Whenever Landlord and Tenant negotiate a long-term ground lease (a “Lease”), two major issues that come to mind, after the rent, relate to protection of Leasehold Mortgages and creation of a financeable Leasehold Estate. As important as those issues are, though, the parties also need to think about Fee Mortgages and how they interact with the Lease.
Just like any Leasehold Estate, the Fee Estate needs to be financeable. The ability to finance both the Fee Estate and the Leasehold Estate, potentially to support more debt than if a single party owned the entire Premises, represents a fundamental reason to create Leases. Any Lease should therefore include a limited set of Fee Mortgagee protections. Those protections should recognize that Fee Mortgagees have concerns that are similar to, but narrower than, those of Leasehold Mortgagees.
This article looks at Fee Mortgage issues from five perspectives:
1. Fee Mortgagee’s generic due diligence in reviewing a Lease;
2. Fee Mortgagee’s other concerns;
3. Tenant’s concerns;
4. Landlord’s concerns; and
5. The interplay between a Fee Mortgage and rights of first offer, first refusal, or some variation (“First Rights”).
After summarizing Fee Mortgage issues considered from those five perspectives, with some sample language in a few cases, this article then offers a complete set of sample provisions Landlord could add to a Lease to address the Fee Mortgage concerns raised in this article.
Wherever this article offers sample language, italics indicate noncrucial (or possibly “overkill”) provisions that sometimes appear, but are not strictly essential.
FEE MORTGAGEE’S GENERIC DUE DILIGENCE
When a prospective Fee Mortgagee reviews a Lease for a Loan to be secured by the Fee Estate, Fee Mortgagee starts by asking some questions about the Lease, much as a Landlord or prospective Landlord would:
- Will the Rent support the Fee Mortgage?
- Does the Lease shift all Premises-related obligations and burdens to Tenant?
- Does Landlord have any residual risks or obligations?
- Can Tenant assert any offsets or reductions against Rent?
- Does Tenant have any termination rights?
- Does the deal require a creditworthy Tenant or Guarantor? If so, does the Lease adequately provide that? And does the deal structure seek to assure that any creditworthy party will stay creditworthy?
- Do the development-related provisions of the Lease mitigate any risk of development failure?
- Do the insurance provisions make sense and match Fee Mortgagee’s expectations?
- Does the Lease obligate Landlord to give Leasehold Mortgagees or Subtenants any rights or protections that could turn out to be burdensome, such as an obligation to nondisturb a substantially below-market or abusive Sublease?
Beyond the typical Landlord’s agenda in any Lease though, Fee Mortgagee will have a few additional concerns, placing more weight than a typical Landlord on some other concerns, because lenders worry more than borrowers about some of those things. The following due diligence checklist represents an idealized version of what Fee Mortgagee would like to see in a Lease. To the extent the Lease does not live up to that standard, Fee Mortgagee will need to evaluate the risk and either figure out a way to live with it (basis points can solve a lot of problems), persuade Landlord to obtain (pay for) a Lease amendment, or not make the Loan.
This due diligence checklist does not purport to be exhaustive. It just touches some major bases, without detail. This discussion disregards generic real estate issues that would arise if the Lease did not exist at all and are not affected by the existence of a Lease.
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JOSHUA STEIN For information on the author, visit www.joshuastein.com. The author appreciates helpful comments from James M. Carolan, of Steptoe & Johnson LLP; Kenneth M. Jacobson, of Katten Muchin Rosenman LLP; Alfredo R. Lagamon, Jr., of Ernst & Young LLP; Donald H. Oppenheim, of Berkeley, CA; Alexa Klein, Deborah Goldman, James Patalano, and Lauren Silk, of the author’s legal staff; and Robert G. Harvey, of the author’s editorial staff. Blame only the author for any errors, omissions, politically incorrect opinions, or injudicious or hurtful comments. The author reserves the right to assert positions inconsistent with this article, which is offered for discussion only. To be notified of publication of the second edition of the author’s book on ground leases, or to submit comments on this article, send email to email@example.com. Copyright © 2018 Joshua Stein. An earlier version of this article appeared in the ACREL Papers, Fall 2018 (New Orleans), published by ALI CLE.
This article will become part of the second edition of the author’s book on ground leases, expected to appear in 2019. Consistent with the style of that book, this article capitalizes, without definition, many terms that any Lease would ordinarily define and capitalize. It is assumed that readers know what those terms mean and can easily find or write s