On July 19, 2005, the Ninth Circuit Court of Appeals issued an opinion in AMB Property, L.P. v. Official Creditors for the Estate of AB Liquidating Corp. (In re AB Liquidating Corp.) that adopted the framework of the Second Circuit case Oldden v. Tonto Realty Co., 143 F.2d 916 (2nd. Cir. 1944), which held that a landlord must deduct a security deposit from its “capped” bankruptcy claim rather than from its total damages.

In AMB Property, after commencing a Chapter 11 bankruptcy case, the debtor rejected its 5-year commercial property lease, for which it had established a $1 million letter of credit security deposit. The landlord filed a proof of claim for $2 million for damages related to rejection of the lease. The landlord reasoned that its gross damages of $5 million, minus the $1 million security deposit, yielded “mitigated damages” of $4 million. This exceeded one year’s rent of $2 million, leaving the landlord with an asserted claim of $2 million. The Creditors’ Committee objected to this claim, arguing that the landlord was required to deduct the $1 million security deposit from the “capped” claim of $2 million, leaving the landlord with an allowed claim of only $1 million.

The Ninth Circuit stated that Bankruptcy Code Section 502(b)(6), commonly known as the “landlord’s cap,” sets forth the mechanism for determining a landlord’s allowable claim against the bankruptcy estate. Section 502(b)(6) provides, in essence, that a landlord’s claim is limited to the lesser of its actual damages or one year’s lease payments. Both the landlord and the Creditors’ Committee agreed that the landlord’s cap applied because the landlord’s actual damages ($5 million) exceeded one year’s rent ($2 million). At issue was whether the $1 million security deposit should be deducted from $5 million gross damages or from the $2 million “capped” damages.

The Creditors’ Committee asserted that, based on the Oldden case, a court must (1) determine the landlord’s gross damages, (2) compare the gross damages to the statutory cap of one year’s rent, and (3) subtract any security deposit from the lesser of gross damages or one year’s rent. The Ninth Circuit agreed, placing emphasis on the fact that Congress explicitly endorsed the Oldden case in a House Judiciary Report to amended Section 502(b)(6). The Ninth Circuit therefore adopted the Oldden framework, holding that a landlord’s allowable claim against the bankruptcy estate, as determined under Section 502(b)(6), will be reduced by any security deposit received.