How Much Protection Does a Leasehold Mortgagee Need? by Joshua Stein

How Much Protection Does a Leasehold Mortgagee Need? By Joshua Stein

Every real estate attorney, devel- to satisfy the literal requirements These “middle ground” Lease- oper, or investor who negotiates a and expectations of the rating agen- hold Mortgagee Protections omit long-term ground lease (a “Lease”)1 cies. The Lease would simply parrot many of the following items that knows it must be “financeable.” That the express requirements of the rat- often inflate and complicate the means the Lease must contain cer- ing agencies (just the words in their treatment of these issues in Leases: tain provisions (“Leasehold Mortgagee published criteria for Leases). In any • Options. “Bells and whistles” for Protections”) to protect the interests securitization, the Lease should then unusual or nonstandard struc- of a future Leasehold Mortgagee. match up to the published words tures; Those interests boil down to assur- and pass without objection. This ing that a Leasehold Mortgagee can approach keeps everything simple • Negotiations. Landlord-oriented always: and minimal and avoids problems. concessions or qualifications, beyond the bare minimum neces- • Take and readily enforce a Lease- “Minimal” Leasehold Mortgage sary to (a) achieve a reasonable hold Mortgage; Protections can work only if: result on each issue; and (b) pre- (a) Landlord and its counsel do not vent laughter by Landlord or its • Preserve the Lease and its value, try to festoon the “minimal” Lease- counsel; and even if part of the transaction hold Mortgagee Protections with too goes into default or surprises many conditions, limitations, proce- • Details. Extremely detailed proce- occur; or dures, qualifications, requirements, dures, time limits, notice require- • Walk away from a bad invest- and restrictions (leading to complexi- ments, and other provisions, and ment.2 ty, fine-tuning, and risk of new mis- extreme levels of clarity, specifici- takes); and (b) no future “B-piece” ty, and completeness. To achieve these goals, a Tenant buyer, Leasehold Mortgagee, partici- (or Leasehold Mortgagee) and its pant, purchaser, rating agency, rating Even after those omissions, these counsel might decide they want a agency counsel, or syndicate mem- “middle ground” Leasehold Mort- Lease to contain: (a) every possible ber ever decides the Lease needs gagee Protections should adequately Leasehold Mortgagee Protection any more than the bare minimum Lease- cover every typical “financeability” real estate lawyer has ever imagined; hold Mortgagee Protections as the issue.6 If a transaction requires “bells (b) absolute clarity and full detail rating agencies defined them at and whistles,” though, these “middle about every facet of those Leasehold Lease signing.4 ground” Leasehold Mortgagee Pro- Mortgagee Protections, leaving not tections will not provide them. The even the slightest uncertainty to be The author has published Lease- author’s “maximum” Leasehold resolved later and no possible hypo- hold Mortgagee Protections at both Mortgagee Protections can fill such thetical sequence or confluence of the “maximum” and “minimum” gaps. events unaddressed; and perhaps extremes.5 This article, in contrast, By leaving out some details, (c) as many words and pages as pos- offers a “middle ground” set of these “middle ground” Leasehold sible devoted to protecting future Leasehold Mortgagee Protections, Mortgagee Protections increase the Leasehold Mortgagees. which could be copied into a Lease and customized as necessary to dra- risk of uncertainty and surprises, Such an approach, if carefully matically shorten and simplify nego- hence the risk of litigation if some and intelligently implemented, tiation of Leasehold Mortgagee Pro- unusual circumstance or sequence of should minimize the likelihood that tections for that Lease. These events occurs. Most details omitted any prospective Leasehold Mort- “middle ground” Leasehold Mort- here, though, relate to very unlikely gagee or its counsel will ever find a gagee Protections seek to give any events. In the real world, Landlords, way to disapprove a Lease. This Tenant and Leasehold Mortgagee a Tenants, and Leasehold Mortgagees approach can, however, also produce reasonably succinct, simple, straight- can and do negotiate reasonable res- complexity, verbosity, excessive forward, “fair,” and nearly always olutions for most issues that arise, negotiations, and risk of error.3 adequate way to address typical con- assuming each has some leverage.7 At the opposite extreme, a Ten- cerns of a typical Leasehold Mort- These model Leasehold Mort- ant (or Leasehold Mortgagee) and its gagee. For each issue, these Lease- gagee Protections omit a few provi- counsel might decide a Lease should hold Mortgagee Protections offer a sions that sometimes appear in contain only the minimum Lease- balanced outcome that all parties Leasehold Mortgagee Protections. hold Mortgagee Protections needed will usually accept. Each such omitted provision would

NYSBA N.Y. Real Property Law Journal | Summer/Fall 2004 | Vol. 32 | No. 3 75 have added too much detail, bur- lished pleas for use of Plain English lord; (c) determining that a Total dened Landlord unreasonably and even in sophisticated commercial Loss has occurred; (d) exercising unnecessarily, or covered a topic real estate transactional documents.10 any Bankruptcy Termination highly unlikely to become relevant— No law requires lawyers to write Option; (e) subordinating this and one that probably can be dealt legal documents in a weird and per- Lease or the Leasehold Estate to with in some other reasonable way if verted form of pompous quasi-Eng- any other estate or interest in the it ever does become relevant. lish, marked by long sentences, con- Premises; or (f) waiving any voluted verb structures, graceless term(s) of this Lease. Most Leasehold Mortgagee Pro- word piles to describe simple con- tections serve a Leasehold Mort- 6. “Lease Termination Notice” cepts, profligate use of the passive gagee’s interests without directly means a notice16 stating this voice, redundancy, and gratuitous benefiting the Tenant. Beyond such Lease has terminated, and complexity.11 “pure” Leasehold Mortgagee Protec- describing in reasonable detail tions, a Leasehold Mortgagee consid- The author welcomes comments any uncured Tenant Defaults. ering a Lease as collateral will care on these Leasehold Mortgagee Pro- 7. “Leased Fee Value” means the about all other terms of the Lease. A tections, both substantive and stylis- fair market value of the Fee Leasehold Mortgagee will consider tic. Comments should be directed to Estate, considered as if unim- nearly every issue in the Lease. Any [email protected]. 17 such issue, if handled badly enough, proved and subject to this 18 can make a Lease “unfinanceable.” Definitions Lease. Covering all such issues in a dis- 1. “Bankruptcy Sale” means a sale 8. “Leasehold Mortgage” means cussion of Leasehold Mortgagee Pro- of any property, or any interest any collateral assignment, deed tections would lead to a general dis- in any property, under 11 U.S.C. of trust, mortgage, or other lien cussion of Leases, not the intention § 363 or otherwise in any bank- (each as modified from time to of this article. Nevertheless, a Tenant ruptcy or insolvency proceeding time) encumbering this Lease, and a Leasehold Mortgagee share a affecting the owner of such the Leasehold Estate, and Ten- 19 few fundamental concerns. The property. ant’s Preemptive Rights. A Leasehold Mortgage shall not issues on that “short list” are often 2. “Bankruptcy Termination attach to the Fee Estate. regarded as Leasehold Mortgagee Option” means Tenant’s right to Protections, even though one might treat this Lease as terminated 9. “Leasehold Mortgagee” means more aptly describe them as funda- under 11 U.S.C. § 365(h)(1)(A)(i) a holder of a Leasehold Mort- mental to any decent Lease. These or any comparable provision of gage (and its successors and “medium” Leasehold Mortgagee law. assigns), provided: (a) it is not Protections cover a few of those fun- an Affiliate of Tenant;20 and (b) 8 3. “Fee Estate” means Landlord’s damental “shared issues” before Landlord has received notice of fee interest in the Premises,12 turning to issues oriented more its name and address and a copy including13 Landlord’s rever- directly toward Leasehold Mort- of its Leasehold Mortgage.21 gagees. sionary interest, all subject to this Lease. 10. “Loss” means a casualty or con- The footnotes in these model demnation affecting the Premis- 4. “Foreclosure Event” means any: Leasehold Mortgagee Protections es. describe some judgment calls that (a) foreclosure sale (or trustee’s went into these Leasehold Mort- sale, assignment in lieu of fore- 11. “Loss Proceeds” means any gagee Protections. Anyone can argue closure, Bankruptcy Sale, or sim- insurance proceeds or condem- for some other judgment call. Any- ilar transfer) affecting the Lease- nation award paid or payable one can deem any omitted issue to hold Estate or14 (b) Leasehold for a Loss. 9 Mortgagee’s exercise of any have been worth covering. These 12. “New Lease” means a new lease other right or remedy under a risks are inevitable in trying to of the Premises and related cus- Leasehold Mortgage (or applica- define any “middle ground” legal tomary documents such as a ble law) that divests Tenant of its document. memorandum of lease and a Leasehold Estate. Beyond offering a “reasonable” deed of the Improvements. Any set of Leasehold Mortgagee Protec- 5. “Lease Impairment” means Ten- New Lease shall: (a) commence tions, the following model seeks to ant’s: (a) canceling, modifying,15 immediately after this Lease ter- demonstrate straightforward, simple, surrendering, or terminating this minated; (b) continue for the and comprehensible legal writing, Lease, including upon Loss; (b) entire remaining term of this consistent with the author’s pub- consenting, or failing to object, Lease, as if no termination had to a Bankruptcy Sale by Land- occurred, subject to any Preemp-

76 NYSBA N.Y. Real Property Law Journal | Summer/Fall 2004 | Vol. 32 | No. 3 tive Rights; (c) give New Tenant stantially all the Premises or, in Loss25 the same rights to the Improve- Tenant’s reasonable determina- If a Loss occurs: (a) the party ments that this Lease gave Ten- tion (with Leasehold Mort- that first becomes aware of it shall ant; (d) have the same terms, gagee’s consent) any: (a) Loss notify the other; (b) the parties shall including Preemptive Rights, after which Tenant cannot legal- direct the payor to pay all Loss Pro- and the same priority, as this ly restore the Improvements as ceeds to Leasehold Mortgagee;26 (c) Lease, subject to any subsequent an architectural whole for eco- Loss Proceeds shall be applied as fol- written amendments that bind nomic use for their previous lows until exhausted; (d) each New Tenant; and (e) require purpose; or (b) casualty after party’s rights to receive Loss Pro- New Tenant to cure, with rea- which, because of changes in ceeds shall be subject to the rights of sonable diligence and continuity, Legal Requirements, Tenant can- its mortgagee(s); and (e) the parties within a reasonable time, all not legally restore the Improve- shall have the following rights and Tenant Defaults (except Tenant- ments to substantially their pre- obligations.27 Specific Defaults) not otherwise vious size. cured or waived. Landlord’s Costs. First, Landlord Use shall receive Loss Proceeds to reim- 13. “New Tenant” means Leasehold burse Landlord and Fee Mortgagee Mortgagee or its designee or Tenant may use the Premises for any lawful purpose.23 for their reasonable costs and nominee, and any of their suc- expenses (including attorneys’ fees cessors and assigns. Assignment and expenses), incurred because of 28 14. “Preemptive Right” means any Without Landlord’s consent, the Loss. expansion, purchase, or renewal Tenant may assign this Lease at any Total Loss. Second, if a Total Loss option; right of first refusal or time, provided only that Tenant or occurs, this Lease shall terminate. first offer; or other preemptive the assignee gives Landlord a copy Landlord may require Tenant to use right this Lease gives Tenant. of the assignment and also, except in Loss Proceeds to remove all debris 15. “Remaining Premises” means the case of any Leasehold Mortgage from, fill any substantial excavations any Premises that Landlord con- or an assignment through a Foreclo- in, and return to a level and vacant tinues to own after a Total Loss. sure Event, Tenant: (a) has achieved condition any Remaining Premises. and paid for Substantial Completion Landlord shall then receive Loss Pro- 16. “Tenant Default” means Ten- of Development; and (b) causes the ceeds equal to the Leased Fee Value ant’s uncured default or breach assignee to deliver to Landlord an measured as if no Loss had occurred, under this Lease. assumption of this Lease. less the value of the Remaining Premises after completion of the 17. “Tenant Default Notice” means Subleases Landlord’s notice of a Tenant work described in the previous sen- Default, describing the Tenant Without Landlord’s consent, tence. Tenant shall then receive all 29 Default in reasonable detail. Tenant may sublease the Premises in remaining Loss Proceeds. whole or in part at any time(s). If 18. “Tenant-Specific Default” this Lease terminates, Landlord shall Termination Option Loss. Third, if means any Tenant Default that: not disturb the possession, interest, a Termination Option Loss occurs, (a) arises from any lien or or quiet enjoyment of any Subtenant Tenant may (subject to the provi- encumbrance attaching solely to not in default beyond applicable sions of this Lease on Lease Impair- the Leasehold Estate (not the Fee cure periods under its Sublease,24 ments) terminate this Lease by notice 30 Estate) but junior to the Lease- provided such Subtenant is not relat- to Landlord. Landlord shall then 31 hold Mortgage; or (b) Leasehold ed to Tenant, at least one Leasehold receive all Loss Proceeds. Mortgagee or New Tenant can- Mortgagee has granted such Sub- Revaluation. Fourth, upon any not reasonably cure. tenant nondisturbance protection, condemnation of the Premises, and the Sublease either: (a) does not 19. “Termination Option Loss” except a temporary condemnation or demise all or substantially all the means any Loss that occurs dur- a Total Loss: (a) future Rent under Premises and was on commercially ing the last ______months of this Lease shall decrease by the reasonable and fair market terms the Term or would cost22 more product of such future Rent (meas- (including fixed subrent that cannot than $______(beyond Loss ured as if the condemnation had not decline except upon Loss) when such Proceeds to be made available) occurred) times the percentage of Subtenant became legally bound; or to restore. the Premises taken, by value; and (b) demises the entire Premises and (b) Landlord shall receive Loss Pro- 20. “Total Loss” means any con- is in all material respects at all times ceeds equal to the diminution in demnation that affects all or sub- no less favorable to Landlord than value of the Fee Estate. this Lease.

NYSBA N.Y. Real Property Law Journal | Summer/Fall 2004 | Vol. 32 | No. 3 77 Restoration. Fifth, if a Loss does Notices New Lease not terminate this Lease, Tenant shall Any notice from Landlord to If this Lease terminates for any apply Loss Proceeds to restore the Tenant shall have no effect unless reason (except with Leasehold Mort- Improvements substantially as they Landlord gives a copy to Leasehold gagee’s consent or because of a Total existed before the Loss (subject to Mortgagee. If any Tenant Default Loss), even if Leasehold Mortgagee changes this Lease allows), to the occurs for which Landlord intends to failed to timely exercise its cure extent reasonably possible under the exercise any remedy, Landlord shall rights for a Tenant Default,41 Land- 32 circumstances. promptly give Leasehold Mortgagee lord shall promptly give Leasehold Disbursement. To the extent this a Tenant Default Notice. Mortgagee a Lease Termination Lease requires Tenant to apply Loss Notice. By giving notice to Landlord 38 Proceeds for a specified purpose, Opportunity to Cure on or before the day that is ___ days Loss Proceeds shall be disbursed: Landlord shall accept Leasehold after Leasehold Mortgagee receives (a) from time to time under reason- Mortgagee’s cure of any Tenant Landlord’s Lease Termination able and customary disbursement Default39 at any time until __ days40 Notice, Leasehold Mortgagee may procedures as Leasehold Mortgagee after both: (a) Tenant and Leasehold require Landlord to promptly enter (or, absent any Leasehold Mort- Mortgagee have received the Tenant into a New Lease with New Tenant. gagee, Landlord) reasonably Default Notice for that Tenant Landlord need not do so, however, requires, except as this Lease other- Default; and (b) Tenant’s cure period unless New Tenant has, consistent wise provides; and (b) to Tenant, for that Tenant Default has expired. with the Lease Termination Notice: only if and when Tenant has accom- If Leasehold Mortgagee cannot rea- (a) cured all reasonably curable Ten- plished the specified purpose. sonably cure the Tenant Default ant Defaults (except Tenant-Specific within Leasehold Mortgagee’s cure Defaults); and (b) reimbursed Land- Fee Mortgages33 period under the preceding sentence, lord’s reasonable costs and expenses Every Fee Mortgage shall be, it shall have such further time as it (including attorneys’ fees and and state that it is, subject and subor- reasonably needs so long as it pro- expenses) to terminate this Lease, dinate to this Lease and any New ceeds with reasonable diligence. If recover the Premises, and enter into 42 Lease,34 and shall attach only to the Leasehold Mortgagee cannot reason- the New Lease. ably cure a Tenant Default without Fee Estate. A Foreclosure Event shall New Lease Implementation impair no estate or right under any possession, or if any Tenant-Specific Fee Mortgage35 and shall transfer Default(s) occur(s), Leasehold Mort- If Leasehold Mortgagee timely only the Leasehold Estate. gagee shall be entitled to such addi- requests a New Lease in conformity tional time as it reasonably needs to with this Lease, then from the date Leasehold Mortgages consummate a Foreclosure Event this Lease terminates until the par- and obtain possession, provided ties execute and deliver a New Without Landlord’s consent, at Leasehold Mortgagee timely exercis- Lease, Landlord shall not: (a) operate any time(s): (a) provided that any es its cure rights for all other Tenant the Premises in an unreasonable Event of Default has been, or simul- Defaults. If Leasehold Mortgagee manner; (b) terminate Sublease(s) taneously is, cured, Tenant may consummates a Foreclosure Event, except for the Subtenant’s default; or grant Leasehold Mortgage(s);36 (b) Landlord shall waive all Tenant-Spe- (c) lease any Premises except to New any Leasehold Mortgagee may initi- cific Defaults. Tenant. When the parties sign a New ate and complete any Foreclosure Lease, Landlord shall transfer to Event and exercise any other rights Cure Rights Implementation New Tenant all Subleases (including and remedies against Tenant and the any security deposits Landlord Leasehold Estate (but not the Fee Whenever Leasehold Mort- held), service contracts, Premises Estate) under its Leasehold Mort- gagee’s time to cure a Tenant Default operations,43 and net income Land- gage; and (c) any transferee through or consummate a Foreclosure Event lord collected from the Premises dur- a Foreclosure Event, and its succes- has not expired, Landlord shall not ing the period described in the previ- sors and assigns, may assign this terminate this Lease, accelerate any ous sentence, and Landlord shall Lease. rent, or otherwise interfere with Ten- ant’s or Leasehold Mortgagee’s pos- cause every Fee Mortgagee to subor- Lease Impairments session and quiet enjoyment of the dinate unconditionally to the New Leasehold Estate. Leasehold Mort- Lease. Any Lease Impairment made gagee may enter the Premises to seek without Leasehold Mortgagee’s con- to cure a Tenant Default. This right Tenant’s Leasehold Rights sent shall be null, void, and of no or its exercise shall not be deemed to If Tenant’s period to exercise any force or effect, and not bind Tenant, give Leasehold Mortgagee posses- Preemptive Right expires, Landlord Leasehold Mortgagee, or New Ten- sion. shall promptly notify Leasehold ant.37

78 NYSBA N.Y. Real Property Law Journal | Summer/Fall 2004 | Vol. 32 | No. 3 Mortgagee. Until __ days after not extend to any Tenant Default sonable attorneys’ fees and expenses, Leasehold Mortgagee receives such that occurred before such Tenant amend this Lease as any current or notice, Leasehold Mortgagee may took title to this Lease (or a New prospective Leasehold Mortgagee exercise such Preemptive Right for Lease), except as identified in a Ten- reasonably requests, provided such Tenant. Notwithstanding anything to ant Default Notice (or Lease Termi- amendment does not materially the contrary in this Lease, so long as nation Notice) delivered to Lease- adversely affect Landlord or reduce Leasehold Mortgagee’s time to hold Mortgagee before such Tenant any payment. obtain a New Lease has not expired, took title; and (b) terminate if and it may exercise Tenant’s rights when any such Tenant assigns (and Miscellaneous (including Preemptive Rights) under the assignee assumes) or abandons Notwithstanding anything to the this Lease,44 even if a Tenant Default this Lease (or a New Lease). contrary in this Lease, Leasehold exists.45 Tenant irrevocably assigns to Mortgagee may: (a) exercise its Leasehold Mortgagee:46 (a) to the Multiple Leasehold rights through an affiliate, assignee, exclusion of Tenant and any other Mortgagees51 designee, nominee, subsidiary, or person, any right to exercise any If at any time multiple Leasehold other Person, acting in its own name Bankruptcy Termination Option;47 Mortgagees exist: (a) any consent by or in Leasehold Mortgagee’s name and (b) any right of Tenant to object or notice to Leasehold Mortgagee (and anyone acting under this clause to any Bankruptcy Sale by refers to all Leasehold Mortgagees; “a” shall automatically have the Landlord.48 (b) except under clause “a,” the most same protections, rights, and limita- senior Leasehold Mortgagee may tions of liability as Leasehold Mort- 49 Certain Proceedings exercise all rights of Leasehold Mort- gagee); (b) refrain from curing any If Landlord or Tenant initiates gagee(s), to the exclusion of junior Tenant Default; (c) abandon such any appraisal, arbitration, litigation, Leasehold Mortgagee(s); (c) to the cure at any time;53 or (d) withhold or other dispute resolution proceed- extent that the most senior Lease- consent or approval for any reason ing affecting this Lease, then the par- hold Mortgagee declines to do so, or no reason, except where this Lease ties shall simultaneously notify any other Leasehold Mortgagee may states otherwise. Any such consent Leasehold Mortgagee. Leasehold exercise those rights, in order of pri- or approval must be written. To the Mortgagee may participate in such ority;52 and (d) if Leasehold Mort- extent any Mortgagee’s rights under proceedings on Tenant’s behalf, or gagees do not agree on priorities, a this Lease apply after this Lease ter- exercise any or all of Tenant’s rights written determination of priority minates, they shall survive such ter- in such proceedings, in each case (at issued by a title insurance company mination. Leasehold Mortgagee’s option) to the licensed in the State shall govern. exclusion of Tenant.50 No settlement Endnotes shall be effective without Leasehold Further Assurances 1. The sample Leasehold Mortgagee Pro- Mortgagee’s consent, unless Tenant Upon request from Tenant or tections below define many but not all simultaneously pays the settlement, capitalized terms. “Lease” should any Leasehold Mortgagee (prospec- include permitted amendments. the amount at issue does not exceed tive or current), Landlord shall 2. A Tenant might not worry itself about $______, and the claimant has promptly, under documentation rea- Leasehold Mortgagees—at least if the released (or does not assert) any sonably satisfactory to the request- Tenant knows with absolute certainty claim against Leasehold Mortgagee. ing party: (a) acknowledge any Sub- that it, and its successors and assigns, will never need leasehold financing. A tenant’s nondisturbance and No Merger more typical Tenant will care very much recognition rights (provided such about Leasehold Mortgagee Protections, If the Leasehold Estate and the Subtenant joins in such agreement); because by making a Lease financeable Fee Estate are ever commonly held, (b) agree directly with Leasehold they make it more attractive to a wider universe of future debt and equity they shall remain separate and dis- Mortgagee that it may exercise investors. tinct estates (and not merge) without against Landlord all Leasehold Mort- 3. It also causes headaches, according to Leasehold Mortgagee’s and Fee gagee’s rights in this Lease; (c) certi- counsel for at least one Landlord. Mortgagee’s consent. fy that (subject to any then exception 4. The rating agencies’ published standards reasonably specified) this Lease is in do not always track their current prac- No Personal Liability full force and effect, no Lease tices. No Leasehold Mortgagee or Impairment has occurred, to Land- 5. See Joshua Stein, Model Leasehold Mort- lord’s knowledge no Tenant Default gagee Protections, The American College New Tenant shall ever have any lia- of Real Estate Lawyers Papers, Oct. bility under this Lease beyond its exists, the date through which Rent 1999. This article has been updated and interest in this Lease, even if it has been paid, and such other simi- reprinted extensively. See, e.g., Chicago becomes Tenant or assumes this lar matters as may be reasonably Title Insurance Company continuing requested; and (d) provided that legal education program (2000); Ass’n of Lease. Any such liability shall: (a) the Bar of the City of New York (2000); Tenant reimburses Landlord’s rea- N.Y.S. Bar Ass’n Real Property Law Sec-

NYSBA N.Y. Real Property Law Journal | Summer/Fall 2004 | Vol. 32 | No. 3 79 tion, Advanced Real Estate Practice 12. “Premises” should include appurtenant 22. Who estimates restoration cost? Omis- (2000); and N.Y. Mortgage Bankers Ass’n air rights and development rights. sion of a detailed estimation procedure (2001). Except the 1999 publication, each 13. The Lease should say once that leaves a tolerable level of uncertainty, included both the “maximum” and the “include” means “without limitation.” much like any other uncertainty about “minimum” Leasehold Mortgagee Pro- whether some condition has been satis- tections. Each also contains a general 14. The Lease should say once that “or” fied or fact exists. includes “and.” discussion of ground lease issues, alter- 23. A Leasehold Mortgagee will usually tol- natives, negotiations, and closing proce- 15. Though “modification” seems synony- erate a somewhat narrower permitted dures. The author periodically updates mous with “amendment” or “change,” use. Any such narrowing affects the the various Leasehold Mortgagee Protec- one often sees all three words piled value of the Lease, not its fundamental tions and related materials. Current ver- together. It hardly seems necessary. financeability, provided the permitted sions may be obtained from the author 16. The Lease should say once that “notice” uses still make sense, allow reasonable and will appear in the author’s book on means “written notice” delivered in a flexibility, and will not intolerably limit ground leases to be published by the certain way. Leasehold Mortgagee’s resale of the American Law Institute/American Bar 17. This assumes the Lease originally Lease after a Foreclosure Event. Association in late 2004 or early 2005. demised raw land. Valuation of the 24. Landlord may also want Subtenant to 6. This is not a representation or warranty. leased Fee Estate raises many issues, agree to pay Subrent (and any Sublease Any prospective Leasehold Mortgagee including nuances such as how to treat termination payments) directly to Land- or its counsel can almost always find changes in zoning or tax incentives after lord. Landlord (and its Fee Mortgagees) some objection to any Lease. the Commencement Date. may hesitate to “nondisturb” (or “recog- 7. The negotiation process can, however, 18. For this and other value-related provi- nize”) all future Subtenants, even under sometimes be painful and expensive. sions, the Lease should establish the conditions stated. Landlord may 8. Beyond the “shared issues” covered appraisal procedures. Usually the par- argue that once the Lease terminates, here, a Leasehold Mortgagee would look ties find three appraisers, who must Landlord should recover clear posses- next at these issues: remaining term, choose either Landlord’s or Tenant’s sion, without worrying about any bits or transferability, rent adjustment (starting proposed result—“baseball arbitration.” pieces of Tenant’s failed development with the absolute clarity of any revalua- Many believe this process gives both plans. Tenants and Leasehold Mort- tion formula), unusual obligations, alter- parties an incentive to act reasonably. gagees usually look ahead to the agenda of any future major Subtenant; reject ations, demolition, insurance, and envi- 19. Mezzanine lenders may also want Landlord’s position; and win that dis- ronmental matters. Leasehold Mortgagee Protections. Land- cussion despite Landlord’s good argu- lord may say a mezzanine lender is just 9. Whatever topics these Leasehold Mort- ments. gagee Protections omit are generally an equity investor and should rely on its covered, often at length, in the author’s rights as an equity investor—the same 25. The possibility of a Loss and its varia- “maximum” Leasehold Mortgagee Pro- rights it relies on for repayment— tions often consume many pages in a tections. instead of bothering Landlord. Landlord Lease or loan agreement. Landlords, Tenants, Leasehold Mortgagees, and 10. See Joshua Stein, Writing Clearly and may want to limit the amount, number, purpose, or type of loan(s) that Lease- counsel to all of them can negotiate this Effectively: How to Keep the Reader’s Atten- topic, creating new categories, condition, N.Y.S. Bar Ass’n Journal, July–Aug. hold Mortgages secure. Such limitations are generally not market standard or tions, and distinctions, to whatever 1999, at 44; Template for a Template: A degree they want or can stand. Of all the Checklist To Prepare or Improve Any Model appropriate, at least after Tenant has completed and paid for initial develop- issues Leasehold Mortgagee Protections Document, The Practical Lawyer, Apr. cover, treatment of Loss is the one least 2000, at 15, reprinted in Real World Docu- ment. After that: (a) any Leasehold Mortgage of any size to any Leasehold suited to a “one size fits all” resolution, ment Drafting: Form, Style, and Sub- but also the one where cost-benefit con- stance (ALI-ABA professional skills Mortgagee merely creates a possible future Lease transfer through a Foreclo- siderations most cry out for it. These course materials), Dec. 2001, at 131 and Leasehold Mortgagee Protections make Apr. 2002, at 151; How to Use Defined sure Event; (b) Landlord should not care; and a valiant effort. One lawyer has pro- Terms to Make Transactional Documents posed, not entirely as a joke, that the Work Better, The Practical Lawyer, Oct. (c) even if overleverage creates some theoretical possibility of temporarily government should: (a) ban condemna- 1997, at 15; and Cures for the (Sometimes) tion clauses; (b) require any condemnor Needless Complexity of Real Estate Docu- deferring Landlord’s rental income, Landlord’s concerns are not compelling. to compensate each holder of an interest ments, Real Estate Review, Fall 1995, at in the condemned property separately 63. Tenant will usually agree that any Lease- hold Mortgagee must: (1) be “institu- for the value lost; (c) collect a minuscule 11. See Joshua Stein, Short and Simple, The tional;” (2) have a minimum net worth; fee from each real estate transaction to American Lawyer, Oct. 2002, at 59. Here, (3) not be related to Tenant, with some establish a “condemnation undercom- the author suggests seven principles for exceptions; and (4) meet other objective pensation protective fund”; and (d) use better legal writing: (1) shorten long sen- and reasonable criteria. These conces- that fund to make whole any owner or tences; (2) get rid of words, sentences, sions will cause definitional issues, com- lender ever undercompensated for a and paragraphs you do not need; (3) plexity, and risk of obsolescence (for condemnation. (In some states, total prefer verbs to nouns; (4) question use of example, see a typical definition of silence on condemnation, and a lack of any word that includes “here”; try to “institutional lender” in 1975). typical language saying any condemna- substitute something less legalistic; (5) tion terminates a Lease, may produce 20. Depending on circumstances, Tenant use simple words if you can; (6) use the the right result. No Leasehold Mort- may want to provide for joint venture active voice; and (7) write larger num- gagee would ever rely on that proposi- partners that might also hold Leasehold bers as numerals. These principles are tion, however.) Mortgages. hardly new. See, e.g., William Strunk, Jr. 26. Even if Landlord has agreed to allow 21. Landlord may also want copies of & E.B. White, The Elements of Style (4th just anyone to be Leasehold Mortgagee, unrecorded loan documents and future ed. 2000). The legal profession still Landlord can legitimately set standards amendments. Neither request seems jus- seems mostly oblivious to them. for who may hold Loss Proceeds. If a tified. third party might hold Loss Proceeds,

80 NYSBA N.Y. Real Property Law Journal | Summer/Fall 2004 | Vol. 32 | No. 3 Leasehold Mortgagee will have similar game”). Insurance might cover some of 34. Tenant should agree, in the Leasehold concerns. this risk. Mortgage, not to subordinate the Lease 27. On the issue of a temporary condemna- 30. Without a specific decision deadline, the to any Fee Mortgage. Landlord or a Fee tion, silence will usually suffice. courts will infer a “reasonable” time, Mortgagee may suggest that the Fee Mortgagee: (a) be superior and prior to 28. Tenant may want to cap or narrow these creating tolerable uncertainty. In a fully nonrecourse Lease: (a) Tenant has a ter- the Lease, but (b) enter into an absolute expenses, or argue they are just a risk of and unconditional nondisturbance ownership. mination option at all times; (b) a further termination option might just waste agreement with Tenant and any Lease- 29. Leasehold Mortgagees often want Loss words, so long as Tenant must unam- hold Mortgagee. Tenants and Leasehold Proceeds to pay all Leasehold Mortgages biguously leave behind all Loss Pro- Mortgagees typically reject that proposi- in full first. Many observers regard this ceeds if Tenant just “walks away”; and tion, in part for fear it might be deemed position as extreme, for these reasons. A (c) a Loss-based termination becomes an executory contract in the Mortgagee’s condemnation clause should give each interesting only when Tenant or Lease- bankruptcy. They may, however, reluc- party a package reflecting the value and hold Mortgagee wants the right to ter- tantly tolerate a prior Fee Mortgage if relative risks/benefits of its position minate for a partial Loss, yet keep some Fee Mortgagee “joins in” the Lease under the Lease, as if the Lease had con- Loss Proceeds, a possibility not offered when the parties sign it—a joinder in the tinued. Neither party should find itself here. present creation of a property interest in a better position, wealthier, after a rather than an “executory” promise to condemnation than before. Absent con- 31. A “Termination Option Loss” lets Tenant do something later. As another option, demnation, Landlord would hold a low- decide whether to terminate. Landlord the Fee Mortgage could be expressly risk high-priority relatively fixed annu- would reasonably argue that Landlord subordinate to the Lease, except during ity much like a first fee mortgage. See, should keep Loss Proceeds, or Tenant any period when Fee Mortgagee is e.g., Special Report: CMBS: Moody’s should nevertheless restore, and Land- bound by a fully effective nondistur- Approach to Rating Loans Secured By lord’s claim for the value of the bance agreement. If the nondisturbance Ground Leasehold Interests (Oct. 23, 2001). Improvements should defeat the claim agreement goes away, then the Lease In contrast, Tenant and Leasehold Mort- of Tenant and Leasehold Mortgagee, subordination goes away. who “walked away.” If, however, Tenant gagees, as holders of a higher-risk and 35. Fee Mortgagee may want the right to lower-priority interest in the real estate, and Leasehold Mortgagee had no real choice, Landlord’s “expectation”-based cure Landlord defaults. Given the limit- bear the risk of “first loss” if the value ed scope of Landlord’s obligations, Fee and cash flow of the property cannot claim to Loss Proceeds becomes less compelling. For example, if a 60-story Mortgagee’s cure rights can be simpler adequately support Landlord, Tenant, than Leasehold Mortgagee’s. Fee Mort- and their various mortgagees. To do jus- office building was originally a “legal nonconforming use” but current code gagee’s cure rights are neither relevant tice to these positions after an unexpect- to financeability nor uniformly included ed “liquidation” of the Premises from a allows restoration only as a single-fami- ly residence, or if the condemnor took in Leases. The same applies to other pos- Loss, Landlord should have first claim sible Fee Mortgagee protections. to Loss Proceeds, but only to the extent 95% of the site (either, a “Total Loss”), of the value of its low-risk annuity Landlord still has a first-priority claim 36. The parties may want to say that a under the Lease, including the reversion. for any resulting diminution in the Leasehold Mortgagee’s rights end when Tenant should own everything else, Leased Fee Value, but any remaining Tenant repays its loan. This seems obvi- including both the risk of inadequate Loss Proceeds (typically more or less the ous and hence unnecessary. Silence Loss Proceeds and the possible windfall value of the Improvements) go to Tenant avoids the need to analyze, carve out, of excessive Loss Proceeds. In response and its Leasehold Mortgagee. and define certain loan repayments that to issues like these, some Leases require 32. Tenant and Leasehold Mortgagee cannot should not terminate a Leasehold Mort- Landlord and Tenant to share Loss Pro- “take the money and run.” Landlord has gagee’s rights (e.g., those resulting from ceeds in proportion to the relative values an independent interest in restoration. a Foreclosure Event). of their positions. Landlord may fear But what if Loss Proceeds will not cover 37. Without Leasehold Mortgagee’s consent, that any formula tied to the value of restoration? Typically a Lease will any Lease amendment cannot even bind Landlord’s position at the moment of require Tenant to make up the shortfall Landlord and Tenant. Though perhaps condemnation may undercompensate before starting work, but will not require “overkill,” this concept does prevent Landlord, especially for a condemnation a guaranty of that obligation at Lease complexity, controversy, and issues that that occurs during high interest rates or signing. Tenant can “walk away.” Land- might arise if some amendments bound an anomalous real estate market, like lord receives the remaining Loss Pro- Landlord and Tenant but did not bind that of 1991. This undercompensation ceeds, licks its wounds, and finds anoth- Leasehold Mortgagee or New Tenant. parallels the loss a mortgagee suffers er tenant—a residual risk of ownership. 38. Although Leasehold Mortgagees want under 11 U.S.C. §§ 506(a) and 1129(a)(7). The Leasehold Mortgage loan docu- extensive cure rights, they will rarely Those sections let a debtor “cram down” ments will also have something to say. exercise them, because of: (a) fear of lia- a mortgagee based on current adverse Landlord will want some ability to con- bility; (b) general free-floating anxiety; circumstances—fleeting impairment of trol how Tenant restores—raising issues (c) institutional inertia and delays; (d) value of the mortgagee’s collateral— like those in any other major construc- bank group dissension; (e) lack of funds; from a temporarily bad market at the tion project and usually justifying simi- (f) unrecoverability; and (g) an inclina- moment of a bankruptcy filing. The lar outcomes. tion to rely on a court-appointed receiv- mortgagee suffers that loss even though 33. These Leasehold Mortgagee Protections er. In reality, cure rights are probably it thought it had bought into the real do not require all Fee Mortgages to be more a monitoring mechanism than a estate for the long haul. The condemna- “subordinate” to all Leasehold Mort- Lease preservation mechanism. tion formula can set a floor for Land- gages. That issue opens a can of worms 39. If the parties disagree about an alleged lord’s share of the award, taking into caused mostly by confusion about lease- account such things as the remaining Tenant Default, a Leasehold Mortgagee hold transactions. Instead, this para- may want the right to pay under protest Lease term, maximum discount rate, and graph tries to explain succinctly how Fee minimum projected residual value. Any and potentially obtain a refund. Such a Mortgages, the Lease, and Leasehold provision probably duplicates what such Landlord protections will create a Mortgages should interact. corresponding risk for Tenant and its courts would allow anyway. Its absence Leasehold Mortgagees (a “zero-sum should create only tolerable risks, hence

NYSBA N.Y. Real Property Law Journal | Summer/Fall 2004 | Vol. 32 | No. 3 81 not impair financeability. Leasehold bankruptcy code lets Tenant offset dam- hold Mortgagee Protection. That issue Mortgagee will want Tenant to have ages against rent. Incorrect offsets can belongs in an intercreditor agreement, ample cure periods and dispute rights conceivably produce Lease terminations. not Leasehold Mortgagee Protections. even before Leasehold Mortgagee’s cure Thus, some Leases let Leasehold Mort- 53. Landlord may want Leasehold Mort- period begins. gagee approve each offset. These Lease- gagee to commit at some point that 40. Landlord may want a shorter cure peri- hold Mortgagee Protections contain no Leasehold Mortgagee will in fact eventu- od for failure to insure. This sounds such procedures, because such offsets ally cure a Tenant Default, especially if compelling, but probably not practical or are quite rare, and if problems arise construction-related. Leasehold Mort- necessary. Landlord should rely on its Leasehold Mortgagee can reasonably gagee, though, will want a “right to own (and Leasehold Mortgagee’s) moni- protect itself through normal notices of walk” at any time, regardless of how toring; a requirement for prior notice of default and, if necessary, preemptive liti- long Landlord may have had to “wait cancellation from the carrier; and the gation. around,” and will point out that all right to force-place single-interest cover- 48. A recent Seventh Circuit case allowed a monetary obligations will have always age quickly at Tenant’s cost. Landlord to destroy a Lease by selling been kept current. The outcome varies. 41. Landlord may argue that this gives a the leased property through a Bankrupt- Leasehold Mortgagee too many bites at cy Sale—a Lease destruction technique Joshua Stein, a real estate part- the apple and, for example, Leasehold that ground lease practitioners had ner in the New York office of Lath- never before envisioned. See Precision Mortgagee should lose its New Lease am & Watkins LLP, is First Vice rights if at any time any monetary obli- Industries v. Qualitech, 327 F.3d 537, 547 gation was more than ___ days past due. (7th Cir. 2003). The result sounds quite Chair of the Real Property Law Sec- Leasehold Mortgagees usually win this alarming, especially if one believes the tion. His articles and books on real discussion. hysteria that many law firms expressed estate law and practice have been on their websites. The tenant in that case 42. If a dispute exists about any of these could, however, easily have prevented widely published. Copies of some items, Leasehold Mortgagee may want a the problem, and saved its Lease, just by are available at http://www.real- New Lease even while the parties fight. asserting its rights under the Bankruptcy Whether this is reasonable may depend estate-law.com. Recently, he served Code. It apparently failed, forgot, or as editor of Commercial Leasing in part on the nature of the dispute. decided not to exercise those rights, 43. From Lease termination until New Lease hence lost its lease. Qualitech stands for (NYSBA 2004). execution, the Lease could control Land- only three principles. First, anyone who lord’s interim leasing program, Subleas- holds an interest in real estate must This article is based on a chap- es, and operations. Given how rarely (if monitor its position and act proactively ter in the author’s recent book, The ever) any Landlord has ever terminated to protect it when necessary. Second, Lender’s Guide: Structuring and a Lease and then entered into a New surprises never end in the world of Closing Commercial Real Estate Lease, the topic probably does not merit ground leases. Third, bad cases produce the attention and verbiage it can receive. longer documents. Loans (Mortgage Bankers Associa- tion Campus MBA 2004). A revised These Leasehold Mortgagee Protections 49. Much like cure rights, a Leasehold Mort- cover it in a minimal and “broad brush” gagee’s rights under this paragraph may version of this article will also way. be more theoretical—monitoring become part of the author’s upcom- 44. This concept is not standard, but some devices—than ever likely to be used. ing book on ground leases to be secondary market players want it. 50. Tenant will want any Leasehold Mort- published by the American Law 45. Landlord may argue that certain rights gagee not to exclude Tenant unless the Institute/American Bar Association. of Tenant under the Lease should go Loan is in default, and perhaps not even away while Tenant is in default, even then. Such concepts belong in the loan Earlier versions appeared in Real though Leasehold Mortgagee might documents, not the Lease. Estate Finance Journal, Practical want the right to exercise them. 51. The senior Leasehold Mortgagee may Real Estate Lawyer, and elsewhere. 46. This assignment should also appear in want more control than this paragraph The author appreciates previous the Leasehold Mortgage and loan docu- grants. All Leasehold Mortgagees need comments from Richard L. ments. an intercreditor agreement. Chadakoff, Andrew L. Herz, James 47. Many Leases address the Bankruptcy 52. This clause “c” governs as between Termination Option at great length. Landlord and Leasehold Mortgagees as I. Hisiger, Donald H. Oppenheim, Everything they say boils down to this a group. The most senior Leasehold Robert M. Safron, and Bruce M. sentence and the definition of Lease Mortgagee might want to go further, Stachenfeld. Copyright (C) 2004 Impairment. Looking ahead, if Landlord reserving the right to decide that no one Joshua Stein (mail to: rejects the Lease and Tenant exercises no at all shall exercise a particular Lease- Bankruptcy Termination Option, the [email protected]).

Reprinted with permission from: N.Y. Real Property Law Journal, Summer/Fall 2004, Vol. 32, No. 3, published by the New York State Bar Association, One Elk Street, Albany, New York 12207.

82 NYSBA N.Y. Real Property Law Journal | Summer/Fall 2004 | Vol. 32 | No. 3