Criteria for Financeability

Encumbrances on The Fee Estate

The landlord's fee interest must either be unencumbered by any fee mortgages, or such fee mortgagees must be required to execute a recordable non-disturbance agreement in favor of the tenant.

Lease Term

The term of the lease must always extend well beyond the maturity date of the loan. If the loan will be part of a securitization, the rating agencies require the term of the lease to expire 10 years beyond the final maturity date of a loan that will fully amortize and 20 years beyond the date of a mortgage loan that has a balloon payment.

Transferability

The lease must be freely assignable without the landlord's consent by means of foreclosure, deed in lieu of foreclosure, purchase by the leasehold mortgagee, or in any subsequent transfers by the leasehold mortgagee. (Some restrictions on shopping center leases will be permissible to the extent that limitations on possible transfers are reasonable (such as those that relate to maintaining the standards of the center).)

Notices/Defaults/Cure

The leasehold mortgagee must have notice of any default and an opportunity and a reasonable period to cure after the expiration of the tenant's notice and cure periods under the lease. The landlord must agree to accept performance by the leasehold mortgagee in lieu of the tenant. The lease may not be terminated for any defaults that are not susceptible of cure by the leasehold mortgagee (either those which are personal to the tenant or which the leasehold mortgagee may not be able to cure until gaining possession of the property). Cure periods should be extended so long as the leasehold mortgagee is diligently exercising its remedies to cure or obtain possession of the property. All default notices, renewal notices, or other material notices must be delivered to the leasehold mortgagee.

New Lease Provisions

The landlord must be obligated to enter into a new lease on the then executory terms of the lease with the leasehold mortgagee (or its designee) if the lease is terminated. The leasehold mortgagee must be entitled to exercise any renewal options if they are not exercised by the tenant.

Condemnation

The tenant and leasehold mortgagee must have rights to participate in the condemnation award, with the landlord entitled to receive only the value of the land unimproved and encumbered by the lease, with the balance of the award divided between the leasehold mortgagee and the tenant. Rent must be equitably reduced upon any partial taking, with a termination of the lease only under those circumstances in which the premises are totally condemned.

Insurance

The insurance must insure full replacement value of the cost of the building. The leasehold mortgagee must be named as an additional insured; proceeds of a casualty payable to it or some neutral party must be applied either toward repayment of the leasehold mortgage or restoration.

Liability

The leasehold mortgagee must not be subject to any liability as an assignee of the tenant's interest in the lease except with respect to the period during which the leasehold mortgagee is the tenant.

Use of the Premises

After foreclosure (or equivalent) the premises may be used by the assignee for any lawful use (except that shopping center leases may impose reasonable use restrictions).

Operating Covenants

The leasehold mortgagee cannot be bound by operating covenants or obligations for the payment of percentage rent during any period of time in which it is arranging for a subsequent transfer of the lease.

Subordination of Lease

Subordination of the lease to a fee mortgage may be permitted only where full non-disturbance is given.

Amendments/Surrender

The lease may not be amended or modified without the consent of the leasehold mortgagee. The landlord should be prohibited from accepting a surrender of the premises without the leasehold mortgagee's consent. The landlord should be required to execute any estoppel certificates reasonably required by the leasehold mortgagee or any subsequent purchaser.

Miscellaneous

The leasehold estate should not merge into the fee estate if the same estate is acquired by the same entity. The tenant should be prohibited from terminating the lease under '365(h) of the Bankruptcy Code in the event of the landlord's bankruptcy without the mortgagee's consent. The tenant should be prohibited from paying rent more than 1 month in advance or accepting any abatements without the leasehold mortgagee's consent.

Even if the tenant does not intend to finance the lease at the time of lease execution, the tenant and its legal counsel should insist at the outset of lease negotiations that the provisions that make a lease financeable be included within the lease. If they are not within the original lease and the tenant decides to finance its lease at a later date, the failure to originally include them can only lead to a situation in which the tenant will have to pay for this flexibility in one way or the other.

Joanne Feil is a member of Sills Cummis Epstein & Gross, P.C., in the firm's New York office.

Among the many real estate assets that may be financed are ground or net leases. Despite many changes in the area of real estate finance over the past number of years, the legal criteria for determining financeability of a tenant's leasehold estate remain constant. Nevertheless, it is useful for the real estate practitioner to periodically take inventory of the standards. Certainty of leasehold financeability is essential, not only to any ground lessee or tenant that wants to finance the cost of constructing its leasehold improvements, but also to any tenant that decides to finance a portfolio of leasehold properties or whose corporate lender requires a collateral assignment of the tenant's interest in its leasehold estates as part of the security for a broader, corporate financing facility. The following sets forth fundamental issues to be considered in determining the financeability of a significant lease.

Mortgaging

The lease or a memorandum of the lease must be recorded in the applicable land records. The lease must specifically permit a mortgage of the tenant's leasehold interest and the right to foreclose the same. In addition, if there are restrictions on the leasehold mortgagee (eg, 'institutional lender,' size of mortgage loan, restriction on cross-collateralization), the leasehold mortgagee must be able to satisfy these criteria, and the mortgage, once made, must be freely assignable.

Encumbrances on The Fee Estate

The landlord's fee interest must either be unencumbered by any fee mortgages, or such fee mortgagees must be required to execute a recordable non-disturbance agreement in favor of the tenant.

Lease Term

The term of the lease must always extend well beyond the maturity date of the loan. If the loan will be part of a securitization, the rating agencies require the term of the lease to expire 10 years beyond the final maturity date of a loan that will fully amortize and 20 years beyond the date of a mortgage loan that has a balloon payment.

Transferability

The lease must be freely assignable without the landlord's consent by means of foreclosure, deed in lieu of foreclosure, purchase by the leasehold mortgagee, or in any subsequent transfers by the leasehold mortgagee. (Some restrictions on shopping center leases will be permissible to the extent that limitations on possible transfers are reasonable (such as those that relate to maintaining the standards of the center).)

Notices/Defaults/Cure

The leasehold mortgagee must have notice of any default and an opportunity and a reasonable period to cure after the expiration of the tenant's notice and cure periods under the lease. The landlord must agree to accept performance by the leasehold mortgagee in lieu of the tenant. The lease may not be terminated for any defaults that are not susceptible of cure by the leasehold mortgagee (either those which are personal to the tenant or which the leasehold mortgagee may not be able to cure until gaining possession of the property). Cure periods should be extended so long as the leasehold mortgagee is diligently exercising its remedies to cure or obtain possession of the property. All default notices, renewal notices, or other material notices must be delivered to the leasehold mortgagee.

New Lease Provisions

The landlord must be obligated to enter into a new lease on the then executory terms of the lease with the leasehold mortgagee (or its designee) if the lease is terminated. The leasehold mortgagee must be entitled to exercise any renewal options if they are not exercised by the tenant.

Condemnation

The tenant and leasehold mortgagee must have rights to participate in the condemnation award, with the landlord entitled to receive only the value of the land unimproved and encumbered by the lease, with the balance of the award divided between the leasehold mortgagee and the tenant. Rent must be equitably reduced upon any partial taking, with a termination of the lease only under those circumstances in which the premises are totally condemned.

Insurance

The insurance must insure full replacement value of the cost of the building. The leasehold mortgagee must be named as an additional insured; proceeds of a casualty payable to it or some neutral party must be applied either toward repayment of the leasehold mortgage or restoration.

Liability

The leasehold mortgagee must not be subject to any liability as an assignee of the tenant's interest in the lease except with respect to the period during which the leasehold mortgagee is the tenant.

Use of the Premises

After foreclosure (or equivalent) the premises may be used by the assignee for any lawful use (except that shopping center leases may impose reasonable use restrictions).

Operating Covenants

The leasehold mortgagee cannot be bound by operating covenants or obligations for the payment of percentage rent during any period of time in which it is arranging for a subsequent transfer of the lease.

Subordination of Lease

Subordination of the lease to a fee mortgage may be permitted only where full non-disturbance is given.

Amendments/Surrender

The lease may not be amended or modified without the consent of the leasehold mortgagee. The landlord should be prohibited from accepting a surrender of the premises without the leasehold mortgagee's consent. The landlord should be required to execute any estoppel certificates reasonably required by the leasehold mortgagee or any subsequent purchaser.

Miscellaneous

The leasehold estate should not merge into the fee estate if the same estate is acquired by the same entity. The tenant should be prohibited from terminating the lease under '365(h) of the Bankruptcy Code in the event of the landlord's bankruptcy without the mortgagee's consent. The tenant should be prohibited from paying rent more than 1 month in advance or accepting any abatements without the leasehold mortgagee's consent.

Even if the tenant does not intend to finance the lease at the time of lease execution, the tenant and its legal counsel should insist at the outset of lease negotiations that the provisions that make a lease financeable be included within the lease. If they are not within the original lease and the tenant decides to finance its lease at a later date, the failure to originally include them can only lead to a situation in which the tenant will have to pay for this flexibility in one way or the other.

Joanne Feil is a member of Sills Cummis Epstein & Gross, P.C., in the firm's New York office.