Commercial lease property
In negotiation of the ground lease, a primary concern of the developer will be assurance that the lease is "finance able", that the tenant's rights under the lease will be acceptable as both a business and a legal matter to sources of project financing, particularly initial project financing. At least one authority on the subject has stated with respect to "unsubordinated" ground leases that they are "finance" or "mortgage able" when the attorney for the long term lender says they are. In a perfect world, the sources of financing will have been identified and will be available to approve the form of leave before it is executed.
As a practical matter, however, ground lease negotiations usually occur prior to or simultaneously with the negotiation of project financing. The lender may be waiting to see if the ground lease will be executed before undertaking serious consideration of a proposed loan; lender's counsel may not be available to review the ground lease until a loan commitment is issued. Or the developer may wish to assure availability of the land before undertaking expensive efforts to obtain permits, financing and other project elements. For these and other reasons the ground lease is usually executed without prior review or approval of lending sources.
The difficulty with financing based on a ground lease is the disparity between risk and reward for the landlord and the mortgage lender. A landlord whose fee interest is subordinated to the tenants financing always feels excessively at risk and may seek concessions from the lender. The lender whose collateral security is limited to the tenants interest under the ground lease is always first concerned that the landlord will terminate the lease, creating a total loss for the lender. Most frequently, the developer is attempting to balance these interests in order to maximize his own position. Sometimes, an unsophisticated landlord or lender may stumble into a transaction involving a level of risk that, upon sober reflection, the landlord or lender should not undertake, resulting in a "windfall" to the clever developer. More often, the developer simply tries to achieve a rational or acceptable balance for both the landlord and the lender so that the developer can proceed with the project.
Sale and Refinancing
The developer has other important considerations, particularly the ability to refinance and to sell the project. The ability to refinance the initial term financing is usually critical since most term financing provides for "balloon" payoffs anywhere between five and fifteen years from initial funding. The ability to refinance an early balloon payment may be critical to obtaining the initial term loan. In addition secondary financing may be a means by which equity contributions can be reduced or returns on equity can be realized short of sale of the project.
The ability to sell the project may depend in large part on the ability of the purchaser to obtain purchase money financing from the seller or a third party or both.
The Non-Terminable Ground Lease
This concept was in fashion not long ago as a means of solving the difficulties of a leasehold mortgagee which arise primarily from the threat that the ground lease may be terminated, resulting in a complete loss of the lender's collateral. There may, of course, be ways to ensure payment and performance of the tenant's obligation under the lease short of termination, bond, deposits, guarantees and similar credit enhancements are only the most obvious. The landlord may always pursue other legal remedies, including actions for damages and for specific performance and injunctive relief. It is often asserted that the tenants equity in the improvements constructed on the property should be adequate security to the landlord. The issue, in the absence of credit enhancements is how the landlord can reach that security if termination of the lease is not permitted. A money judgment could ultimately be executed against the tenant's interest in the leasehold estate, but subject to any leasehold mortgages, not an acceptable result for most landlords.
Rejection: Termination or Breach
The bankruptcy code contributes to the confusion. Section provides that rejection constitutes a breach of the lease immediately before the date of the filing of the petition, frequently cited in support of the view that rejection is a breach, not termination. However, section provides that if a lease under which the debtor is tenant is not assumed within 60 days after the date of the order of relief, the lease is deemed rejected and the trustee shall immediately surrender such nonresidential real property to the lessor. This is the basis for the conclusion that a breach plus the surrender obligation can only be seen as termination of any of the trustee's or debtor's rights in the leasehold.
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