FOR PUBLICATION

UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

In re: EL TORO MATERIALS 

COMPANY, INC.,

Debtor,

No. 05-56164

SADDLEBACK VALLEY COMMUNITY BAP Nos.

CHURCH,  CC-04-01287-PaBK

Appellant, CC-04-01300-PaBK

v. OPINION

EL TORO MATERIALS COMPANY,

INC.,

Appellee. 

Appeal from the Ninth Circuit

Bankruptcy Appellate Panel

Klein, Brandt and Pappas, Bankruptcy Judges, Presiding

Argued and Submitted

June 7, 2007—Pasadena, California

Filed October 1, 2007

Before: Daniel M. Friedman,* Alex Kozinski and

Ronald M. Gould, Circuit Judges.

Opinion by Judge Kozinski

*The Honorable Daniel M. Friedman, Senior United States Circuit

Judge for the Federal Circuit, sitting by designation. 

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COUNSEL

Robert C. Braun, Penelope Parmes and Roger F. Friedman,

Rutan & Tucker, LLP, Costa Mesa, California, for the appellant. 

Ronald K. Van Wert, Robert K. Van Wert P.C., Costa Mesa,

California, and William Malcom, Malcom & Cisneros, Irvine,

California, for the appellee. 

OPINION

KOZINSKI, Circuit Judge: 

Bankruptcy presents a unique challenge: How should a

paucity of resources be allocated to cover a multiplicity of

claims? Distributing money to satisfy claims is, in most cases,

a zero-sum game: Every dollar given to one creditor is a dollar unavailable to satisfy the debt owed to others. For Paul to

be paid in full, Peter must be short-changed. Congress sought

to balance the interests of competing creditors through an

extensive set of rules organizing, prioritizing and structuring

claims against the estate. E.g., 11 U.S.C. § 507(a) (prioritizing

claims); id. § 502(e)(1) (disallowing claims for reimbursement or contribution); id. § 502(b)(1)-(5), (7)-(9) (limiting or

disallowing various claims). 

IN RE: EL TORO MATERIALS CO. 13367
The bankruptcy estate of mining company El Toro Materials hopes to use one of these rules—a cap on damages “resulting from the termination of a lease of real property,” id.

§ 502(b)(6)—to limit its liability for allegedly leaving one

million tons of its wet clay “goo,” mining equipment and

other materials on Saddleback Community Church’s property

after rejecting its lease.1 Saddleback brought an adversary

proceeding against El Toro claiming $23 million in damages

for the alleged cost of removing the mess, under theories of

waste, nuisance, trespass and breach of contract. The bankruptcy court, on a motion for partial summary judgment,

found that Saddleback’s recovery would not be limited by the

section 502(b)(6) cap. On certified cross-appeal the Bankruptcy Appellate Panel (BAP) reversed, holding that any damages would be capped. Saddleback appeals. 

* * *

Claims made by landlords against their bankrupt tenants for

lost rent have always been treated differently than other unsecured claims. Prior to 1934, landlords could not recover at all

for the loss of rental income they suffered when a bankrupt

tenant rejected a long-term lease agreement; future lease payments were considered contingent and thus not provable debts

in bankruptcy. See Manhattan Props., Inc. v. Irving Trust Co.,

291 U.S. 320, 332-36, 338 (1934). 

The Great Depression created pressure to reform the system: A wave of bankruptcies left many landlords with broken

long-term leases, buildings sitting empty and no way to

recover from the estates of their former tenants. See Oldden

v. Tonto Realty Corp., 143 F.2d 916, 919-920 (2d Cir. 1944).

On the one hand, allowing landlords to make a claim for lost

rental income would reduce the harm done to them by a ten1The parties entered into a stipulation that the lease would be rejected

under 11 U.S.C. § 365(a) (allowing bankrupt tenants to reject the remaining term of leases). 

13368 IN RE: EL TORO MATERIALS CO.
ant’s breach of a long-term lease, especially in a down market

when it was difficult or impossible to re-lease the premises.

On the other hand, “extravagant claims for . . . unearned rent”

could quickly deplete the estate, to the detriment of other

creditors. See In re Best Prods. Co., 229 B.R. 673, 676

(Bankr. E.D. Va. 1998). The solution was a compromise in

the Bankruptcy Act of 1934 allowing a claim against the

bankruptcy estate for back rent to the date of abandonment,

plus damages no greater than one year of future rent. See Oldden, 143 F.2d at 920-21. 

[1] Congress dramatically overhauled bankruptcy law when

it passed the Bankruptcy Reform Act of 1978. However, section 502(b)(6) of the 1978 Act was intended to carry forward

existing law allowing limited damages for lost rental income.

S. Rep. No. 95-989, at 63 (1978) as reprinted in 1978

U.S.C.C.A.N. 5787, 5849 (the cap on damages is “derived

from current law”). Only the method of calculating the cap

was changed. Under the current Act, the cap limits damages

“resulting from the termination of a lease of real property” to

“the greater of one year, or 15 percent, not to exceed three

years, of the remaining term of such lease.” 11 U.S.C.

§ 502(b)(6). The damages cap was “designed 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. 95-989, at 63. 

[2] The structure of the cap—measured as a fraction of the

remaining term—suggests that damages other than those

based on a loss of future rental income are not subject to the

cap. It makes sense to cap damages for lost rental income

based on the amount of expected rent: Landlords may have

the ability to mitigate their damages by re-leasing or selling

the premises, but will suffer injury in proportion to the value

of their lost rent in the meantime. In contrast, collateral damages are likely to bear only a weak correlation to the amount

of rent: A tenant may cause a lot of damage to a premises

IN RE: EL TORO MATERIALS CO. 13369
leased cheaply, or cause little damage to premises underlying

an expensive leasehold.2

[3] One major purpose of bankruptcy law is to allow creditors to receive an aliquot share of the estate to settle their

debts. Metering these collateral damages by the amount of the

rent would be inconsistent with the goal of providing compensation to each creditor in proportion with what it is owed.

Landlords in future cases may have significant claims for both

lost rental income and for breach of other provisions of the

lease. To limit their recovery for collateral damages only to

a portion of their lost rent would leave landlords in a materially worse position than other creditors. In contrast, capping

rent claims but allowing uncapped claims for collateral damage to the rented premises will follow congressional intent by

preventing a potentially overwhelming claim for lost rent

from draining the estate,3 while putting landlords on equal

footing with other creditors for their collateral claims. 

[4] The statutory language supports this interpretation. The

cap applies to damages “resulting from” the rejection of the

lease. 11 U.S.C. § 502(b)(6). Saddleback’s claims for waste,

nuisance and trespass do not result from the rejection of the

lease—they result from the pile of dirt allegedly left on the

property. Rejection of the lease may or may not have triggered Saddleback’s ability to sue for the alleged damages.4

But the harm to Saddleback’s property existed whether or not

the lease was rejected. A simple test reveals whether the damages result from the rejection of the lease: Assuming all other

2Here, El Toro is alleged to have caused $23 million of damage to a

property that it leased for only $28,000 per month. 

3The structure of the cap suggests congressional concern about damages

from long-term leases spanning many years: The cap maxes out at 15%

of 20 years, or 3 years’ rent. A claim for lost rent for a full 20 years would

in many cases overwhelm any other claims against the estate. 

4We need not, and do not, decide whether Saddleback could have

brought its claims before the lease terminated. 

13370 IN RE: EL TORO MATERIALS CO.
conditions remain constant, would the landlord have the same

claim against the tenant if the tenant were to assume the lease

rather than rejecting it? Here, Saddleback would still have the

same claim it brings today had El Toro accepted the lease and

committed to finish its term: The pile of dirt would still be

allegedly trespassing on Saddleback’s land and Saddleback

still would have the same basis for its theories of nuisance,

waste and breach of contract. The million-ton heap of dirt was

not put there by the rejection of the lease—it was put there by

the actions and inactions of El Toro in preparing to turn over

the site.5

Interpreting the section 502(b)(6) cap to include damage

collateral to the lease would also create a perverse incentive

for tenants to reject their lease in bankruptcy instead of running it out: Rejecting the lease would allow the tenant to cap

its liability for any collateral damage to the premises and thus

reduce its overall liability, even if staying on the property

would otherwise be desirable and preserve the operating value

of the business. Bankrupt tenants—especially those who have

damaged the property and thus may face liability upon expiration of the lease—would pack up their wares6

 and reject otherwise desirable leases in order to gain the benefit of capping

unrelated damages. This would both reduce the operating

value of the business and deny recovery to a creditor—a loselose situation counter to bankruptcy policy. An incentive to

sacrifice efficiency in order to exploit a loophole in the

liability-capping provisions would be plainly counter to congressional intent to maximize the value of the estate to creditors. 

5Our ruling is consistent with K-4, Inc. v. Midway Engineered Wood

Prods., Inc. (In re Treesource Indus., Inc.), 363 F.3d 994 (9th Cir. 2004).

There, we determined the priority of a claim for failure to remove materials from the premises, id. at 995, whereas today we decide whether similar

claims are capped by the section 502(b)(6) limitation. Prioritization of the

claim is a separate issue from determining the amount of the claim that

will be permitted. 

6Or fail to pack them up at all, as is alleged here. 

IN RE: EL TORO MATERIALS CO. 13371
Further, extending the cap to cover any collateral damage

to the premises would allow a post-petition but pre-rejection

tenant to cause any amount of damage to the premises—either

negligently or intentionally—without fear of liability beyond

the cap. If the tenant’s debt to the landlord already exceeded

the cap then there would be no deterrence against even the

most flagrant acts in violation of the lease, possibly even to

the point of the tenant burning down the property in a fit of

pique. Absent clear statutory language supporting such an

absurd result, we cannot suppose that Congress intended it. 

[5] The BAP reached a contrary conclusion because it considered itself bound by its precedent in Kuske v. McSheridan

(In re McSheridan), 184 B.R. 91 (B.A.P. 9th Cir. 1995), and

therefore held that Saddleback’s recovery against El Toro

would be capped under section 502(b)(6).7 To the extent that

McSheridan holds section 502(b)(6) to be a limit on tort

claims other than those based on lost rent, rent-like payments

or other damages directly arising from a tenant’s failure to

complete a lease term, it is overruled.8

7Two of the three judges on the appellate panel filed concurring opinions in which they expressed reservations about McSheridan, going as far

as to foreshadow that “it may be doubted that [McSheridan] . . . would

survive scrutiny by the court of appeals.” El Toro Materials Co. v. Saddleback Valley Cmty. Church (In re El Toro Materials Co.), No. CC-04-

01287, slip op. at 31 (B.A.P. 9th Cir. July 8, 2005) (Klein, J., concurring

in result). When the panel believes that one of its precedents is wrongly

decided or otherwise deserves reconsideration, the goal of judicial efficiency may be best served by allowing the BAP itself to overrule its own

precedent. The BAP, promulgating its rules under supervision of the Ninth

Circuit Judicial Council, has not yet implemented a rule creating an en

banc procedure. Cf. Textile Mills Sec. Corp. v. Comm’r of Internal Revenue, 314 U.S. 326, 335 (1941) (statutory authorization for three-judge panels in the courts of appeals did not preclude the Third Circuit from

instituting the “more effective” procedure of hearing select cases en banc).

As this case suggests, the time may be ripe for the BAP to consider instituting such a procedure. 

8McSheridan also holds that damages flowing from the failure of a party

that has rejected a lease to perform future routine repairs or pay utility

bills are capped. 184 B.R. at 95, 102. As the tort claims at issue here are

not based on a failure to perform routine maintenance, we do not address

the propriety of that holding. 

13372 IN RE: EL TORO MATERIALS CO.
Saddleback’s argument that section 502(b)(6) does not cap

its claim for damages is properly raised before us; Saddleback

did not waive the argument by failing to question the breadth

of the section 502(b)(6) cap in its cross-appeal from the bankruptcy court to the BAP, as the ruling of the bankruptcy court

on this issue was entirely favorable to Saddleback. Saddleback had no reason to challenge a favorable decision. 

We remand for a determination on the merits of Saddleback’s claim. 

REVERSED and REMANDED.

IN RE: EL TORO MATERIALS CO. 13373