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Eighth Circuit Rules that Bankruptcy Code's Cap on Lease Damage Claims Applies to Fraudulent Transfer Judgment

To prevent landlords under long-term real property leases from reaping a windfall for future rent claims at the expense of other creditors, section 502(b)(6) of the Bankruptcy Code caps the amount of a landlord's claims against a debtor-tenant for damages "resulting from the termination" of a real property lease. The U.S. Court of Appeals for the Eighth Circuit recently addressed the scope of this provision in an unusual case. In Lariat Cos. v. Wigley (In re Wigley), 951 F.3d 967 (8th Cir. 2020), the court of appeals reversed a bankruptcy appellate panel decision and held that an individual debtor's joint liability with the guarantor of a real property lease for a fraudulent transfer judgment: (i) was not discharged as a result of the lease guarantor's prior bankruptcy discharge; but (ii) was nonetheless capped under section 502(b)(6). According to the Eighth Circuit, the fraudulent transfer judgment was "one step removed from the breach of the lease, but [the debtor's] liability results from the breach of the lease, so the cap applies."

Statutory Cap on Landlord Future Rent Claims

Section 502(b)(6) of the Bankruptcy Code provides that, upon the filing of a timely objection, a claim filed in a bankruptcy case shall be disallowed 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—

(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….

Section 502(b)(6) thus imposes a ceiling, or "cap," on the allowed amount of a landlord's claim for damages resulting from the termination of a lease of real property. The purpose of the rent cap is to balance the interests of landlords and other unsecured creditors by allowing a landlord "to receive compensation for losses suffered from a lease termination while not permitting a claim so large as to prevent general unsecured creditors from recovering from the estate." Solow v. PPI Enterprises, Inc. (In re PPI Enterprises (U.S.), Inc.), 324 F.3d 197 (3d Cir. 2003); see generally Collier on Bankruptcy ¶ 502.03(7)(a) (16th ed. 2020). Although section 502(b)(6) does not expressly refer to claims against guarantors of a lease, most courts that have considered the issue have ruled that the provision caps the future rent claims of a lessor against a debtor-guarantor of a lease. See In re Ancona, 2016 WL 828099, at *5 (Bankr. S.D.N.Y. Mar. 2, 2016) (citing cases and noting contrary authority representing the minority view).

In Wigley, the Eighth Circuit considered whether an individual debtor's joint liability with the guarantor of a lease for a fraudulent transfer judgment was capped under section 502(b)(6).

Wigley

Michael Wigley guaranteed a 10-year commercial lease between his restaurant company Baja Sol Cantina EP, LLC ("Baja Sol") and Lariat Companies, Inc. ("Lariat"). After Baja Sol defaulted on the lease in 2010, Lariat obtained a $2.2 million judgment against Mr. Wigley under the guaranty in Minnesota state court. The judgment included future rent payable under the lease.

In 2011, Lariat sued Mr. Wigley and his wife Barbara in state court pursuant to the Minnesota Uniform Fraudulent Transfer Act ("MUFTA") to avoid and recover $800,000 transferred by Mr. Wigley to Mrs. Wigley with the actual intent to hinder, delay, or defraud creditors (specifically, Lariat, in attempting to collect amounts due under the lease and guaranty). After a trial, the state court adjudged the defendants jointly and severally liable to Lariat for the $800,000 under the MUFTA.

Mr. Wigley filed for chapter 11 protection in February 2014 in the District of Minnesota. Lariat filed a proof of claim in the amount of approximately $1.7 million, consisting of unpaid rent and other fees due under the lease, future rent, interest, attorneys' fees, and the unpaid fraudulent transfer judgment. After disallowing certain elements of the claim, including the avoidance action liability, which it deemed duplicative of an earlier state court judgment awarding Lariat damages for Baja Sol's breach of the lease, the bankruptcy court applied the statutory cap in section 502(b)(6) and allowed Lariat's claim in an amount that was later stipulated to be approximately $310,000. The court later confirmed a chapter 11 plan over Lariat's objection under which Mr. Wigley paid Lariat's claim in the full capped amount and received a discharge. Lariat was deemed to accept the plan because its allowed claim was paid in full. Lariat appealed the confirmation order to an Eighth Circuit Bankruptcy Appellate Panel, which affirmed.

In 2014, the state court ruled that Mr. Wigley's bankruptcy discharge did not retroactively relieve Mrs. Wigley of her liability for the fraudulent transfer judgment. Thereafter, Mrs. Wigley filed her own bankruptcy case. Lariat filed a proof of claim in the case in the amount of approximately $1 million based on the fraudulent transfer judgment and related items. Mrs. Wigley objected to the claim, arguing that Lariat's acceptance of her husband's chapter 11 plan extinguished her fraudulent transfer judgment liability.

As a matter of apparent first impression, the bankruptcy judge ruled that, although Mr. Wigley's bankruptcy did not discharge his wife's joint and several fraudulent transfer debt, Lariat's claim should be capped by section 502(b)(6) at $310,000 because it "result[ed] from the termination of a lease of real property." Another Eighth Circuit Bankruptcy Appellate Panel ("BAP") reversed the ruling and disallowed Lariat's claim in its entirety, holding that the "predicate claim" had been satisfied by payment of the claim in Mr. Wigley's chapter 11 case, leaving the wife with no liability. Lariat appealed to the Eighth Circuit.

The Eighth Circuit's Ruling

A three-judge panel of the Eighth Circuit reversed the BAP. Writing for the panel, Circuit Judge Duane Benton explained that section 524(e) of the Bankruptcy Code provides that the "discharge of a debt of the debtor does not affect the liability of any other entity on … such debt." He accordingly agreed with the bankruptcy court's conclusion that Mrs. Wigley's liability for the state court fraudulent transfer judgment was not discharged when her husband's debt was discharged in his chapter 11 case. Judge Benton also cited a century-old decision of the U.S. Supreme Court for the proposition that "'discharge destroys the remedy, but not the indebtedness'" (quoting Zavelo v. Reeves, 227 U.S. 625, 629 (1913)).

Next, Judge Benton addressed whether the fraudulent transfer judgment against Mrs. Wigley was capped by section 502(b)(6). The judge rejected Lariat's argument that section 502(b)(6) did not apply because the judgment against Mrs. Wigley was based on the receipt of a fraudulent transfer, in contrast to her husband's capacity as a guarantor of the lease. According to Judge Benton, like courts in other jurisdictions, courts in the Eighth Circuit have held that section 502(b)(6) caps liability for guarantors and garnishees of leases. He reasoned that guarantors and garnishees are "analogous to fraudulent transferees because their liability is one step removed from the breach of lease."

Allowing Lariat's claim in an uncapped amount, Judge Benton explained, would violate the purpose of section 502(b)(6) because Lariat would receive a windfall at the expense of other creditors. "Lariat, as lessor," the judge wrote, "should not avoid the cap—and receive a windfall—because it is filing a claim based on a fraudulent-transfer judgment from a breach of the lease, instead of a claim based just on the breach."

According to Judge Benton, the fraudulent transfer judgment "is one step removed from the breach of the lease, but [Mrs. Wigley's] liability results from the breach of the lease, so the cap applies." Lariat's claim against her, he concluded, "result[ed] from the termination of a lease" within the meaning of section 502(b)(6). Moreover, applying the cap "complies with the statute's text, which focuses on the 'claim of a lessor'—not claim against a lessee."

The Eighth Circuit accordingly reversed the judgment of the BAP and remanded the case to the bankruptcy court for the purpose of entering an order allowing Lariat's claim in the amount of $310,000.

Outlook

The Eighth Circuit's expansive reading of the scope of section 502(b)(6) in Wigley speaks to both the policy concerns underpinning the provision and the unusual circumstances involved. Section 502(b)(6) was enacted to prevent long-term commercial lease damage claims, which in many cases are readily subject to mitigation, from overwhelming the claims of a debtor's other creditors and thereby diluting creditor recoveries. Here, the court of appeals focused on the nexus between the guarantor's liability under the lease guaranty and the nature of the avoidance judgment—i.e., the guarantor fraudulently transferred funds to his wife with the intent to evade his guaranty obligations and defraud the landlord. The Eighth Circuit accordingly interpreted the phrase "resulting from the termination of a lease" in section 502(b)(6) broadly to include the fraudulent transfer judgment against the wife, even though she was not the tenant, the guarantor or in any other way obligated to pay amounts due under the lease.

The Eighth Circuit did leave room for a different outcome under a different factual circumstance, however. A seemingly key fact in Wigley was that Mrs. Wigley and Lariat stipulated that Mr. Wigley's payment did not cover all the money owed to Lariat. Had Mr. Wigley's payment satisfied all of Lariat's uncapped claim or had the unpaid amount been less than the calculated cap under section 502(b)(6), the result may have been different on appeal.

A version of this article is being published in Lexis Practice Advisor. It has been reprinted here with permission.

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