By Nancy Little, Partner, McGuirewoods LLP
Introduction
Whether you are a borrower or a lender, if you are considering a loan supported by a ground lease, you need to be sure the ground lease is "financeable." A financeable ground lease includes either (a) "subordination" of the landlord's fee interest in the land or (b) provisions to protect the lender (as leasehold mortgagee) from certain risks that could arise as a result of the borrower having a leasehold interest in the land instead of fee ownership. The so-called "subordinated fee" referred to in clause (a), above, is less common and essentially allows a fee mortgage. According, the top ten considerations below focus on protections needed in a ground lease in order for a leasehold mortgagee to consider the ground lease financeable.
1. Avoid a Sublease.
The lender will prefer (or may require) that the ground lease not be a sublease. A sublease would require additional review associated with the prime lease and can create additional complexities. The lender may impose requirements for additional security and/or protections and assurances if the ground lease is a sublease.
2. Fixed Rent.
The lender will want to be able to quantify its risk if it should face taking back the property in foreclosure. Should it step into the shoes of the borrower as lessee under the ground lease, it will want to know that the rent is fixed or at least predictable, preferably with limited or no escalations.
3. Long Term.
Leasehold lenders prefer that the term of the ground lease be significantly longer than the term of the loan because the lender will want a sufficiently long period of time after foreclosure to try to recover its investment from the property. Accordingly, ground leases with a relatively short remaining term can be problematic.
4. Right to Exercise Renewal and Purchase Options.
Consistent with item 3 above, the lender will want the right to exercise renewal options to be sure that the term will be sufficiently long. The lender will also want the right to exercise any renewal options even if the borrower/ground lessee is in default or has failed to exercise the renewal options. The same applies to any purchase options, which the lender will also want the right to exercise in case it determines that its best course of action is to buy out the fee owner's/ground lessor's interest in the land.
5. Broad Use Clause.
The lender will want broad rights to use the property, without undue restrictions. After foreclosure, the lender may need to change the use of the property to facilitate the sale, lease or other disposition of the property or to enhance revenue. The lender will not want to have to seek consent of the ground lessor for a change in use.
6. No Merger Clause.
The ground lease should include a "no merger" provision that the estates and interests of the ground lessor and the ground lessee do not "merge" if the ground lessee acquires the ground lessor's fee interest in the property. A merger issue could arise, for example, if the ground lessee exercises an option to purchase that may have been granted under the ground lease. The "no merger" clause is intended to prevent such a merger from wiping out the lender's leasehold mortgage that could occur by operation of law if the leasehold interest upon which the mortgage is based disappears if the leasehold estate and fee estate merge.
7. Limited Liability of Lender.
From the lender's perspective, the ground lease should provide that, in the event of foreclosure, the leasehold lender will only have liability during its period of ownership and will not have continuing liability after its sale and/or assignment of its interest in the property.
8. Few Personal Covenants.
The ground lease should contain few, if any, "personal" covenants, that is, provisions that are personal to, or can only be performed by, the borrower/ground lessee. Such covenants, if breached, generally are not capable of cure by the leasehold lender before or after foreclosure and could result in a non-curable default and the risk of termination of the ground lease.
9. Right to Mortgage and Waiver of Landlord's Lien.
The ground lease should include an express right for the ground lessee to enter into a leasehold mortgage, pledging as security its ground lease interest in the land as well as its interest in the improvements. The lender will also want to see a waiver of any landlord's lien that may otherwise be available to the ground lessor under applicable law.
10. Leasehold Mortgage to Control Use of Proceeds.
The leasehold lender will require that the leasehold mortgage controls the use of proceeds of casualty and condemnation, as opposed to any contrary provision in the ground lease. The lender has an interest in the use of such proceeds and whether they are used for restoration or rebuilding or are applied to the loan balance, and the lender will want such proceeds applied as provided in the mortgage. With respect to condemnation, the ground lessor does have a residual interest in the land so the ground lease may provide that an award for a temporary taking is payable to the ground lessee for the temporary loss of use of the property. For a partial taking, the award may be applied to rebuilding or restoration, and for a total taking, the award may be applied first to payment of the loan and then equitably distributed to the ground lessee and ground lessor.
Conclusion
The foregoing is a brief overview of how certain basic terms of a ground lease are viewed from the lender's perspective for a financeable ground lease. The ground lessee would be well served by negotiating for these provisions upfront and not waiting for a leasehold lender to raise these points at the time of loan negotiation. There are other important features of a financeable ground lease, such as cure rights, waivers of certain defaults and no termination of the ground lease pending foreclosure to name a few, that are critical as well. These provisions may be the subject of future articles.
