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Banking & Finance Law Report

Planning For Leasehold Financing

Posted in Commercial Lending, Commercial Loans and Leases, Finance, Ohio Law, Other Articles, Real Estate

Commercial leases often lack leasehold financing provisions despite the significant impact such provisions can have on the business dealings of the tenant during the term of the lease.

Long-term, creditworthy tenants, those who have value in their leaseholds such as restaurants and hotels, are often prime candidates for leasehold financing. A leasehold mortgage is very similar to a regular mortgage, except that, if a default occurs the holder of a leasehold mortgage has the right to foreclose not by conducting a sale of the building, but instead by taking over as the tenant under the lease. Usually a leasehold mortgage also includes a pledge of the tenant’s personal property on the leased premises, and by foreclosing the leasehold mortgage, the mortgage holder also takes title to the personal property in the leased premises. Because giving a leasehold mortgage does not require the mortgagor to own the real property it mortgages, leasehold financing allows businesses that rent space, and rather than own property, to obtain financing for their businesses.

Many businesses eligible for leasehold mortgages cannot reap the benefits of such arrangements due to restrictions in their leases on leasehold financing. Many commercial leases contain a general prohibition on any and all “transfers” of the lease. Absent an express exception in the lease, such an anti-transfer provision would likely be interpreted to prohibit the tenant from entering into a leasehold mortgage. The best time to consider leasehold financing provisions is during the drafting and negotiation of the lease, when the tenant still has some leverage.

So, what should be in leasehold financing lease provisions? The biggest concern for lenders is that the leasehold will disappear, so leasehold financing provisions should contain notices and approval and cure rights, to avoid the termination or modification of the lease to decrease its value as collateral. Many lenders will also want the right to enter into a new lease with the landlord for the remainder of the term. An example of a comprehensive lender-friendly leasehold financing provision is set forth below.

Finally, tenants should remember during the negotiation phase of the lease that for a leasehold to be valuable as collateral, it must be useful to the lender – therefore, tenants should avoid overly restrictive exclusive use provisions so a lender could change the use if it is forced to foreclose on the leasehold. If the use is limited to just one use that a lender has no interest in running as a business, then the tenant probably cannot obtain leasehold financing despite favorable leasehold financing provisions in the lease.

 Example:

     Section 1.01 Leasehold Mortgages Permitted. Notwithstanding anything in this Lease to the contrary, Tenant shall have the absolute and unconditional right, without Landlord’s consent, to mortgage or collaterally assign Tenant’s interest in this Lease and Tenant’s leasehold interest in the Demised Premises and Tenant’s Improvements.

      Section 1.02 Provisions for Benefit of Leasehold Mortgagees. The provisions in this Article shall apply to, and benefit, any mortgagee or collateral assignee of Tenant’s leasehold interest in the Demised Premises or Tenant’s Improvements (“Leasehold Mortgagee”). Any mortgage or collateral assignment secured by or securing Tenant’s leasehold interest is hereinafter referred to as a “Leasehold Mortgage”. Tenant shall furnish Landlord with a true and complete copy of each Leasehold Mortgage and a current notice address for the Leasehold Mortgagee. If any (prospective) Leasehold Mortgagee shall require any reasonable modification(s) of this Lease (including cure rights, rights to obtain a new lease, and other customary mortgagee protections), then Landlord shall, at Tenant’s reasonable request and sole cost and expense, execute and deliver to Tenant such reasonable instruments in recordable form effecting such modification(s) as such (prospective) Leasehold Mortgagee reasonably requires, provided they do not materially adversely affect Landlord’s rights or materially increase Landlord’s obligations hereunder.

     Section 1.03 Notice of Default Served on Leasehold Mortgagees.

     (a) No notice of default required by this Lease shall be valid, binding, or effective until the notice is served on all Leasehold Mortgagees in the manner set forth in this Lease for effective notice, at the address the Leasehold Mortgagee provides to Landlord according to the provisions set forth in this Lease.

     (b) If there is a Monetary Default, then Landlord shall not exercise any of the rights and remedies provided herein unless the Monetary Default shall have continued for at least thirty (30) days after notice in writing to all Leasehold Mortgagees.

     (c) If there is a curable Non-Monetary Default (“Curable Non-Monetary Default”), then Landlord shall not exercise any of the rights and remedies provided herein unless the Curable Non-Monetary Default shall have continued for at least sixty (60) days after notice in writing to all Leasehold Mortgagees. However, if it is not reasonably possible to cure the default within sixty (60) days, then the time period for curing the Curable Non-Monetary Default shall be extended, provided, however, that the default cure shall have been commenced and shall be continuing as expeditiously as reasonably practicable by actions undertaken continuously, diligently and in good faith.

     (d) If there is a noncurable default (“Noncurable Default”), Landlord shall not exercise any of the termination rights or remedies provided in this Lease, or any termination remedies provided by law, if within sixty (60) days after notice in writing of such Noncurable Default, a Leasehold Mortgagee notifies Landlord it has commenced the foreclosure of its Leasehold Mortgage, and that Leasehold Mortgagee diligently and continuously prosecutes to completion such foreclosure proceedings and sale of Tenant’s leasehold interest in the Demised Premises, or causes that leasehold interest to be conveyed and assigned in lieu of foreclosure.

      Section 1.04 Mortgagee’s Option to Obtain New Lease.

     (a) If this Lease is terminated under the terms of this Lease, then Landlord shall serve notice of such termination on all Leasehold Mortgagees, specifying all sums of money then due and payable under this Lease and specifying any other default then existing. Each Leasehold Mortgagee shall have the option of obtaining a new lease (“New Lease”) on terms set forth in this Article; provided, however, that such option shall be waived if it is not exercised in writing within forty-five (45) days after the Leasehold Mortgagee receives written notice of termination. If more than one Leasehold Mortgagee elects to obtain a New Lease, the New Lease shall be entered into with Leasehold Mortgagee holding the Leasehold Mortgage senior in priority.

     (b) The New Lease entered into between Landlord and Leasehold Mortgagee as the new tenant shall contain terms identical to the terms of this Lease, except that the commencement date of the New Lease shall be the date of termination of this Lease, and the term of the New Lease shall be equal to the remaining portion of the Term (including any unexercised renewal options).

     (c) The New Lease shall be subject to and conditioned upon the prior satisfaction of the following terms:

          (i) All Monetary Defaults and Curable Non-Monetary Defaults shall have been cured by the new tenant;

          (ii) there shall exist no Noncurable Defaults; and

          (iii) All fees and expenses, including reasonable counsel fees, incurred by Landlord in connection with Tenant’s defaults, termination of this Lease, recovery of possession, securing and weatherizing, negotiations with Leasehold Mortgagees, and preparation and execution of the New Lease, shall have been paid by the new tenant.

     Section 1.05 Performance of Terms by Leasehold Mortgagee; Leasehold Mortgagee to be Recognized as Successor Tenant.

     (a) Landlord shall accept performance of the terms of this Lease or a New Lease by a Leasehold Mortgagee, or any agent, nominee, or designee of a Leasehold Mortgage, as if the terms were performed by Tenant.

     (b) If a Leasehold Mortgagee shall become the owner of Tenant’s leasehold interest in the Premises by foreclosure or otherwise, such Leasehold Mortgagee shall be deemed Tenant’s successor and assignee under this Lease and shall be entitled to all rights, benefits, and privileges of Tenant under this Lease.

      Section 1.06 No Liability by Assignment; Assignment of Lease or New Lease by Leasehold Mortgagee. No Leasehold Mortgagee shall have any liability or obligation under this Lease by acceptance of a Leasehold Mortgage. If any Leasehold Mortgagee shall enter into a New Lease or acquire Tenant’s leasehold interest in the Demised Premises by foreclosure or otherwise, and the Leasehold Mortgagee assigns or otherwise conveys its interest in this Lease or the New Lease, then on that assignment or conveyance the Leasehold Mortgagee shall be discharged and relieved from all liability for performance of this Lease or the New Lease subsequently accruing, but nothing in this Lease shall relieve the Leasehold Mortgagee from its liabilities and obligations accruing before the assignment or conveyance.

     Section 1.07 Written Consent of Leasehold Mortgagees. This Lease shall not be modified or amended, nor shall it be voluntarily terminated by Tenant, without the prior written consent of all Leasehold Mortgagees.