Opinion ID: 3013276
Heading Depth: 2
Heading Rank: 2

Heading: R. 980, 990 (Bankr. N.D. Ill. 1991).

Text: 18. In determining the final § 502(b)(6) calculation, the Bankruptcy Court should make a finding of fact as to the exact date of Solow’s termination or PPIE’s formal surrender of the leasehold agreement, and start the calculation from that point. 17 B. Once the § 502(b)(6) calculation is complete, the prevailing view, and the view adopted by the Bankruptcy Court here, favors deduction of a security deposit from the § 502(b)(6) cap of a landlord’s claim. E.g., Atl. Container, 133 B.R. at 988 (“[It is] well-settled that a security deposit held by a lessor on a rejected lease must be applied against the maximum claim for lease termination damages allowed to the lessor under § 502(b)(6).”). Equating a letter of credit with a security deposit, the Bankruptcy Court held that “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.”19 PPI Enters., 228 B.R. at 350. The Bankruptcy Court relied upon Oldden v. Tonto Realty Corp., 143 F.2d 916, 921 (2d Cir. 1944), which established the pre-Code practice of deducting security deposits from § 502(b)(6) calculations. See also H.R. Rep. No. 95-595, at 354 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6310 (“[A landlord] will not be permitted to offset his actual damages against his security deposit and then claim for the balance under [§ 502(b)(6)]. Rather, his security deposit will be applied in satisfaction of the claim that is allowed under [the statute].”). Oldden stands for the proposition that a bankruptcy filing limits damages for breach of a leasehold agreement and requires a return of the tenant’s security deposit. 143 F.2d at 921. Nonetheless, it bears noting that Oldden involved a security deposit given directly to the creditor from the debtor, not from a third party. We must consider whether this factor requires different treatment under § 502(b)(6). Solow contends § 502(b)(6) applies only to funds collected by the landlord directly from the tenant, and that any other funds recovered by a landlord, whether from a letter of 19. Solow also contends that even if he had a security deposit, and not a letter of credit, the Bankruptcy Court’s application of the security deposit rule was erroneous because he drew down the letter of credit’s proceeds before the Chapter 11 filing. But the § 502(b)(6) cap starts to operate on the date on which the lessee surrendered the leased property, and the Bankruptcy Court correctly rejected Solow’s argument. 18 credit or a new tenant, are immaterial. Accord Atl. Container, 133 B.R. at 990 (post-petition rent, use, and occupancy payments “should not be applied against the Landlord’s maximum allowable lease termination claim”); see also In re Conston Corp., 130 B.R. 449, 453-54 (Bankr. E.D. Pa. 1991). In this context, Solow suggests a security deposit and a letter of credit are fundamentally different. Solow argues he never had the functional equivalent of a security deposit and instead simply maintained contractual rights to the letter of credit’s proceeds, which should not affect his recovery under § 502(b)(6). This distinction is important because if Sanwa Bank had defaulted on its letter of credit to Solow, Solow would have pursued a separate legal action against Sanwa Bank; he would have no claim against PPIE based on the letter of credit. Because the letter of credit allegedly is independent of his claim against PPIE, Solow contends the $650,000 should not be deducted from the § 502(b)(6) cap calculation. Under similar circumstances, some courts have adopted the “independence principle” to separate proceeds from a letter of credit from the debtor’s estate. E.g., Kellogg v. Blue Quail Energy Inc., 831 F.2d 586, 589-90 (5th Cir. 1987) (holding that “the independence principle [is] the cornerstone of letter of credit law”); Musika v. Arbutus Shopping Ctr., L.P., 257 B.R. 770, 772 (Bankr. D. Md. 2001) (determining the § 502(b)(6) cap without regard to the letter of credit); see also 5 Collier on Bankruptcy, § 549.04[1] (“Property of the estate does not include the proceeds of a letter of credit paid to a creditor of the debtor who is a beneficiary of the letter.”); Geoffrey L. Berman et al, Last in Line: Landlords Use Letters of Credit to Bypass the Claim Cap of § 502(b)(6), 20 Am. Bankr. Inst. J. 16 (Dec. 2001). Under this view, the independence principle should generally govern in situations where a third-party issuer, not the tenant itself, provides the letter of credit. Yet there is another view. PPIE argues that once the letter of credit is drawn down, Sanwa Bank, as guarantor, will pursue recovery of its $650,000 loss directly against PPIE. Under Solow’s interpretation, this means Solow would keep the $650,000 and PPIE would be liable for that same 19 amount to Sanwa Bank. In effect, this result would be an end run around § 502(b)(6), since Solow would receive a windfall at PPIE’s, and other creditors’, expense, and PPIE would be liable twice for the same amount of money. The more appropriate outcome under the relevant case law and legislative history, PPIE contends, is to treat the letter of credit as a payment from PPIE to Solow, thus reducing PPIE’s burden under § 502(b)(6) in bankruptcy. Chapter 11 is intended to permit the debtor to rehabilitate itself while simultaneously protecting creditors. The parties here posit competing legal and equitable arguments that reflect the dual purposes of bankruptcy. Although there are reasons to the contrary, we are not inclined to disturb the rationale followed since Oldden. As the Second Circuit explained in Oldden: Although the instant case is admittedly different in that the tenant here pledged his own property to cover the possibility of default, and the rights of a third party are in no way involved, yet in both situations there is an attempt on the part of the landlord to insure performance by the tenant. The difference is purely technical. . . . [I]n one case the insurance is security put up by the tenant himself, while in the other it is the credit standing of a third party procured by the tenant; this difference is insufficient to justify divergent rules as to the respective allowable claims. If the total damages are limited in the one instance, they should likewise be limited in the other instance. 143 F.2d at 921. Nonetheless, we need not decide the underlying question because it is clear the parties intended the letter of credit to operate as a security deposit. Article 33A of the parties’ lease required PPIE to give Solow a security deposit in the amount of $650,000. Article 50 of the rider attached to the lease clarified PPIE’s obligation: 50. Cash Security: Letter of Credit A. In lieu of the cash security provided for in Article 33A, Tenant may deliver to Landlord, as security pursuant to Article 33A, an irrevocable, clean, 20 commercial letter of credit in the amount of $650,000 issued by a bank . . . , which shall permit Landlord (a) to draw thereon up to the full amount of the credit evidenced thereby in the event of any default by Tenant . . . or (b) to draw the full amount thereof to be held as cash security pursuant to Article 33A hereof if for any reason the Letter is not renewed . . . . B. If Landlord shall use or apply any of the cash security deposited pursuant to Article 33A or any of the cash drawn by Landlord under the Letter of Credit . . . , Tenant shall, promptly on Landlord’s demand therefor, deposit with Landlord the amount of cash required to restore the cash security deposited with Landlord to the level specified in Article 33A or in lieu thereof, shall deliver to Landlord a Letter of Credit in the amount and complying with the requirements specified in Part A above. Interpreting this language, we find the parties intended the letter of credit to serve as a security deposit. Entitled “Cash Security: Letter of Credit,” the rider expressly provided the letter of credit was “in lieu” of PPIE’s cash security obligation in the leasehold agreement. The rider also provided that PPIE would be liable to Solow for replenishment of the security if he was forced to draw upon the letter of credit. We will affirm the Bankruptcy Court’s treatment of the letter of credit under § 502(b)(6).