N.Y. Real Property Law Journal| Summer/Fall 2004 | Vol. 32 | No. - PDF document

N.Y. Real Property Law Journal| Summer/Fall 2004 | Vol. 32 | No. 3 How Much Protection Does a Leasehold Mortgagee Need? Every real estate attorney, devel-oper, or investor who negotiates along-term ground lease (a “ N.Y. Real Property Law Journal| Summer/Fall 2004 | Vol. 32 | No. 3 dened Landlord unreasonably andunnecessarily, or covered a topichighly unlikely to become relevant—and one that probably can be dealtwith in some other reasonable way ifit ever does become relevant.Most Leasehold Mortgagee Pro-gagee’s interests without directlybenefiting the Tenant. Beyond such“pure” Leasehold Mortgagee Protec-ering a Lease as collateral will careabout all other terms of the Lease. Anearly every issue in the Lease. Anycussion of Leasehold Mortgagee Pro-cussion of Leases, not the intentionof this article. Nevertheless, a Tenantand a Leasehold Mortgagee share afew fundamental concerns. Theissues on that “short list” are oftenregarded as Leasehold MortgageeProtections, even though one mightmore aptly describe them as funda-Protections cover a few of those fun-damental “shared issues”beforeturning to issues oriented moredirectly toward Leasehold Mort-Leasehold Mortgagee Protectionswent into these Leasehold Mort-gagee Protections. Anyone can arguefor some other judgment call. Any-risks are inevitable in trying todefine any “middle ground” legalBeyond offering a “reasonable”set of Leasehold Mortgagee Protec-demonstrate straightforward, simple,and comprehensible legal writing,consistent with the author’s pub- even in sophisticated commercialreal estate transactional documents.No law requires lawyers to writelegal documents in a weird and per-verted form of pompous quasi-Eng-voluted verb structures, gracelessword piles to describe simple con-cepts, profligate use of the passivevoice, redundancy, and gratuitouscomplexity.on these Leasehold Mortgagee Pro-tic. Comments should be directed tojoshua.stein@lw.com.1.“of any property, or any interestin any property, under 11 U.S.C.ruptcy or insolvency proceedingaffecting the owner of suchproperty.2.“Bankruptcy Termination” means Tenant’s right totreat this Lease as terminatedunder 11 U.S.C. § 365(h)(1)(A)(i)or any comparable provision oflaw.3.“” means Landlord’sfee interest in the Premises,Landlord’s rever-sionary interest, all subject to4.“(a) foreclosure sale (or trustee’ssale, assignment in lieu of fore-closure, Bankruptcy Sale, or sim-ilar transfer) affecting the Lease-Mortgagee’s exercise of anyother right or remedy under able law) that divests Tenant of its5.“” means Ten-surrendering, or terminating thisLease, including upon Loss; (b)to a Bankruptcy Sale by Land- lord; (c) determining that a TotalLoss has occurred; (d) exercisingany Bankruptcy TerminationOption; (e) subordinating thisany other estate or interest in thePremises; or (f) waiving any6.“Lease Termination Noticedescribing in reasonable detailany uncured Tenant Defaults.7.“Leased Fee ValueEstate, considered as if unim-proved8.“of trust, mortgage, or other lien(each as modified from time tothe Leasehold Estate, and Ten-ant’s Preemptive Rights.9.“assigns), provided: (a) it is notan Affiliate of Tenant;Landlord has received notice ofits name and address and a copy10.“demnation affecting the Premis-11.“insurance proceeds or condem-nation award paid or payable12.“of the Premises and related cus-deed of the Improvements. Anyimmediately after this Lease ter-minated; (b) continue for theentire remaining term of thisoccurred, subject to any Preemp- N.Y. Real Property Law Journal| Summer/Fall 2004 | Vol. 32 | No. 3 not terminate this Lease, Tenant shallapply Loss Proceeds to restore theImprovements substantially as theyexisted before the Loss (subject toextent reasonably possible under thecircumstances.. To the extent thisLease requires Tenant to apply LossProceeds for a specified purpose,Loss Proceeds shall be disbursed:(a) from time to time under reason-procedures as Leasehold Mortgagee(or, absent any Leasehold Mort-gagee, Landlord) reasonablyrequires, except as this Lease other-wise provides; and (b) to Tenant,only if and when Tenant has accom-Fee Estate. AForeclosure Event shallWithout Landlord’s consent, atany time(s): (a) provided that anytaneously is, cured, Tenant mayate and complete any ForeclosureEvent and exercise any other rightsand remedies against Tenant and thegage; and (c) any transferee througha Foreclosure Event, and its succes-Any Lease Impairment madeforce or effect, and not bind Tenant,Leasehold Mortgagee, or New Ten- Any notice from Landlord toTenant shall have no effect unlessLandlord gives a copy to LeaseholdMortgagee. If any Tenant Defaultoccurs for which Landlord intends toexercise any remedy, Landlord shallpromptly give Leasehold Mortgageea Tenant Default Notice.Opportunity to CureLandlord shall accept LeaseholdMortgagee’s cure of any Tenantafter both: (a) Tenant and LeaseholdMortgagee have received the TenantDefault Notice for that TenantDefault; and (b) Tenant’s cure periodfor that Tenant Default has expired.If Leasehold Mortgagee cannot rea-sonably cure the Tenant Defaultwithin Leasehold Mortgagee’s cureperiod under the preceding sentence,reasonably needs so long as it pro-ceeds with reasonable diligence. IfLeasehold Mortgagee cannot reason-ably cure a Tenant Default withoutpossession, or if any Tenant-Specifictional time as it reasonably needs toconsummate a Foreclosure Eventand obtain possession, providedLeasehold Mortgagee timely exercis-es its cure rights for all other Tenantconsummates a Foreclosure Event,Landlord shall waive all Tenant-Spe-Cure Rights Implementationgagee’s time to cure a Tenant Defaultor consummate a Foreclosure Eventhas not expired, Landlord shall notrent, or otherwise interfere with Ten-session and quiet enjoyment of thegagee may enter the Premises to seekto cure a Tenant Default. This rightor its exercise shall not be deemed to reason (except with Leasehold Mort-gagee’s consent or because of a TotalLoss), even if Leasehold Mortgageefailed to timely exercise its curerights for a Tenant Default,lord shall promptly give LeaseholdMortgagee a Lease TerminationNotice. By giving notice to Landlordon or before the day that is ___ daysafter Leasehold Mortgagee receivesLandlord’s Lease Terminationrequire Landlord to promptly enterinto a New Lease with New Tenant.Landlord need not do so, however,unless New Tenant has, consistentwith the Lease Termination Notice:(a) cured all reasonably curable Ten-ant Defaults (except Tenant-SpecificDefaults); and (b) reimbursed Land-lord’s reasonable costs and expensesexpenses) to terminate this Lease,recover the Premises, and enter intorequests a New Lease in conformitywith this Lease, then from the datethis Lease terminates until the par-Lease, Landlord shall not: (a) operatethe Premises in an unreasonable(c) lease any Premises except to NewTenant. When the parties sign a NewLease, Landlord shall transfer toNew Tenant all Subleases (includingany security deposits Landlordheld), service contracts, Premiseslord collected from the Premises dur-ing the period described in the previ-ous sentence, and Landlord shallTenant’s Leasehold RightsIf Tenant’s period to exercise anyPreemptive Right expires, Landlordshall promptly notify Leasehold N.Y. Real Property Law Journal| Summer/Fall 2004 | Vol. 32 | No. 3 tion, Advanced Real Estate Practice(2000); and N.Y. Mortgage Bankers Ass’n“minimum” Leasehold Mortgagee Pro-discussion of ground lease issues, alter-natives, negotiations, and closing proce-dures. The author periodically updatesthe various Leasehold Mortgagee Protec-tions and related materials. Current ver-sions may be obtained from the authorand will appear in the author’s book onground leases to be published by the6.This is not a representation or warranty.Any prospective Leasehold Mortgagee7.The negotiation process can, however,8.Beyond the “shared issues” coveredhere, a Leasehold Mortgagee would looknext at these issues: remaining term,transferability, rent adjustment (startingwith the absolute clarity of any revalua-ronmental matters.9.Whatever topics these Leasehold Mort-gagee Protections omit are generallycovered, often at length, in the author’s“maximum” Leasehold Mortgagee Pro-Writing Clearly andEffectively: How to Keep the Reader’s Atten-, N.Y.S. Bar Ass’n Journal, July–Aug.Template for a Template: AChecklist To Prepare or Improve Any Model, The Practical Lawyer, Apr.reprinted inReal World Docu-stance(ALI-ABAprofessional skillsApr. 2002, at 151; Terms to Make Transactional DocumentsWork Better, The Practical Lawyer, Oct.Cures for the (Sometimes), Real Estate Review, Fall 1995, at11.American Lawyer, Oct. 2002, at 59. Here,tences; (2) get rid of words, sentences,prefer verbs to nouns; (4) question use ofany word that includes “here”; try tosubstitute something less legalistic; (5)use simple words if you can; (6) use theactive voice; and (7) write larger num-bers as numerals. These principles arehardly new. , William Strunk, Jr.ed. 2000). The legal profession still 12.“Premises” should include appurtenant13.The Lease should say once that14.The Lease should say once that “or”15.Though “modification” seems synony-one often sees all three words piledtogether. It hardly seems necessary.16.The Lease should say once that “notice”means “written notice” delivered in acertain way.17.This assumes the Lease originallydemised raw land. Valuation of theincluding nuances such as how to treat18.For this and other value-related provi-appraisal procedures. Usually the par-ties find three appraisers, who mustchoose either Landlord’s or Tenant’sproposed result—“baseball arbitration.”Many believe this process gives bothparties an incentive to act reasonably.19.Mezzanine lenders may also wantLeasehold Mortgagee Protections. Land-lord may say a mezzanine lender is justan equity investor and should rely on itsrights it relies on for repayment—instead of bothering Landlord. Landlordmay want to limit the amount, number,hold Mortgages secure. Such limitationsare generally not market standard orappropriate, at least after Tenant hasment. After that: (a) any LeaseholdMortgagee merely creates a possiblefuture Lease transfer through a Foreclo-sure Event; (b) Landlord should notcare; and(c) even if overleverage creates sometheoretical possibility of temporarilydeferring Landlord’s rental income,Landlord’s concerns are not compelling.Tenant will usually agree that any Lease-(3) not be related to Tenant, with someand reasonable criteria. These conces-sions will cause definitional issues, com-plexity, and risk of obsolescence (for20.Depending on circumstances, Tenantmay want to provide for joint venture21.Landlord may also want copies ofunrecorded loan documents and futureamendments. Neither request seems jus- 22.Who estimates restoration cost? Omis-sion of a detailed estimation procedureleaves a tolerable level of uncertainty,23.ALeasehold Mortgagee will usually tol-erate a somewhat narrower permitteduse. Any such narrowing affects thefinanceability, provided the permitteduses still make sense, allow reasonableflexibility, and will not intolerably limitLeasehold Mortgagee’s resale of theLease after a Foreclosure Event.24.Landlord may also want Subtenant toagree to pay Subrent (and any Subleasetermination payments) directly to Land-lord. Landlord (and its Fee Mortgagees)may hesitate to “nondisturb” (or “recog-nize”) all future Subtenants, even underthe conditions stated. Landlord mayargue that once the Lease terminates,Landlord should recover clear posses-pieces of Tenant’s failed developmentplans. Tenants and Leasehold Mort-of any future major Subtenant; rejectLandlord’s position; and win that dis-cussion despite Landlord’s good argu-25. The possibility of a Loss and its varia-Lease or loan agreement. Landlords,Tenants, Leasehold Mortgagees, andtopic, creating new categories, condi-degree they want or can stand. Of all theissues Leasehold Mortgagee Protectionscover, treatment of Loss is the one leastsuited to a “one size fits all” resolution,but also the one where cost-benefit con-Leasehold Mortgagee Protections makea valiant effort. One lawyer has pro-posed, not entirely as a joke, that thetion clauses; (b) require any condemnorto compensate each holder of an interestin the condemned property separatelyfee from each real estate transaction toestablish a “condemnation undercom-pensation protective fund”; and (d) uselender ever undercompensated for ation terminates a Lease, may producethe right result. No Leasehold Mort-gagee would ever rely on that proposi-tion, however.)26.Even if Landlord has agreed to allowLandlord can legitimately set standardsfor who may hold Loss Proceeds. If athird party might hold Loss Proceeds, N.Y. Real Property Law Journal| Summer/Fall 2004 | Vol. 32 | No. 3 not impair financeability. LeaseholdMortgagee will want Tenant to haveample cure periods and dispute rightseven before Leasehold Mortgagee’s cure40.Landlord may want a shorter cure peri-od for failure to insure. This soundscompelling, but probably not practical ornecessary. Landlord should rely on itstoring; a requirement for prior notice ofcancellation from the carrier; and theright to force-place single-interest cover-age quickly at Tenant’s cost.41. Landlord may argue that this gives agation was more than ___ days past due.42.If a dispute exists about any of theseWhether this is reasonable may dependin part on the nature of the dispute.43.From Lease termination until New Leaseexecution, the Lease could control Land-lord’s interim leasing program, Subleas-es, and operations. Given how rarely (ifever) any Landlord has ever terminateda Lease and then entered into a NewLease, the topic probably does not meritthe attention and verbiage it can receive.These Leasehold Mortgagee Protectionscover it in a minimal and “broad brush”way.44.This concept is not standard, but some45.Landlord may argue that certain rightsof Tenant under the Lease should goaway while Tenant is in default, evenwant the right to exercise them.46.This assignment should also appear in47.Many Leases address the BankruptcyTermination Option at great length.Impairment. Looking ahead, if Landlordrejects the Lease and Tenant exercises noBankruptcy Termination Option, the bankruptcy code lets Tenant offset dam-ages against rent. Incorrect offsets canconceivably produce Lease terminations.gagee approve each offset. These Lease-hold Mortgagee Protections contain nosuch procedures, because such offsetsare quite rare, and if problems ariseLeasehold Mortgagee can reasonablyprotect itself through normal notices ofdefault and, if necessary, preemptive liti-48.Arecent Seventh Circuit case allowed aLandlord to destroy a Lease by sellingthe leased property through a Bankrupt-cy Sale—a Lease destruction techniquethat ground lease practitioners hadnever before envisioned. SeePrecisionIndustries v. Qualitech, 327 F.3d 537, 547(7th Cir. 2003). The result sounds quitealarming, especially if one believes thehysteria that many law firms expressedcould, however, easily have preventedthe problem, and saved its Lease, just byasserting its rights under the BankruptcyCode. It apparently failed, forgot, ordecided not to exercise those rights,stands foronly three principles. First, anyone whoholds an interest in real estate mustmonitor its position and act proactivelyto protect it when necessary. Second,ground leases. Third, bad cases produce49.Much like cure rights, a Leasehold Mort-be more theoretical—monitoring50.Tenant will want any Leasehold Mort-gagee not to exclude Tenant unless theLoan is in default, and perhaps not even51.The senior Leasehold Mortgagee maywant more control than this paragraphgrants. All Leasehold Mortgagees needan intercreditor agreement.52.This clause “c” governs as betweenLandlord and Leasehold Mortgagees asa group. The most senior LeaseholdMortgagee might want to go further,reserving the right to decide that no oneat all shall exercise a particular Lease- hold Mortgagee Protection. That issuebelongs in an intercreditor agreement,not Leasehold Mortgagee Protections.53.Landlord may want Leasehold Mort-ally cure a Tenant Default, especially ifconstruction-related. Leasehold Mort-walk” at any time, regardless of howlong Landlord may have had to “waitaround,” and will point out that allbeen kept current. The outcome varies.ner in the New York office of Lath-am & Watkins LLP, is First Viceare available at http://www.real-estate-law.com. Recently, he servedCommercial Leasing(NYSBA2004).ter in the author’s recent book, Lender’s Guide: Structuring andClosing Commercial Real Estatetion Campus MBA2004). Arevisedbecome part of the author’s upcom-Chadakoff, Andrew L. Herz, JamesI. Hisiger, Donald H. Oppenheim,Robert M. Safron, and Bruce M.joshua.stein@lw.com). N.Y. Real Property Law Journal, Summer/Fall 2004, Vol. 32,No. 3, published by the New York State Bar Association, One Elk Street, Albany, New York 12207.