedy Mall Co. Claim for Lease Termination Damages


This matter is before the Court on the objection of the debtor, Armstrong's, Inc. (the debtor) to the claim of Kennedy Mall Co. (Kennedy) for damages under 11 U.S.C. 502(b)(6)(1)

for the debtor's termination of its lease with Kennedy. This is a core proceeding pursuant to 28 U.S.C. 157(b)(2)(B). The following opinion limiting Kennedy's claim to $304,996.74 constitutes this Court's findings of fact, conclusions of law, and order pursuant to Fed.R.Bankr.P. 7052.

Findings of Fact

The facts in this case are not in dispute. On November 18, 1982, the debtor and Kennedy entered into a lease agreement (the lease) for space in the Kennedy Mall in Dubuque, Iowa, which the debtor used for running its retail department store. The parties agree that this lease constitutes a long-term lease under 502(b)(6). Kennedy was the lessor and the debtor was the lessee. On June 23, 1984, the parties executed an amendment to the lease (lease amendment). The lease amendment changed or supplemented a number of provisions in the lease.

On November 1, 1990, the debtor filed for relief under Chapter 11 of the Bankruptcy Code. The debtor continued to operate its business for a short time as a debtor-in-possession pursuant to 1107 and 1108 of the Bankruptcy Code. In doing so, the debtor continued to use the space it held under the lease with Kennedy. The debtor eventually ceased business and with the Court's approval rejected the lease pursuant to 365 effective January 31, 1991.

Kennedy filed its original proof of claim on January 3, 1991, requesting $526,232.82 for pre-petition charges and for damages resulting from breach of the lease and lease agreement. On March 11, 1991, after the lease and lease agreement were rejected, Kennedy filed proof of claim No. 1518 requesting $515,339.57. This proof of claim amended and replaced the proof of claim filed on January 3, 1991. Claim No. 1518 included Kennedy's claim for damages for rejection of the lease and lease agreement. Kennedy sought damages consisting of minimum rent, common area maintenance charges, and real estate taxes.

The debtor contends that only the amount of money attributable to the minimum rent and common area maintenance charges should be included in the 502(b)(6) computation of "rent reserved." The debtor contends that Kennedy's claim should be limited to $304,996.74 under the 502(b)(6) computation.

Conclusions of Law

The parties agree that 502(b)(6) governs this dispute. That section provides:

(b) Except as provided in subsections (e)(2), (f), (g), (h) and (i) of this section, if such objection to a claim is made, the court, after notice and a hearing, shall determine the amount of such claim in lawful currency of the United States as of the date of the filing of the petition, and shall allow such claim in such amount, except to the extent that-

(6) if such claim is the claim of a lessor for damages resulting from the termination of a lease of real property, such claim exceeds-

(A) 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 such lease, following the earlier of-

(i) the date of the filing of the petition; and (ii) the date on which such lessor repossessed, or the lessee surrendered, the leased property; plus

(B) any unpaid rent due under such lease without acceleration, on the earlier of such dates;

502(b)(6). The focus of this dispute is 502(b)(6)(A). The parties agree that the applicable damage limit will be 15% of the "rent reserved" under the lease for a period not to exceed 3 years.

Both the courts and the legislative history accompanying 502(b)(6) have noted its dual purpose of protecting landlords as well as general unsecured creditors. The court in In re Emple Knitting Mills, Inc., 123 B.R. 688, 690 (Bankr. D. Me. 1991) summarized this purpose as follows:

The obvious purpose of this provision of the Code is to provide the nondebtor contracting party with a breach of contract action for the rejection of an executory contract or unexpired lease. Both the case law and legislative history make clear that this remedy was provided to relieve the nondebtor party from the harshness associated with rejection. See, e.g., Oldden v. Tonto Realty Corp., 143 F.2d 916 (2d Cir. 1944); S.Rep. No. 989, 95th Cong. 2d Sess. 62-65 (1978), U.S. Code Cong. & Admin. News 1978, pp. 5787, 5848-5851; In re Picnic IN Chicken, Inc., 58 B.R. 523 (Bankr. S.D. Cal. 1986). "One of the primary purposes of the original statute allowing landlords' claims with some limitations was to help landlords, not hurt them. Prior to the 1934 amendments of the Bankruptcy Act of 1898, landlords had no provable claim for rent accruing after the trustee's rejection of a lease. The claim for future rent was not discharged and the landlord did not share in the distribution." In re Danrik, Ltd., 92 B.R. 964, 968-69 (Bankr. N.D. Ga. 1988). Previously, "the tenant's bankruptcy removed all his assets from the reach of the landlord and left, as the latter's only remedy, suits against an empty corporate shell or a destitute individual." Id. at 969 (citing Kuehner v. Irving Trust Co., 299 U.S. 445, 453, 57 S. Ct. 298, 302, 81 L.Ed. 340 (1937)). Thus, the legislature enacted various code provisions intended to "compensate the landlord for his loss while not permitting a claim so large (based on a long-term lease) as to prevent other general unsecured creditors from recovering a dividend from the estate." S.Rep. No. 989, 95th Cong.2d Sess 63 (1978), U.S. Code Cong. & Admin. News 1978, p. 5849.

See also In re First Alliance Corp., 126 B.R. 589, 591 (Bankr. S.D. Cal. 1991) (noting two-part purpose); In re Conston Corp., Inc., 130 B.R. 449, 452 (Bankr. E.D. Pa. 1991) (pointing out the same foundations for 502(b)(6)).

The courts have noted that " 502(b)(6) provides no formula for ascertaining the allowable damages for a lessor-" In re First Alliance Corp., 126 B.R. 589, 591 (Bankr. S.D. Cal. 1991); see also In re Goldblatt Bros., Inc., 66 B.R. 337, 345 (Bankr. N.D. Ill. 1986). Instead, the courts have found that 502(b)(6) requires courts to look to the damages allowable under state law and the contract between the parties, and if that amount exceeds what is allowable under 502(b)(6), then the court will limit the landlord's recovery to the limits under 502(b)(6). First Alliance Cor-P., 126 B.R. at 591; Goldblatt Bros., 66 B.R. at 346; see also In re Heck's. Inc., 123 B.R. 544, 546 (Bankr. S.D. W.Va. 1991) (noting the difference between elements included in the full damage calculation and the elements of damage which are allowable under 502(b)(6)); In re Storage Technology Corp., 77 B.R. 824, 825 (Bankr. D. Colo. 1987) (noting that full damages are calculated, then subjected to 502(b)(6)ls arbitrary cap measured by reserved rent). Hence, 502(b)(6) requires courts first to calculate the landlord's full damages resulting from the lease termination including all elements of damage and all principles of mitigation. Then, courts must determine if that damage figure exceeds the "rent reserved" for the applicable period under 502(b)(6). If the damages exceed the rent reserved, 502(b)(6) limits the allowable claim of the landlord to the "rent reserved" under the agreement for the applicable period.

Here, there is no dispute that the landlord's damages under the lease and state law exceed the maximum allowable under

502(b)(6), and that the allowable damages are limited to 15% of the rent reserved for a period not to exceed three years under the lease. The dispute centers on what elements of damage may be included in calculating the "rent reserved."

Kennedy argues that under 502(b)(6) it is entitled to recover 15% of the base rent, common area maintenance fees, and real estate tax payments for three years of the lease. Kennedy argues that all of these elements may appropriately be included in the "rent reserved" computation.

The debtor here agrees with Kennedy that the rent and common area expenses should be included in the 502(b)(6) analysis. However, the debtor believes that the real estate taxes should not be included. Hence, the dispute in this case boils down to whether real estate taxes should be included as "rent reserved" under 502(b)(6). A number of cases support Kennedy's request to include real estate taxes in that they have found that many items other than rent can be included in the reserved rent calculation under 502(b)(6). Conston Corp., 130 B.R. at 455 (utility fees are included); Heck's, Inc., 123 B.R. at 546 (rent reserved includes real estate taxes, insurance, and common area maintenances charges but does not include utility charges, janitorial expenses, cost of keys, and electrical repairs because these elements do not relate to the property and value of the lease); Goldblatt Bros., 66 B.R. at 345 (reserved rent includes fixed base rent, taxes, and common area maintenance fees); In re William I. Brittingham, Inc., 39 B.R. 575, 577 (Bankr. D. Del. 1984) (finding that under predecessor statute to 502(b)(6) rent reserved included property taxes, water, and insurance). As noted, a couple of these courts have specifically found that real estate taxes could be included. Heck's, Inc., 123 B.R. at 546; Goldblatt Bros., 66 B.R. at 345.

The debtor acknowledges this line of authority and agrees that in the appropriate circumstances, a number of elements other than fixed base rent may properly be included in the "rent reserved" computation. The debtor focuses its argument on determining when it is appropriate to include other elements as rent reserved, and urges this Court to find that the circumstances of this case are not appropriate for including real estate taxes in the "rent reserved" computation. The debtor asks the Court to apply the "test" the Conston Corp. case used for determining what constitutes rent reserved to the facts presented in this case.

In Conston Corp, the court indicated that:

appendages to "pure" rent are allowable as "rent reserved" under 502(b)(6) only if the lease expressly so provides and the charges in question are properly classifiable as rent because they are regular, fixed, periodic charges payable in the same way as "pure" rent.

130 B.R. at 455. The debtor urges the Court to apply this "twopart test" to determine the rent reserved in this case. The debtor acknowledges that the court in Conston Corp. concluded that both components of the test were satisfied. 130 B.R. at 455. The debtor argues, however, that in this case the test cannot be satisfied because the real estate taxes Kennedy seeks to include are not characterized as "rent" under the applicable standards anywhere in the lease.

This Court believes that the first part of the Conston Corp. methodology for determining rent reserved comports with case law from this circuit. The first part of the Conston Corp. test requires the "appendages" to fixed base rent to be expressly characterized as rent in the lease to qualify as "rent reserved." Case law from the Eighth Circuit has adopted:

the general rule that there is a clear distinction between taxes and rent in common usage, and that the term "rent" may not be so construed as to include taxes, "in the absence of a clear intention of the parties to that effect expressed in the lease."



Lamoine Mott Estate v. Neiman, 77 F.2d 744, 747 (8th Cir. 1935) (interpreting Iowa landlord's lien statute in a bankruptcy proceeding) (citations omitted). The Lamoine Mott court went on to point out that the rule allowing "taxes" to be included as rent only if the lease agreement indicates that they should be characterized as rent is well-developed in the Eighth Circuit. Id. (citing Britton v. Western Iowa Co., 9 F.2d 488, 491 (8th Cir. 1925) (another bankruptcy case interpreting Iowa landlord's lien statute)). This rule was reaffirmed in Allbaugh v. U.S., 184 F.2d 109, 112-13 (8th Cir. 1950) (citing Lamoine Mott & Britton). This Court believes that the forgoing Eighth Circuit case law indicates that elements other than fixed base rent can qualify as "rent" only if the parties clearly intended this to be the case in the lease. Hence, this Court will adopt the first portion of the Conston Corp. test as being consistent with case law in.this circuit.

In applying this test, the Court will take further guidance from the particular holdings of each of these Eighth Circuit cases. In the Britton case, the court found that the parties intended to include real estate taxes in "rent" when the lease specifically stated that the taxes would be paid "as an additional consideration for the leasing of said premises." 9 F.2d at 491. The Lamoine Mott case, however, found that the lease language in its case could be distinguished from Britton and determined that the lease did not mean to include real estate taxes as part of "rent." In Lamoine Mott the relevant lease provisions stated that where the lessee failed his duty to pay real estate taxes and "the lessor might pay the same, and the amount so paid should be taken 'as so much additional and further rental for said premises, and the lessor should have a lien for the repayment of the same, to the same extent as for other rent herein reserved'." 77 F.2d at 747. The Lamoine Mott court held that the taxes were not "rent" because they were to be paid as an "addition to rent - not as a part thereof." Id. The court concluded that "[m]anifestly, accrued taxes were not made rental, in the absence of payment by the lessor, under the general terms of the lease." Id. at 747-48.

In the Allbaugh case, the Eighth Circuit observed:

By long-settled principles of landlord and tenant law, where a lessee has agreed to pay taxes as rental and does not make payment of them to the proper public authority when they are due, the amount thereof becomes a debt owing to the lessor and is collectible as such, like any other delinquent rent.

184 F.2d at 112 (citation omitted). The Allbaugh case then went on to find that the tenant had specifically agreed to pay taxes as part of the rental because the lease required the tenant to pay cash "plus taxes per acre to the Superintendent of Winnebago Agency as rental for said land and premises." 184 F.2d at 112 (emphasis added). The lease also specifically provided that the Superintendent would credit the tax payments as rental. The court concluded that because the "leases unequivocally made the rental consist of a cash amount plus taxes" the landlord was entitled to taxes as part of delinquent rental. Id.

Read together, these Eighth Circuit cases require the lease provisions to state clearly and unequivocally that elements other than "pure rent" are included in "rent." This Court believes that in referring to "rent" these Eighth Circuit cases mean only the minimum base rent for the lease provided in the rental covenant. This definition excludes "additions to rent." Lamoine Mott, 77 F.2d at 747. The Lamoine Mott case pointed out that "additions to rent", which cannot be included in "rent", encompasses "additional or further rental" for the premises which arise by virtue of a landlord paying taxes the tenant had the responsibility to pay. Id.

Applying the above test in this case leads the Court to the conclusion that the real estate taxes in this case may not be treated as "reserved rent" under 502(b)(6). The lease does not characterize the real estate taxes as reserved rent under the Eighth Circuit standards.

Whether the real estate taxes in the lease between Kennedy and the debtor should be treated as part of "rent reserved" under 502(b)(6) presents a very difficult determination under the law in this circuit. Essentially, this Court must determine whether the language in the lease between Kennedy and the debtor more closely resembles the language of the leases from the Britton and Allbaugh cases or the language of the lease in the Lamoine Mott case.

After an exhaustive review of the lease, this Court must

conclude that the language and structure of the lease, reviewed

under the applicable standards, indicates that the parties did not originally intend the real estate taxes to be part of the base rent. The Court believes the language and structure of the lease regarding payment of real estate taxes most closely resembles the language in the Lamoine Mott case which the Eighth Circuit found did not include real estate taxes as part of base rent.

The relevant language in the lease states:

Tenant alone shall be responsible for payment of any type of tax . . . . Tenant shall pay the full amount of such tax, excise or assessment directly to the appropriate governmental authority, unless the applicable law expressly imposes solely on Landlord the duty to pay or collect such tax, excise or assessment, in which case Tenant shall pay the full amount of such tax, excise of assessment: as additional rent under this lease to Landlord, on or before the date when any fine, penalty or interest would be added thereto for nonpayment. Notwithstanding that the applicable law may impose on Landlord the duty to collect such tax, excise or assessment, Landlord shall in no event be obligated by Tenant to pay such tax, excise or assessment and Landlord shall be indemnified against and saved harmless from the same by Tenant. In the event (i) Tenant fails to timely pay such tax, excise or assessment and Landlord pays the same, or (ii) Landlord elects in its sole discretion to pay the same in advance, Tenant shall promptly reimburse Landlord for the amount thereof (including the fine, penalty or interest, if any) as additional rent under this lease, and such additional rent shall be deemed to be due as of the last date before any fine, penalty or interest would be added to such tax, excise or assessment for nonpayment.

The relevant lease language in Lamoine Mott states:

in case of default in the payment of the taxes by the lessee, the lessor might pay the same, and the amount so paid should be taken as so much additional and further rental for the said premises, and the said lessor shall have a lien for the repayment of the same, to the same extent as for other rent herein reserved.

77 F.2d at 747. This Court believes the language from the Lamoine Mott lease is very similar, if not identical in some places, to the language in the lease before this Court. The Eighth Circuit found that under this type of language, requiring the tenant to pay the landlord "additional rent" when the landlord had to pay the taxes, the "additional rent" payments are not part of the original base rent.

Moreover, as the debtor points out, I 4.02B states that the debtor was required to pay the real estate taxes in monthly installments and "said monthly installment shall be due along with the minimum rent." Again, this language indicates that the taxes are treated as an "addition to rent - not as a part thereof." Lamoine Mott, 77 F.2d at 747. Hence, the real estate taxes cannot be "rent" and, therefore, are not appropriately included the damage calculation of "rent reserved" under 502(b)(6).

Pursuant to the Eighth Circuit authority, this Court concludes that the lease does not evidence an intent of the parties to treat the real estate taxes as "rent".

ORDER


IT IS THEREFORE ORDERED that the claim of Kennedy Mall is allowed as a general unsecured claim in the amount of $304,996.74.

DONE AND ORDERED this 28TH day of February, 1992.

Michael J. Melloy
Chief Bankruptcy Judge


1. All statutory references are to Title 11 of the United States Code, the Bankruptcy Code, unless otherwise indicated.