The bankruptcy cap applies to the claim before the recovery rate, so a leaseback investor gets back far less of the rent it loses than a simple recovery assumption suggests.
When a leaseback tenant in Chapter 11 rejects the lease, the landlord's claim for future rent is capped by section 502(b)(6) of the US Bankruptcy Code at the greater of one year's rent or 15 per cent of the remaining term, never more than three years, plus rent unpaid at filing, and that capped claim is generally unsecured. On an illustrative $10.0m leaseback with 15 years left, a 2 per cent escalator and $31.1m of damages after re-letting, the allowed claim is $23.6m, and at a 35 per cent unsecured recovery the landlord collects $8.3m, about a quarter of what it loses.
Worked in full in Sale and Leaseback by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A sale and leaseback is priced on the tenant's promise to pay rent for the full term. In a US bankruptcy the tenant can break that promise: section 365 lets it assume or reject each unexpired lease, and section 502(b)(6) limits what the landlord can claim for the rent it will not receive. The cap is the reason a leaseback investor's loss in a tenant failure is mostly the gap between contract rent and market rent, not a claim it can collect. This is arithmetic on stated assumptions, not legal advice; the outcome in a real case turns on the lease, the court and the plan.
| Input | Value |
|---|---|
| Rent in the first year after filing | 10.0 |
| Fixed annual escalator | 2% |
| Term remaining at the petition date, years | 15 |
| Rent unpaid at filing, months | 1 |
| Months before the lease is rejected, rent paid meanwhile | 7 |
| Void after rejection, months | 18 |
| Re-letting rent, share of contract rent | 80% |
| Discount rate for damages | 7% |
| Recovery on general unsecured claims, illustrative | 35% |
Seven months reflects the timetable for a non-residential lease: the debtor has 120 days to assume or reject, extendable by 90 days for cause, 210 in all, and further only with the landlord's consent. Until then it must keep paying rent, so those months are not part of the loss. The re-letting rent sits at 80 per cent of contract because leaseback rents are often set above market, the over-rent worked in does the over-rent repay the over-price.
Step 1: the landlord's damages. From month 7 to the end of the lease, contract rent less re-letting rent, which is nil during the 18-month void. Discounted monthly at 7 per cent, the shortfall is $31.1m ($45.6m undiscounted), against $100.0m of contract rent still to come over the same period, also in present value.
Step 2: the cap. Fifteen per cent of 15 years is 2.25 years, more than one year and less than three, so the 15 per cent limb applies. Courts have split on what it measures.
Time reading: rent reserved for the first 2.25 years after filing = 10.00 + 10.20 + 0.25 × 10.40 = $22.80m
Rent reading: 15% × total remaining rent of $172.93m = $25.94m, within three years' rent
Allowed claim = min(damages, cap) + rent unpaid at filing
Excel, rent reading: =MAX(Rent1,MIN(15%*SUM(Rents),SUM(First36MonthsRent)))
The rent reading gives more whenever rent escalates, because 15 per cent of a back-loaded stream is worth more than the first 27 months of it.
Step 3: the claim and the cash. Damages of $31.1m exceed both caps, so the cap binds.
| Reading of the cap | Capped damages | Plus unpaid rent | Allowed claim | Cash at 35% | Share of the loss | Unrecovered |
|---|---|---|---|---|---|---|
| Time | 22.80 | 0.83 | 23.6 | 8.3 | 25.9% | 23.7 |
| Rent | 25.94 | 0.83 | 26.8 | 9.4 | 29.3% | 22.6 |
The landlord loses $31.9m in present value, the damages plus the month unpaid at filing, and recovers $8.3m to $9.4m. The cap cuts the claim to 73.3 per cent of the damages on the time reading, and the unsecured recovery does the rest. The landlord still owns the building, and its re-let value is already netted in the damages. What it cannot recover is most of the over-rent and the void, which is why the pricing of a leaseback has to treat that gap as credit exposure to the tenant, not as property value.
| Years left | Years of rent in the cap | Cap, time reading | Cap, rent reading | Rent remaining | Cap as % of remaining, time |
|---|---|---|---|---|---|
| 3 | 1.00 | 10.0 | 10.0 | 30.6 | 32.7% |
| 5 | 1.00 | 10.0 | 10.0 | 52.0 | 19.2% |
| 10 | 1.50 | 15.1 | 16.4 | 109.5 | 13.8% |
| 15 | 2.25 | 22.8 | 25.9 | 172.9 | 13.2% |
| 20 | 3.00 | 30.6 | 30.6 | 243.0 | 12.6% |
| 25 | 3.00 | 30.6 | 30.6 | 320.3 | 9.6% |
Below about six and two-thirds years the one-year floor applies; from 20 years the three-year ceiling does. A long leaseback, the structure sellers prefer because a longer lease supports a higher price, is exactly where the claim covers the smallest share of the rent at stake: 9.6 per cent with 25 years left. Length adds value only as long as the tenant stays solvent, which is the trade-off in how lease length changes a leaseback price.
The common mistake is to model a tenant failure as a claim for the remaining rent, or for the full damages, multiplied by a recovery rate. Here that would give 35 per cent of $31.9m, $11.2m, against $8.3m under the cap. The cap applies to the claim, before the recovery rate, and on a portfolio the tenant may also reject only the weaker sites, which is what a master lease is drafted to prevent.
Price a leaseback tenant's insolvency in three steps: damages after re-letting, the 502(b)(6) cap on both readings, then the unsecured recovery. On this lease $31.9m of loss becomes $8.3m to $9.4m of cash. Two features change the answer and belong in legal diligence: whether a court could recharacterise the transaction as a financing, in which case the investor would generally be treated as a lender rather than a landlord, section 502(b)(6) would not govern its claim, and its position would turn on whether it holds security, and what deposit, letter of credit or guarantee sits behind the rent. The companion files include the free workbook for this case, whose recovery column carries the same logic for a nine-building portfolio.
It limits a landlord's claim for rent after a rejected real property lease to the greater of one year's rent or 15 per cent of the remaining term, not exceeding three years, measured from the earlier of the filing and repossession, plus rent unpaid at that date. With 15 years left, 15 per cent is 2.25 years of rent, $22.80m on an illustrative $10.0m escalating lease.
Courts have split. One reading takes the rent for 15 per cent of the remaining time, the other 15 per cent of the total remaining rent. With a 2 per cent escalator and 15 years left, the illustrative cap is $22.80m on the time reading and $25.94m on the rent reading, since escalating rent is back-loaded.
Under a non-residential lease the debtor must keep performing until it assumes or rejects, and it has 120 days to decide, extendable by 90 for cause, 210 in all, longer only with the landlord's consent. In the illustrative case seven months of rent, $5.83m, is paid before rejection and is not part of the claim.
This article is one calculation from Sale and Leaseback. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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