Alert
04.13.26
In In re Tupperware Brand Corporation, the U.S. Bankruptcy Court for the District of Delaware recently found that, although letter of credit proceeds are not estate property, the Bankruptcy Code’s statutory cap on landlord claims may still apply and reduce the benefit the landlord receives as the beneficiary of the letter of credit. The Court thus allowed litigation seeking to recover the proceeds of a landlord’s draw on a letter of credit to proceed, despite the general rule that such draws are independent transactions.
Independence Principle of Letters of Credit
Draws on letters of credit are generally honored without reference to the underlying transaction between the debtor and the creditor because the issuer’s obligation to the creditor is independent of the underlying contract, and the payment is made from the issuer’s own assets and not property of the debtor’s estate. Standby letters of credit—like the one at issue in Tupperware—embody this “independence principle,” promoting certainty and facilitating prompt payment to beneficiaries upon the debtor’s breach of an obligation.
In In re PPI Enters. (U.S.), Inc., the Third Circuit addressed the intersection of the independence principle with the Bankruptcy Code’s cap on landlord claims. There, after the debtor defaulted on its lease, the landlord fully drew on a letter of credit provided as security. The Third Circuit held that the letter of credit essentially functioned as the tenant’s security deposit and, as a result, the payment of the proceeds to the landlord were subject to the limitations of section 502(b)(6) on the amount of the landlord’s allowable bankruptcy claim. Solow v. PPI Enters. (U.S.) (In re PPI Enters (U.S..)), 324 F.3d 197, 209-210 (3d Cir. 2003); see also Oldden v. Tonto Realty Corp. 143 F.2d 916, 918 (2d Cir. 1944).
In Re Tupperware Brand Corporation: The Bankruptcy Court’s Decision
Tupperware Brand Corporation (Tupperware) leased real property from Spirit Realty L.P., (Spirit). The lease required Tupperware to obtain a $10 million letter of credit as security and had a $10 million liquidated damages provision.
Shortly after Tupperware filed for chapter 11, Party Products LLC (Party Products) acquired Tupperware’s assets and assumed certain liabilities, including Tupperware’s obligation to reimburse the issuing bank under the letter of credit. After Tupperware defaulted under the lease, Spirit submitted a $9.5 million draw request under the letter of credit. As the party that had assumed Tupperware’s reimbursement obligation, Party Products would be required to repay the issuing bank.
Party Products filed a proof of claim on Spirit’s behalf and sought to enjoin the draw. The Court denied that motion and Spirit drew $9.5 million on the letter of credit. Party Products then commenced an adversary proceeding against Spirit, seeking a determination that the amount drawn exceeded the cap in section 502(b)(6) of the Bankruptcy Code. The cap limits landlord damages to the greater of either one year’s rent or fifteen percent of the remaining lease term (not to exceed three years)—in this case, less than the $9.5 million taken by Spirit. (See our previous client alert for a discussion of how this section caps landlord damage claims in bankruptcy cases.) Spirit moved to dismiss, arguing that because the letter of credit proceeds are not property of the estate, they are not subject to the limitation in section 502(b)(6) and that the filing of the proof of claim by Party Products was ineffective.
The Court denied the motion to dismiss. It first held that Party Products had standing to assert Spirit’s claim, including the ability to file a proof of claim for the landlord. This was significant because Spirit deliberately chose not to file its own proof of claim to avoid Bankruptcy Court jurisdiction and the Third Circuit’s decision in PPI. However, because a proof of claim had been filed, the Court concluded the claim could be subject to section 502(b)(6)’s cap under the Third Circuit’s ruling in PPI.
Crucial to the Court’s reasoning was its finding that the letter of credit appears to have been intended to function as a security deposit as the lease stated the letter was deposited as security for full performance of the tenant’s obligations under the lease. Having reached this conclusion, the Court held that the landlord’s recovery could be subject to the statutory cap based on PPI. It, therefore, allowed the complaint to proceed beyond the motion to dismiss stage without deciding whether Spirit’s draw ultimately violated section 502(b)(6) or the lease.
Conclusion
While landlords often view letters of credit as ideal security for lease obligations, section 502(b)(6) may limit the amount ultimately recoverable when a tenant files for bankruptcy. Tupperware underscores that the statutory cap may apply even where a landlord does not file a proof of claim or otherwise seek recovery directly from the estate—particularly if the debtor or another party files a claim on the landlord’s behalf. Landlords should closely monitor tenant bankruptcy cases for claims filed in their name and assess whether such claims create exposure under section 502(b)(6) or present procedural deficiencies that can be challenged. Landlords concerned about this risk should also consider the availability of other credit enhancements, including third-party guaranties, for tenant obligations that might be structured in ways to limit the impact of section 502(b)(6)’s claim cap.