YOU RE GROUNDED : ADDRESSING FINANCING ISSUES RELATED TO GROUND LEASES. Joe M. Doren P:

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1 YOU RE GROUNDED : ADDRESSING FINANCING ISSUES RELATED TO GROUND LEASES Joe M. Doren E:jdoren@fbtlaw.com P:

2 LEASES- WHAT IS A GROUND LEASE? Ground Lease v. Space Lease. Common Characteristics of Ground Lease: Undeveloped, separately subdivided tract. Whole tract leased to ground lessee. Ground lessee has right to develop and sublease tract. Long lease term. Ground lessee has all responsibilities of ownership. Common Characteristics of Space Lease: Only a portion of the larger tract leased to lessee. Lessor retains control rights over property. Shorter terms. Lender financing of Ground Leases v. Space Leases. Reversionary interests in ground lessor/lessor.

3 LEASES- LEASEHOLD MORTGAGEE PROTECTIONS Lenders perceive leasehold collateral as higher risk collateral than fee interests, and will treat a ground lease with a high-level of scrutiny. In determining whether or not a ground lease is financeable, a lender will look for the following leasehold mortgagee protections contained within the ground lease or through an ancillary agreement: Adequate length of ground Lease term (fully amortizing loans v. non-fully amortizing) Ability to encumber leasehold estate with a security instrument. No amendment, modification of ground lease without leasehold mortgagee consent. Notice of defaults/opportunity to cure (including sufficient time to acquire title in order to cure). Ground lease is assignable to a leasehold mortgagee upon acquisition of leasehold title and further assignable thereafter (without consent).

4 LEASES- MORTGAGEE PROTECTIONS (Cont.) Casualty/Condemnation proceeds and awards can be applied to pay down loan. Each of leasehold estate and fee estate are entitled to their own separate condemnation awards. New lease upon termination of ground lease for any reason (expressly including rejection or disaffirmation in a bankruptcy or any other law affecting creditor s rights). No merger of fee and leasehold estates. Ground lease and leasehold mortgage are not required to be subordinated to a fee mortgage (even with receipt of SNDA/NDA). Ground lessor waives all non-curable defaults upon acquisition of title by leasehold mortgagee. Leasehold mortgagee has right to exercise any lease extension options on behalf of ground lessee.

5 LEASES- COMMON GROUND LEASE SHORTFALLS Antiquated ground lease does not contain any leasehold mortgagee protection provisions. Term of ground lease does not go beyond loan amortization period (refinance risk). Deficient new lease provisions. Rights of first refusal/options to purchase (fee owner can purchase improvements). Recapture provisions- space lease form operating as ground lease. Restrictions on assignment/subleasing. Ground lease is required to be subordinated to fee mortgage. Affiliate ground lessor. Insurance proceeds held by ground lessor or other third party.

6 LEASES- CURING GROUND LEASE SHORTFALLS Amendments to lease (Agreement of ground lessor). Lease termination insurance policies (high price and only few carriers). Fee owner joins in mortgage. Recourse carveouts (for non-recourse loans).

7 LEASES- AVOID THESE DEFICIENT PROVISIONS Subordination to an existing or future fee mortgage: This Ground Lease shall be subject and subordinate to any mortgage or mortgages on Ground Lessor s interest in the Leased Premises, upon such mortgagee granting to Ground Lessee non-disturbance pursuant to a subordination, nondisturbance and attornment agreement Note that SNDAs/NDAs are executory contracts which can be rejected in bankruptcy of fee mortgagee, and fee mortgagee can wipe-out ground lease in foreclosure.

8 LEASES- AVOID THESE DEFICIENT PROVISIONS Fee Owner Fee Mortgage Fee Mortgagee NDA/SNDA Leasehold Owner Leasehold Mortgage Leasehold Mortgagee

9 LEASES- AVOID THESE DEFICIENT PROVISIONS Assume big box store wants to move into a shopping mall, but wants to own and construct its own building. The box store ground leases a piece of land from the shopping mall owner and immediately assigns the lease to developer to lease-back to the big box store upon completion of construction. Ground lease (now between shopping center owner and developer) contains this provision: In connection with an assignment or sublease of this lease, ground lessee shall pay to landlord 50% of the rent received by ground lessee from such sublease/assignment which is in excess of the rent payable under this ground lease Fatal financing flaw-recapture type provision. Space lease concept stuck in to a ground lease.

10 LEASES- AVOID THESE DEFICIENT PROVISIONS Deficient new lease provision: In the event of a termination of this ground lease or any extension thereof prior to expiration of the term of this lease, ground lessor will enter into a new lease with leasehold mortgagee on the same terms and conditions as this lease Does not specifically reference rejection or disaffirmation of the lease in a bankruptcy. In a CMBS transaction, this will result in a pricing adjustment if not amended or clarified. New lease should be of equal priority.

11 LEASES- TRENDS Case Law Lender Preferences. Ground Lessor Pushback. Developer Leases. Sandwich Leases Mezzanine Lender (entitled to protections?)