Drafting a Ground Lease When the Underlying Tenant Will Be a Single-Use Entity

Term

The primary provisions that must be compatible and flexible in both leases are those that pertain to the ground lease term, ie, satisfaction of all conditions precedent prior to commencement, the right to early termination and the option of extension. The Ground Lessee/Sublessor should ensure that its obligations to commence the ground lease and to make rental payments do not begin until the Tenant's sublease commences. The Ground Lessee/Sublessor does not want to be obligated to pay rent under the ground lease at a time during which it is not receiving rent from the Tenant under the Tenant's sublease. In addition, if the Tenant has the right to early termination of its sublease, the Ground Lessee/ Sublessor must also have the right to early termination of the ground lease. Unlike a situation in which the Ground Lessee/Sublessor leases to multiple tenants, if the single-use Tenant opts out of its sublease, the Ground Lessee/Sublessor may not be able to replace such a tenant easily. Thus, if the Tenant chooses to terminate its sublease, the Ground Lessee/Sublessor must also be able to terminate its ground lease. Similarly, in the event that the Tenant has the option to extend its sublease, the Ground Lessee/Sublessor must also have the option to extend the ground lease. Thus, not only must the term of the ground lease be compatible with the sublease, but the ground lease must also be flexible enough to allow the Ground Lessee/Sublessor the right to terminate early, or to extend the term, based on the terms of the sublease and on the actions of the Tenant.

Sample clause:

Conditions Precedent

This Lease and the duties and obligations of the parties herein are expressly made contingent upon the following conditions precedent: (a) the Commencement of Tenant's lease with Ground Lessee/Sublessor. …

Condemnation

One of the primary issues involved with a ground lease of this type is the negotiation of the condemnation clause. The condemnation clause must balance the interests of the Ground Lessor, the Ground Lessee/Sublessor, the Tenant, and the leasehold mortgagee. The leasehold mortgagee likely will insist that it have a first priority claim on the Ground Lessee/Sublessor's share of the award to be applied toward the payment of any outstanding balance on its loan, or that such award be used to restore the premises.

The Ground Lessor will seek to be compensated for loss in value of its fee estate, while the Ground Lessee/Sublessor will seek compensation for loss in value of the sublease and any improvements constructed by it. Finally, the Tenant will seek a portion of the award for loss due to displacement.

Sample clause:

Condemnation

If any taking or condemnation occurs in a judicial proceeding in which specific condemnation awards are made separately to Ground Lessor and Ground Lessee/Sublessor, then in that event such condemnation awards shall be binding upon Ground Lessor and Ground Lessee/Sublessor, and shall limit and define the rights of each party in and to such condemnation awards. Both Ground Lessor and Ground Lessee/Sublessor may seek a condemnation award for their respective interests. Condemnation awards awarded by virtue of the taking or condemnation of all or any part of the Improvements and/or the Premises, whether by consent of the parties or any judicial proceeding, where condemnation awards are not made to Ground Lessor and Ground Lessee/Sublessor separately, shall be divided between Ground Lessor and Ground Lessee/Sublessor as may be mutually agreed, subject to the rights of any Leasehold Mortgagee, giving consideration to the value of the rights and interests of each party in and to the Improvements and the Premises.

Ground Lessee/Sublessor and [Tenant] may claim and recover from such lawful authority causing the taking or condemnation, but not from Ground Lessor, such compensation as may be separately awarded or recoverable by Ground Lessee/ Sublessor or [Tenant], in their own right on account of any and all damages to Ground Lessee/ Sublessor's and [Tenant's] businesses by reason of such taking or condemnation, and any condemnation award which may be made under federal, state or local law for moving expenses, for the taking of personal property, or for damages for business interruption or displacement.

Use/Right to Modify

A situation may arise in which, although the Tenant's sublease has terminated early, the Ground Lessee/ Sublessor does not want to terminate the ground lease. Moreover, the Tenant may have included in its lease the right to change its use or to modify its structure. The ground lease, therefore, must allow the Ground Lessee/Sublessor to change the use or to modify the structure, provided no diminution in the value of the Ground Lessor's interest results.

Sample clause:

Use/Right to Modify

Ground Lessee/Sublessor may use the Premises for the Initial Use and for such other income producing uses as may be permitted by law. Ground Lessee/Sublessor shall not use or occupy, or permit all or any part of the Premises to be used or occupied for any unlawful or illegal business, use or purpose, or in any manner constituting a nuisance of any kind. Subject to all applicable restrictions, building and fire codes, zoning ordinances and other governmental regulations, Ground Lessee/Sublessor or [Tenant] may, at its sole cost and expense, and at any time and from time to time, make such repairs, additions, alterations and replacements in and to the Premises and the Improvements, as Ground Lessee/ Sublessor or [Tenant] deems desirable; provided such repairs, additions, alterations and replacements shall not result in a decrease in the value of the Improvements.

Exclusivity

The ground lease should contain an exclusivity clause for several reasons. First, when the Tenant is a single-use entity, the Ground Lessee/Sublessor will know at the time of ground lease negotiations the use to which the parcel will be put. In addition, the Tenant will most likely seek a strong exclusivity clause in its lease with the Ground Lessee/Sublessor. Finally, the Ground Lessor may own additional land contiguous to, or nearby, the parcel, and the Ground Lessee/Sublessor may have an interest in optimizing the potential of the Tenant to succeed, perhaps because it is receiving percentage rent, or perhaps because of the difficulty the Ground Lessee/ Sublessor would endure in the event that the Tenant defaulted. It is to the benefit of the Ground Lessee/ Sublessor, therefore, to obtain an exclusivity clause in its ground lease.

Environmental Issues

The Ground Lessee/Sublessor will seek to limit any exposure it may have in terms of environmental liability because the only contact it has to the land is during the construction process. The Ground Lessee/ Sublessor should seek a strong indemnity provision from the Ground Lessor to protect it from any environmental liability that could arise as a result of the Ground Lessor's actions, and it should also seek representations and warranties from the Ground Lessor regarding hazardous substances on the premises prior to the commencement of the ground lease. Furthermore – although it may be unlikely – the Ground Lessee/Sublessor should attempt to force the Ground Lessor to look solely to the Tenant in the event of any environmental liability, and vice versa, unless such liability was caused by the Ground Lessee/ Sublessor. The Ground Lessor may be amenable because it would have recourse against an established, AAA-rated entity, rather than the typical single-asset holding company. Thus, in its lease with the Tenant, the Ground Lessee/Sublessor should obtain a strong indemnity from the Tenant regarding any environmental liability resulting from Tenant's use, and the Ground Lessee/Sublessor should limit its own indemnity to any liability resulting from its construction of the premises.

Sample clause:

Environmental

Ground Lessor shall defend, indemnify and save harmless Ground Lessee/Sublessor from and against any and all liability, damage, penalty, judgment, cost and expense, including, without limitation, reasonable attorneys' fees and expenses, arising from loss, damage or injury to person or property sustained by anyone on or about the Premises resulting from any act or omission of Ground Lessor, its agents, employees or contractors. Ground Lessor shall, at its sole cost and expense, defend, indemnify and save harmless Ground Lessee/Sublessor against any and all suits or actions (just or unjust) which may be brought against Ground Lessee/Sublessor or in which Ground Lessee/Sublessor may be impleaded with others upon any claim(s) related to the Premises prior to the Lease Commencement Date, including, but not limited to, any claims arising from the existence of Hazardous Materials on the Premises prior to the Lease Commencement Date as more fully described in Section __ hereof, except as may result from an act, omission or negligence of Ground Lessee/Sublessor, its agents, employees, subtenants or contractors.

Ground Lessor covenants, represents and warrants that the Premises shall, at the time Ground Lessee/Sublessor takes possession, be free of Hazardous Substances. [Tenant] shall be fully liable for any and all costs and expenses related to the presence or disposal of a Hazardous Substance on or about the Premises by [Tenant], its agents, employees, contractors and invitees. Ground Lessor shall defend, indemnify and hold harmless [Tenant] and its agents from and against any and all claims, demands, penalties, fines, liabilities, settlements, damages, costs and expenses (including, without limitation, reasonable attorney's fees, consultant's fees, court costs and litigation expenses) of whatever kind or nature known or unknown, contingent or otherwise, arising out of, or any way related to, a Hazardous Substance not brought onto the Premises by Ground Lessee/Sublessor or [Tenant]. The terms, covenants and conditions of this Subsection shall be in addition to any other obligation and liability that Ground Lessor may have to Ground Lessee/Sublessor at law or in equity, and shall survive the expiration or other termination of this Lease.

Default

It is essential that, in the event of any default by the Ground Lessee/ Sublessor, the Tenant have an opportunity to cure such default. Thus, the ground lease should provide that any notice of default be sent to the Tenant, and should provide the Tenant with an opportunity to perform on behalf of the Ground Lessee/Sublessor. The ground lease could also allow the Tenant to pay its rent directly to the Ground Lessor in the event of a Ground Lessee/Sublessor default.

Sample clause:

Right to Cure

Any assignee or subtenant, including the [Tenant], shall be bound by the terms and conditions of this Lease. Any act required to be performed by Ground Lessee/Sublessor pursuant to this Lease may be performed by any subtenant of Ground Lessee/Sublessor occupying all or any part of the Premises, and the performance of such act by a subtenant shall be deemed to be performance by Ground Lessee/Sublessor and shall be acceptable by Ground Lessor as Ground Lessee/Sublessor's act; provided, such subtenancy has been approved (if such approval is required) by Ground Lessor pursuant to the terms and conditions of this Lease.

Simultaneous with the sending of any written notice to Ground Lessee/Sublessor, Ground Lessor shall send copies of such notice to such subtenant and Leasehold Mortgagee, which Ground Lessor is notified of, in writing, from time to time.

The lease with the such subtenant shall provide that in the event Ground Lessee/Sublessor is in default under any of the terms and conditions of this Lease and if Ground Lessee/Sublessor fails to cure said default within the expiration of applicable cure periods, such subtenant shall be obligated to pay all rentals directly to Ground Lessor, until such time as said default has been cured, at which time such subtenant shall continue to pay an amount equal to the Minimum Annual Rent directly to Ground Lessor for the remainder of the Primary Term or Extended Term, if applicable.

Financibility

When drafting a ground lease of this type, care must be taken to ensure the financibility of the lease. To be financible, the ground lease must 1) provide a leasehold mortgagee with an opportunity to cure any default, and 2) be freely assignable by the Ground Lessee/Sublessor and the leasehold mortgagee. Thus, in addition to notifying the Tenant of any default (as mentioned above), the Ground Lessor must provide written notice to the leasehold mortgagee of any event of default and provide the leasehold mortgagee with an opportunity to cure such default. The ground lease must provide the leasehold mortgagee with the right to exercise all of the Ground Lessee/Sublessor's rights under the ground lease.

Conclusion

The situation in which a Ground Lessee/Sublessor enters into a ground lease knowing that it will then sublease to a single-use entity is unique and must be addressed accordingly. By making the ground lease compatible with such Tenant's lease, by remaining flexible enough to address any of Ground Lessee/ Sublessor's concerns resulting from the Tenant's actions during the term of its sublease, and by enabling the ground lease to be financible, the drafter of the ground lease will ensure that the ground lease meets the needs of the Ground Lessee/Sublessor.

Commercial real estate professionals often draft ground leases for those situations in which a tenant (the “Ground Lessee/Sublessor”) leases land from a fee owner (the “Ground Lessor”) to be developed into a shopping center or some other development with a mix of retail or other commercial tenants. Numerous occasions arise, however, in which a ground lease is needed because the Ground Lessee/Sublessor intends to sublease the parcel to a single-use tenant entity (the “Tenant”). When drafting the sublease for this Tenant, the real estate practitioner must tailor the ground lease to take into account the specific requirements of the Tenant's sublease.

The attorney representing the Ground Lessee/Sublessor should follow certain key principles: compatibility, flexibility, and “financibility.” Specifically, the terms of the ground lease must work in concert with the Tenant's sublease and be compatible so that the Ground Lessee/Sublessor is adequately protected.

The principles of flexibility and compatibility refer simply to the need of the Ground Lessee/Sublessor to ensure maximum freedom to react to decisions made by the Tenant and to give the Tenant the flexibility it expects or demands during the term of the Tenant's sublease. Most importantly, the ground lease must be drafted in such a way that it remains financible. By adhering to these principles, the drafter will be in a better position to ensure that the ground lease meets the needs of both the Ground Lessee/Sublessor and the Tenant.

Term

The primary provisions that must be compatible and flexible in both leases are those that pertain to the ground lease term, ie, satisfaction of all conditions precedent prior to commencement, the right to early termination and the option of extension. The Ground Lessee/Sublessor should ensure that its obligations to commence the ground lease and to make rental payments do not begin until the Tenant's sublease commences. The Ground Lessee/Sublessor does not want to be obligated to pay rent under the ground lease at a time during which it is not receiving rent from the Tenant under the Tenant's sublease. In addition, if the Tenant has the right to early termination of its sublease, the Ground Lessee/ Sublessor must also have the right to early termination of the ground lease. Unlike a situation in which the Ground Lessee/Sublessor leases to multiple tenants, if the single-use Tenant opts out of its sublease, the Ground Lessee/Sublessor may not be able to replace such a tenant easily. Thus, if the Tenant chooses to terminate its sublease, the Ground Lessee/Sublessor must also be able to terminate its ground lease. Similarly, in the event that the Tenant has the option to extend its sublease, the Ground Lessee/Sublessor must also have the option to extend the ground lease. Thus, not only must the term of the ground lease be compatible with the sublease, but the ground lease must also be flexible enough to allow the Ground Lessee/Sublessor the right to terminate early, or to extend the term, based on the terms of the sublease and on the actions of the Tenant.

Sample clause:

Conditions Precedent

This Lease and the duties and obligations of the parties herein are expressly made contingent upon the following conditions precedent: (a) the Commencement of Tenant's lease with Ground Lessee/Sublessor. …

Condemnation

One of the primary issues involved with a ground lease of this type is the negotiation of the condemnation clause. The condemnation clause must balance the interests of the Ground Lessor, the Ground Lessee/Sublessor, the Tenant, and the leasehold mortgagee. The leasehold mortgagee likely will insist that it have a first priority claim on the Ground Lessee/Sublessor's share of the award to be applied toward the payment of any outstanding balance on its loan, or that such award be used to restore the premises.

The Ground Lessor will seek to be compensated for loss in value of its fee estate, while the Ground Lessee/Sublessor will seek compensation for loss in value of the sublease and any improvements constructed by it. Finally, the Tenant will seek a portion of the award for loss due to displacement.

Sample clause:

Condemnation

If any taking or condemnation occurs in a judicial proceeding in which specific condemnation awards are made separately to Ground Lessor and Ground Lessee/Sublessor, then in that event such condemnation awards shall be binding upon Ground Lessor and Ground Lessee/Sublessor, and shall limit and define the rights of each party in and to such condemnation awards. Both Ground Lessor and Ground Lessee/Sublessor may seek a condemnation award for their respective interests. Condemnation awards awarded by virtue of the taking or condemnation of all or any part of the Improvements and/or the Premises, whether by consent of the parties or any judicial proceeding, where condemnation awards are not made to Ground Lessor and Ground Lessee/Sublessor separately, shall be divided between Ground Lessor and Ground Lessee/Sublessor as may be mutually agreed, subject to the rights of any Leasehold Mortgagee, giving consideration to the value of the rights and interests of each party in and to the Improvements and the Premises.

Ground Lessee/Sublessor and [Tenant] may claim and recover from such lawful authority causing the taking or condemnation, but not from Ground Lessor, such compensation as may be separately awarded or recoverable by Ground Lessee/ Sublessor or [Tenant], in their own right on account of any and all damages to Ground Lessee/ Sublessor's and [Tenant's] businesses by reason of such taking or condemnation, and any condemnation award which may be made under federal, state or local law for moving expenses, for the taking of personal property, or for damages for business interruption or displacement.

Use/Right to Modify

A situation may arise in which, although the Tenant's sublease has terminated early, the Ground Lessee/ Sublessor does not want to terminate the ground lease. Moreover, the Tenant may have included in its lease the right to change its use or to modify its structure. The ground lease, therefore, must allow the Ground Lessee/Sublessor to change the use or to modify the structure, provided no diminution in the value of the Ground Lessor's interest results.

Sample clause:

Use/Right to Modify

Ground Lessee/Sublessor may use the Premises for the Initial Use and for such other income producing uses as may be permitted by law. Ground Lessee/Sublessor shall not use or occupy, or permit all or any part of the Premises to be used or occupied for any unlawful or illegal business, use or purpose, or in any manner constituting a nuisance of any kind. Subject to all applicable restrictions, building and fire codes, zoning ordinances and other governmental regulations, Ground Lessee/Sublessor or [Tenant] may, at its sole cost and expense, and at any time and from time to time, make such repairs, additions, alterations and replacements in and to the Premises and the Improvements, as Ground Lessee/ Sublessor or [Tenant] deems desirable; provided such repairs, additions, alterations and replacements shall not result in a decrease in the value of the Improvements.

Exclusivity

The ground lease should contain an exclusivity clause for several reasons. First, when the Tenant is a single-use entity, the Ground Lessee/Sublessor will know at the time of ground lease negotiations the use to which the parcel will be put. In addition, the Tenant will most likely seek a strong exclusivity clause in its lease with the Ground Lessee/Sublessor. Finally, the Ground Lessor may own additional land contiguous to, or nearby, the parcel, and the Ground Lessee/Sublessor may have an interest in optimizing the potential of the Tenant to succeed, perhaps because it is receiving percentage rent, or perhaps because of the difficulty the Ground Lessee/ Sublessor would endure in the event that the Tenant defaulted. It is to the benefit of the Ground Lessee/ Sublessor, therefore, to obtain an exclusivity clause in its ground lease.

Environmental Issues

The Ground Lessee/Sublessor will seek to limit any exposure it may have in terms of environmental liability because the only contact it has to the land is during the construction process. The Ground Lessee/ Sublessor should seek a strong indemnity provision from the Ground Lessor to protect it from any environmental liability that could arise as a result of the Ground Lessor's actions, and it should also seek representations and warranties from the Ground Lessor regarding hazardous substances on the premises prior to the commencement of the ground lease. Furthermore – although it may be unlikely – the Ground Lessee/Sublessor should attempt to force the Ground Lessor to look solely to the Tenant in the event of any environmental liability, and vice versa, unless such liability was caused by the Ground Lessee/ Sublessor. The Ground Lessor may be amenable because it would have recourse against an established, AAA-rated entity, rather than the typical single-asset holding company. Thus, in its lease with the Tenant, the Ground Lessee/Sublessor should obtain a strong indemnity from the Tenant regarding any environmental liability resulting from Tenant's use, and the Ground Lessee/Sublessor should limit its own indemnity to any liability resulting from its construction of the premises.

Sample clause:

Environmental

Ground Lessor shall defend, indemnify and save harmless Ground Lessee/Sublessor from and against any and all liability, damage, penalty, judgment, cost and expense, including, without limitation, reasonable attorneys' fees and expenses, arising from loss, damage or injury to person or property sustained by anyone on or about the Premises resulting from any act or omission of Ground Lessor, its agents, employees or contractors. Ground Lessor shall, at its sole cost and expense, defend, indemnify and save harmless Ground Lessee/Sublessor against any and all suits or actions (just or unjust) which may be brought against Ground Lessee/Sublessor or in which Ground Lessee/Sublessor may be impleaded with others upon any claim(s) related to the Premises prior to the Lease Commencement Date, including, but not limited to, any claims arising from the existence of Hazardous Materials on the Premises prior to the Lease Commencement Date as more fully described in Section __ hereof, except as may result from an act, omission or negligence of Ground Lessee/Sublessor, its agents, employees, subtenants or contractors.

Ground Lessor covenants, represents and warrants that the Premises shall, at the time Ground Lessee/Sublessor takes possession, be free of Hazardous Substances. [Tenant] shall be fully liable for any and all costs and expenses related to the presence or disposal of a Hazardous Substance on or about the Premises by [Tenant], its agents, employees, contractors and invitees. Ground Lessor shall defend, indemnify and hold harmless [Tenant] and its agents from and against any and all claims, demands, penalties, fines, liabilities, settlements, damages, costs and expenses (including, without limitation, reasonable attorney's fees, consultant's fees, court costs and litigation expenses) of whatever kind or nature known or unknown, contingent or otherwise, arising out of, or any way related to, a Hazardous Substance not brought onto the Premises by Ground Lessee/Sublessor or [Tenant]. The terms, covenants and conditions of this Subsection shall be in addition to any other obligation and liability that Ground Lessor may have to Ground Lessee/Sublessor at law or in equity, and shall survive the expiration or other termination of this Lease.

Default

It is essential that, in the event of any default by the Ground Lessee/ Sublessor, the Tenant have an opportunity to cure such default. Thus, the ground lease should provide that any notice of default be sent to the Tenant, and should provide the Tenant with an opportunity to perform on behalf of the Ground Lessee/Sublessor. The ground lease could also allow the Tenant to pay its rent directly to the Ground Lessor in the event of a Ground Lessee/Sublessor default.

Sample clause:

Right to Cure

Any assignee or subtenant, including the [Tenant], shall be bound by the terms and conditions of this Lease. Any act required to be performed by Ground Lessee/Sublessor pursuant to this Lease may be performed by any subtenant of Ground Lessee/Sublessor occupying all or any part of the Premises, and the performance of such act by a subtenant shall be deemed to be performance by Ground Lessee/Sublessor and shall be acceptable by Ground Lessor as Ground Lessee/Sublessor's act; provided, such subtenancy has been approved (if such approval is required) by Ground Lessor pursuant to the terms and conditions of this Lease.

Simultaneous with the sending of any written notice to Ground Lessee/Sublessor, Ground Lessor shall send copies of such notice to such subtenant and Leasehold Mortgagee, which Ground Lessor is notified of, in writing, from time to time.

The lease with the such subtenant shall provide that in the event Ground Lessee/Sublessor is in default under any of the terms and conditions of this Lease and if Ground Lessee/Sublessor fails to cure said default within the expiration of applicable cure periods, such subtenant shall be obligated to pay all rentals directly to Ground Lessor, until such time as said default has been cured, at which time such subtenant shall continue to pay an amount equal to the Minimum Annual Rent directly to Ground Lessor for the remainder of the Primary Term or Extended Term, if applicable.

Financibility

When drafting a ground lease of this type, care must be taken to ensure the financibility of the lease. To be financible, the ground lease must 1) provide a leasehold mortgagee with an opportunity to cure any default, and 2) be freely assignable by the Ground Lessee/Sublessor and the leasehold mortgagee. Thus, in addition to notifying the Tenant of any default (as mentioned above), the Ground Lessor must provide written notice to the leasehold mortgagee of any event of default and provide the leasehold mortgagee with an opportunity to cure such default. The ground lease must provide the leasehold mortgagee with the right to exercise all of the Ground Lessee/Sublessor's rights under the ground lease.

Conclusion

The situation in which a Ground Lessee/Sublessor enters into a ground lease knowing that it will then sublease to a single-use entity is unique and must be addressed accordingly. By making the ground lease compatible with such Tenant's lease, by remaining flexible enough to address any of Ground Lessee/ Sublessor's concerns resulting from the Tenant's actions during the term of its sublease, and by enabling the ground lease to be financible, the drafter of the ground lease will ensure that the ground lease meets the needs of the Ground Lessee/Sublessor.