Opinion
Bankruptcy Case No. 03-31906DM.
December 6, 2005
MEMORANDUM DECISION RE APPLICATION OF LETTER OF CREDIT DRAWS TO LANDLORD'S CAPPED CLAIM FOR LOST FUTURE RENT
On October 14, 2005, this court heard the motion for partial summary judgment filed by Deltagen, Inc. ("Deltagen") and the counter-motion for partial summary judgment filed by Woodside Technology Center, LLC ("Woodside"). Both motions pertained to Woodside's amended proof of claim and Deltagen's objections to it. Pamela E. Singer, Esq. appeared on behalf of Deltagen and Patricia S. Mar, Esq. appeared on behalf of Woodside. The court took both motions under submission. For the reasons set forth below, the court will deny Deltagen's motion and grant Woodside's counter-motion.
Woodside's claim against Deltagen is based on its status as Deltagen's landlord. Both parties agree that Woodside's claim is capped under 11 U.S.C. § 502(b)(6). Both parties agree that the amount remaining as of the petition date on a letter of credit issued in favor of Woodside must be applied to reduce Woodside's maximum capped claim for lease termination damages. The parties disagree whether amounts drawn on that letter of credit by Woodside prior to the petition date should reduce the capped claim. The court agrees with Woodside that those amounts do not reduce the capped claim.
Unless otherwise indicated, all chapter, section and rule references are to the Bankruptcy Code, 11 U.S.C. §§ 101- 1330, as enacted and promulgated prior to the effective date of The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub.L. 109-8, Apr. 20, 2005, 119 Stat. 23.
The following discussion constitutes the court's findings of fact and conclusions of law. Fed.R.Bankr.P. 7052(a).
On or about July 11, 2001, Woodside and Deltagen entered into a lease (the "Lease") whereby Deltagen leased space in a building located in Redwood City, California (the "Premises"). Deltagen's monthly rent was $225,462.11 and Deltagen provided Woodside with a collateralized letter of credit ("Letter of Credit") in the amount of $1,701,481.00 to secure the rent payments.
On or about March 31, 2003, Deltagen and Woodside entered into an option agreement ("Agreement") which authorized Woodside to make draws on the Letter of Credit to pay rent accruing after March 1, 2003. Agreement at ¶¶ 3(a) and 4(a). Debtor filed for chapter 11 relief on June 27, 2003. Prior to the petition date, and pursuant to the Agreement, Woodside drew $901,848.00 on the Letter of Credit.
The Agreement provided Deltagen with an option (exercisable through June 30, 2003) to terminate the Lease prior to its 2010 scheduled expiration date upon notice to Woodside and tender of a termination payment equaling more than $2 million. Agreement at ¶¶ 1, 2 and 3. In the interim, Deltagen's ongoing rent obligations would be satisfied by Woodside drawing monthly rent amounts on the Letter of Credit.
In paragraph 5 of the Agreement, Deltagen and Woodside acknowledged that as of March 31, 2003, Deltagen had vacated and surrendered the Premises. Notwithstanding that paragraph, the Agreement provides that the Lease was not terminated, as evidenced by (1) the ability of Woodside to draw on the Letter of Credit to satisfy ongoing rent obligations, (2) the ability of Deltagen to terminate the Lease upon making the termination payment, (3) the parties' recognition (in ¶ 3(e)) that other leases had been terminated, and (4) the parties' agreement (in ¶ 6) that Deltagen would be the sublessor under any sublease if Woodside were able to locate another tenant for the Premises.
In the event Deltagen did not exercise the termination option by the deadline set forth in Agreement, "Then the Termination Option shall be void and of no further force or effect and the parties' rights and obligations under the Lease shall be as though this Agreement had never existed." Agreement at ¶ 1(a).
The parties agree that Woodside's damages are capped at $2,178,429.00 pursuant to section 502(b)(6) and that this claim should by offset by the amount remaining on the Letter of Credit as of the petition date ($799,633.00). They disagree, however, whether the capped amount should be reduced by the prepetition draws on the Letter of Credit or whether those prepetition draws shall be applied towards Woodside's gross claim for lost future rent in excess of the statutory cap.
II. Issues
1. Were the prepetition draws against the Letter of Credit payments of current, accruing rent and thus not subject to section 502(b)(6)'s cap on the lost future rent claim?
2. Even if the draws were not payments of current rent, does the section 502(b)(6) cap apply to prepetition, post-termination draws?
III. Discussion
A. The Draws Satisfied Current, Ongoing Rent Obligations
"Summary judgment is appropriate when contract terms are clear and unambiguous, even if the parties disagree as to their meaning." U.S. v. King Features Entertainment, Inc., 843 F.2d 394, 398 (9th Cir. 1988); United Bhd. of Carpenters and Joiners of Am. Lathers Local 42-L v. United Bhd. of Carpenters and Joiners of Am., 73 F.3d 958, 961 (9th Cir. 1996). "Interpretation of a contract is a matter of law, including whether the contract is ambiguous." King Features, 843 F.2d at 398. Here, the Agreement clearly and unambiguously provides that the prepetition draws against the Letter of Credit were used to satisfy ongoing, accruing monthly rent obligations; thus, as a matter of law, such draws are not subject to the cap of section 502(b)(6).
Section 502(b)(6) limits the claims allowable to a landlord for future rent or damages resulting from the termination of a lease. In particular, the landlord's claim is limited to the rent reserved by the lease, without acceleration, for the greater of either one year or fifteen percent (not to exceed three years) of the remaining lease term following the earlier of the petition date or the surrender/repossession date. The limitation does not apply to rents that accrued prior to the petition date. See 11 U.S.C. § 502(b)(6); Lawrence P. King, 4 Collier on Bankruptcy ¶ 502.03[7][e] (rev'd 15th ed. 2005).
Under the Agreement, Deltagen agreed to pay its post-March 1, 2003 gross rent by draws on the Letter of Credit. Agreement at ¶¶ 3(a) and 4(a) ("Landlord shall have the right to draw on the Letter of Credit to pay Gross Rent accruing under the Lease from and after March 1, 2004"). The Agreement thus clearly treats the rent obligation as ongoing and accruing. Other provisions of the Agreement unambiguously demonstrate that the Lease was not terminated upon surrender of the Premises and that rent continued to accrue (and be paid via Letter of Credit draws) on a monthly basis. For example, the parties agreed that Woodside could sublease the Premises — after obtaining the consent of Deltagen — and that Deltagen would be the sub-lessor under any such sub-lease. See Agreement at ¶ 6. Other provisions explicitly provided Deltagen an option to terminate the Lease upon paying certain amounts and specifically referenced the immediate termination of other leases between Woodside and Deltagen (of other property in Menlo Park and Alameda). See Agreement at ¶¶ 3(e) and 1-3.
Deltagen seeks to avoid the effect of these provisions (while ironically seeking to use the "surrender" clause of the Agreement) by pointing to the provision in paragraph 1(a) providing that the termination option (but not the Agreement itself) would be null and void and the parties' rights to be as if the Agreement never existed. As a result, under California Civil Code sections 1951.2 and 1951.4, termination occurred in March 2003 when surrender purportedly occurred.
Sections 1951.2 and 1951.4 of the California Civil Code do provide that termination occurs when a lessee surrenders leased property. Those sections, however, are subject to California Civil Code section 3268, which provides that those provisions are "subordinate to the intention of the parties" as ascertained by the provisions on interpretation of contracts. Here, the Agreement demonstrates that the parties did not intend to terminate the Lease as of the date of purported surrender. If Deltagen wants to argue that the Agreement demonstrates that surrender did indeed occur on March 1, 2003, it must also concede that the Agreement demonstrates that the parties did not intend to terminate the Lease on the same date. In any event, the clause voids the termination option and not the Agreement itself; the Agreement (which clearly treats the rent obligation as ongoing) is not void. To the extent the parties stated that they would act as though the Agreement never existed if the termination option were not exercised, the Lease remained in effect during the term of the Agreement and the draws on the Letter of Credit were thus for ongoing rent.
B. Prepetition Draws Are Not Subject to Cap In Any Event
Even if the prepetition draws were not payments of ongoing rent but were payments of termination damages, section 502(b)(6)'s cap would not apply. The plain language of section 502(b)(6) does not require the cap to be reduced by prepetition payments. Rather, such payments plainly reduce the total claim for termination damages, but do not affect the mathematical calculation of the cap. Section 502(b)(6) contains no suggestion that prepetition payments would reduce the cap. Therefore, for the reasons set forth below, the timing of the draws (prepetition versus post-petition) insulate them from the cap.
The parties agree that under AMB Prop., L.P. v. Official Creditors for the Estate of AB Liquidating Corp. (In re AB Liquidating Co.), 416 F.3d 961, 964-65 (9th Cir. 2005), a security deposit or letter of credit held by a landlord post-petition must be applied against the landlord's capped, and not its gross, damages. See also Redback Networks, Inc. v. Mayan Networks Corp. (In re Mayan Networks Corp.), 306 B.R. 295, 299 (9th Cir. BAP 2004) (landlord's post-petition draw on letter of credit must be deducted from the landlord's capped damages). Deltagen, citing a Delaware bankruptcy court case, argues that whether a draw is made against a letter of credit pre- or post-petition is immaterial; instead, whatever amount was held by the landlord at the termination of the lease should be offset against the capped amount. In re PPI Enterprises (U.S.), Inc., 228 B.R. 339, 350 (Bankr. D. Del. 1998), aff'd, 324 F.3d 197 (3d Cir. 2003).
In PPI, the debtor abandoned its leased premises in September 1991 and the landlord terminated the lease by notice on October 21, 1991. Id. at 342. Subsequent to the 1991 termination, the landlord drew upon a $650,000 standby letter of credit. Id. at 350. Almost five years later (in April 1996), the debtor filed its bankruptcy petition, and argued that the landlord's capped damages should be offset by the amount of the prepetition draw against the letter of credit. The bankruptcy court agreed with the debtor, stating that "The legislative history and case law pertaining to the treatment of security deposits under § 502(b)(6) makes clear that any security deposit held by a landlord at the time of termination of the lease of real property will be applied in satisfaction of the claim allowed under § 502(b)(6)." Id. (emphasis added) (citing cases involving post-petition draws against letters of credit or security deposits). The PPI court dismissed the landlord's argument that all of the cases requiring setoff of letters of credit or security deposits against the capped section 502(b)(6) amount involved landlords who held the full deposit or the full amount of the letter of credit as of the petition date:
However, these differences in timing are irrelevant because § 502(b)(6)'s cap on a landlord's claim takes effect at the earlier of (I) the date of filing and (ii) the date on which lessee surrenders or lessor repossesses the property. Thus, so long as the landlord applied the security deposit at a time subsequent to either (I) or (ii) above, § 502(b)(6) will require that security deposit to be subtracted from the landlord's § 502(b)(6) claim. In this case, because Solow drew down the letter of credit for $650,000 subsequent to termination of the lease, Solow's § 502(b)(6) claim should be reduced by that amount.
Id. at 350. Therefore, the PPI court required a landlord who had drawn against a tenant's security deposit almost five years prior to the petition date to reduce its capped claim by the amount of that security deposit.
In response, Woodside relies on the Ninth Circuit Bankruptcy Appellate Panel's ("BAP") decision in Young v. Condor Systems, Inc. (In re Condor Systems, Inc.), 296 B.R. 5 (9th Cir. BAP 2003), that prepetition, post-termination payments made by the debtor could not be offset against the employee's capped (under section 502(b)(7)) damages. Id. at 13-15. In Condor, a case of first impression, BAP explained why golden parachute payments made to a former employee after termination but before bankruptcy do not affect the section 502(b)(7) cap. The panel analyzed the language and statutory construction of section 502(b)(7), which for the purposes of this particular analysis is the same as section 502(b)(6). Condor is more persuasive than PPI and should control.
In Condor, the panel stated that in another case, it "declined to analogize §§ 502(b)(6) and (b)(7) in derogation of § 502(b)(7)'s plain language . . ." Condor, 296 B.R. at 14, citing Bitters v. Networks Elec. Corp. (In re Networks Elec. Corp.), 195 B.R. 92, 100 (9th Cir. BAP 1996). In Bitters, the terminated employee cited a case which relied on the legislative history of section 502(b)(6) in deciding that the plain language of section 502(b)(7) did not apply. The Bitters panel rejected that approach, noting that the "employee-creditor of § 502(b)(7) cannot readily be analogized to the landlord of § 502(b)(6)."Bitters, 195 B.R. at 100. The Bitters court did not, however, state that sections 502(b)(6) and (b)(7) cannot be analogized, particularly when the issue pertains to the interpretation of similar plain language.
The Condor bankruptcy court held that prepetition termination payments count against the section 502(b)(7) cap, comparing the prepetition termination payments to prepetition security deposits which apply to the section 506(b)(6) cap. In reversing, BAP correctly noted that the bankruptcy court had compared "apples to oranges." Id. at 14. Unlike the facts of Condor (and in the present case), none of the cases cited by the Condor bankruptcy court in support of its (ultimately reversed) decision involved prepetition draws against prepetition letters of credit or prepetition security deposits. In contrast, the facts here and the facts of Condor are more "apples to apples": both cases involve prepetition payments (or draws).
In Condor, the former employee was terminated prepetition and was the beneficiary of a severance package paying him $1,400,000 in eight quarterly installments. The $1,400,000 was funded by an irrevocable letter of credit. The employee drew $1,050,000 in prepetition payments against the letter of credit and ultimately drew the remaining $350,000 on the letter of credit. The Condor court faced two issues: whether the prepetition draws had to be offset against the capped damages (to which BAP answered "no") and whether the post-petition draws had to be offset against the cap (to which BAP also answered "no", applying an analysis that is irrelevant here).
Only the first issue is pertinent here. The Ninth Circuit distinguished BAP's holding with respect to the second issue inAB Liquidating. The Ninth Circuit, not having faced the first issue in any published decision, has not criticized or distinguished Condor's analysis of the first issue, notwithstanding Deltagen's implications to the contrary.
The panel in Condor notes that section "502(b)(6) tracks the language of [section] 502(b)(7)" (id. at 14, n. 10) and holds that the language and structure of section 502(b)(7) do not contemplate offsets of prepetition payments (or, in this case, draws):
The sections provide:
(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;
(7) if such claim is the claim of an employee for damages resulting from the termination of an employment contract, such claim exceeds —
(A) the compensation provided by such contract, without acceleration, for one year following the earlier of —
(I) the date of the filing of the petition; or
(ii) the date on which the employer directed the employee to terminate, or such employee terminated, performance under such contract; plus
(B) any unpaid compensation due under such contract, without acceleration, on the earlier of such dates;
(Emphasis added.)
The preambular portion of § 502(b) — "shall determine the amount of such claim in lawful currency of the United States as of the date of the filing of the petition" — admits of one reading. 11 U.S.C. § 502(b) (emphasis added).
The date of filing bankruptcy is the measuring date for determining substantive damages, while the earlier of the date of termination or date of filing is the measuring date for determining the § 502(b)(7) cap [and the section 502(b)(6) cap]. The use of the earlier of the date of bankruptcy or of termination as the measuring date for cap determination, but not damages, compels the conclusion that prepetition payments are irrelevant.
The fact that the back pay provision at § 502(b)(7)(B) raises the cap by the amount of "unpaid compensation due under such contract, without acceleration, on the earlier of such dates" supports our conclusion. Consistent with canons of construction that require terms such as "unpaid" and "due" to be interpreted so as to give effect to each, the term "unpaid" makes the most sense as a separate concept if it means back pay due [or unpaid rent] that remains unpaid at the time of the filing of the petition.
Likewise, section 502(b)(6)(B) raises the landlord's cap by "any unpaid rent due under such lease, without acceleration, on the earlier of such dates." 11 U.S.C. § 502(b)(6)(B).
Likewise, section 502(b)(6)(B) raises the landlord's cap by "any unpaid rent due under such lease, without acceleration, on the earlier of such dates." 11 U.S.C. § 502(b)(6)(B).
* * *
If Congress meant for the damages cap of § 502(b)(7)(A) to be reduced by prepetition payments, it could have included the term "unpaid" that it used in § 502(b)(7)(B). Compare, § 502(b)(7)(A) ("the compensation provided"), with § 502(b)(7)(B) ("any unpaid compensation due").
Id. at 14-15 (emphasis and bracketed commentary added). This court agrees with BAP that if Congress had intended prepetition payments (or, in this case, prepetition draws) to be applied against the capped amount of section 502(b)(6), it would have used "unpaid" in that subsection.
As in Condor, those amounts received by Woodside in prepetition draws in the interval between the surrender of the Premises and the petition date do not have to be offset against the section 502(b)(6) capped claim. While those amounts reduce Woodside's gross claim, the calculation of the capped, and thus allowable, portion of that claim is a purely mathematical function, made as of the date of the termination of the Lease and without regard to subsequent, prepetition payments.
IV. Conclusion
Because the prepetition draws against the Letter of Credit were used to satisfy ongoing rent payments, the cap of section 502(b)(6) is inapplicable. Moreover, to the extent such draws were made prepetition, they do not have to be offset against the cap. The court will therefore grant Woodside's counter motion for partial summary judgment and deny Deltagen's motion for summary judgment. Counsel for Woodside is directed to prepare orders and a partial summary judgment in accordance with this Memorandum Decision, stating that relief is being granted or denied for the reasons set forth in this Memorandum Decision, and to comply with B.L.R. 9021-1.