Most of the jobs involve tax-exempt lessor structures. Since federal government entities and nonprofit organizations are exempt from real residential or commercial property taxes in the majority of jurisdictions, a ground lease between such entities and a borrower-sponsor supplies a project the opportunity to either be exempt from residential or commercial property taxes or subject to a payment-in-lieu of taxes arrangement, both of which can provide considerable savings over the life of a job.

In higher education, universities normally utilize conduit financed ground lease structures to build trainee housing projects. These jobs consist of a ground lease between a university, as landlord, and the borrower-sponsor, as renter. The university agrees to the ground lease due to the fact that, considering that the borrower-sponsor is accountable for repayment of the bonds and the mortgage is on the leasehold, the university can construct a job on campus without incurring financial obligation and keep the task free of charge once the ground lease is ended. During the regard to the ground lease, the arrangements of the ground lease supplies a method for the university to manage or monitor the task and get an annual ground lease rent.

In other industries, the issuer often owns the land and ground rents the arrive on which the job is to be developed to the borrower-sponsor, who constructs the project and subleases it back to the company. Such a project qualifies for a real residential or commercial property tax exemption due to the fact that it is owned by a government entity, and considering that the government entity is also renter under the sublease, the project gets approved for sales tax exemptions on materials during building. The issuer, as renter under the sublease, is accountable for payment of the bonds, while the borrower-sponsor develops and operates the job pursuant to terms of arrangements with the company. The borrower-sponsor typically has an opportunity to buy the land and project once the bonds are paid.

These structures present distinct risks to bond buyers. The bonds are typically protected by mortgages on the leasehold and/or subleasehold estates. Bondholders need to bear in mind the rights of celebrations to terminate the ground lease or hinder their capability to work out treatments. If the ground lease is ended or the trustee can not acquire the task, the matching lien on the physical task is snuffed out and the security package has no worth.

With that in mind, shareholders need to seek the following defenses in any ground lease that belongs to a community bond financing:

Term - the term of the ground lease must be at least five years beyond the maturity date of the bonds, and shareholders must press for more if at all possible. The additional five or more years enables a workout and extension of the regard to the bonds in the event it is required to allow the project to capital to cover business expenses and financial obligation service. If the bonds on a task have a bullet maturity, the term of the ground lease ought to be at least double the term of the bonds to permit a refunding of the developing bonds.

Authorization - the ground lease should explicitly license the borrower-sponsor to incur a mortgage on the ground lease otherwise a court would think about the lien on the leasehold estate void.

Transfer and Assignment - the ground lease ought to be assignable by the trustee without restrictions. Failure to include such arrangements might prevent a mortgagee from offering or transferring the leasehold estate (by sale or otherwise) upon foreclosure or the execution of an assignment-in-lieu of foreclosure. It is necessary for the arrangements to enable for the trustee to designate another entity to take position in lieu of the trustee since the financing structure might depend on the status of borrower-sponsor to maintain the tax-exempt status of the bonds and/or provide other tax advantages. Additionally, such designee needs to be entitled to a new lease to assist in the restructuring of the project upon foreclosure or assignment-in-lieu of foreclosure.

Notice and Opportunity to Cure - any notification of default by the renter under the ground lease must be offered to the trustee, and the trustee should have an opportunity to cure of at least 1 month. An uncured event of default of renter under the ground lease typically gives the lessor the right to terminate the ground lease, which would get rid of the trustee's security. A notification and chance to cure permits the trustee to protect its collateral and later seek reimbursement for such expenses of borrower under the leasehold mortgage, trust indenture or other bond documents.

New Lease - if the ground lease is terminated for any reason, like termination upon default, or is declined in personal bankruptcy, the trustee should have the chance to participate in a new lease on the very same terms.

No Modification - the ground lease need to not be permitted to be customized without the approval of mortgagee, or else the proprietor and customer could modify mortgagee rights and solutions without mortgagee's knowledge or consent.

In our experience representing bondholders, many of the ground rents we have actually reviewed have included the foregoing provisions. As we have experienced more complicated financings, we have seen the following severe problems:

Cross-Default - the ground lease and sublease should not cross-default with the trust indenture, loan arrangement or any other bond file (Example: "A default under the Trust Indenture is a default under this Lease ..."). Any occasion of default under the bond files ought to supply the trustee the possibility to work out solutions, not provide the property manager the chance to get rid of the leasehold estate and, as a result, the security, unless the trustee remedies borrower-sponsor's default.

3rd Party Beneficiary - the ground lease and sublease must acknowledge the trustee and any follower trustee as third-party beneficiaries. This can be done by consisting of an arrangement that designates any leasehold mortgagee as a third-party beneficiary that can implement the contract against the property manager and the renter. Leasehold mortgagees are not celebrations to the ground lease, so a third-party beneficiary designation is needed to impose mortgagee securities in the ground lease and sublease against the property owner and tenant in court. Additionally, if success of the task depends on the proprietor and borrower-sponsor conference particular requirements or providing specific services under the ground lease or sublease, the third-party recipient classification is essential for the leasehold mortgagee to enforce those arrangements against the celebrations if they fail to meet expectations.

Borrower Notices and Consents - if the task is a lease-sublease structure where the borrower-sponsor is the tenant under the ground lease and the property owner under the sublease, the borrower-sponsor should have no authorization rights on any mortgagee matters under the ground lease or the sublease. The borrower-sponsor as ground lease renter and sublease proprietor is more of a passthrough entity for the task until the bonds are paid, while the borrower-sponsor as designer and supervisor is a real party-in-interest to the task. Just as designers and managers normally do not have permission rights to adjustments of the collateral, the borrower-sponsor must not have those consent rights to the mortgage in the task. It gives the borrower-sponsor major take advantage of in an exercise against shareholders. If the borrower-sponsor has permission rights over mortgages in the sublease, for example, it might prevent the execution of a mortgage on the subleasehold estate over unpaid management and designer costs that are subordinate to debt service.

Shared Parcels - the ground lease and sublease should be on their own partitioned plot, not part of a larger fee estate parcel. When ground lease jobs become part of a larger cost estate parcel, the project is at risk of unrelated actions and charges on the fee estate. For example, if a landlord that has actually part of the charge residential or commercial property to a task, moneyed by bonds and protected by a leasehold mortgage, decides to develop the rest of the residential or commercial property on the cost estate and secure it by a fee mortgage, a foreclosure of that charge mortgage would snuff out the leasehold and subleasehold estates. Similarly, if the landlord's fee job incurs taxes, utility charges, homeowners association charges or other expenses that have the prospective to end up being "incredibly liens" superior to the leasehold estate, a foreclosure of those liens would end the ground lease and sublease. If the ground lease and sublease should become part of a larger fee parcel, the ground lease and sublease ought to (a) need that any mortgage or lien put on the cost interest is secondary to the ground lease, (b) need that the proprietor without delay pays any charges or costs that risks the leaseholds, and (c) permit the borrower-sponsor and the leasehold mortgagee to cure charges on the fee estate and seek reimbursement from the landlord.

Multiple Mortgagees - The ground lease need to acknowledge the potential for multiple mortgagees and focus on the most senior mortgagee. We have come across tasks with numerous mortgagees where the mortgagees do not have an intercreditor contract. In those cases, either the secondary mortgagees are subordinate to the senior mortgagees based upon time of recording and the other bond files, or the secondary mortgagees have a springing security interest that attaches once the senior bonds are paid off. Because there is no intercreditor contract, the deal is quiet regarding negotiation procedures upon an occasion of default. Subordinate mortgagees, who generally have a closer relationship with the borrower-sponsor and misaligned interest with the senior mortgagees, too frequently take the reins negotiating with property managers in an exercise without informing or seeking advice from the senior mortgagees. Either the ground lease must clarify that the proprietor will focus on the most senior protected mortgagee in settlement and conflict resolution, and/or an intercreditor arrangement with clear guidelines need to be taped on the job.

Before purchasing a ground lease job, shareholders must totally understand the job and its threats. While reviewing the official declaration and engaging with the underwriter, this client alert should work as a thorough list of concerns that must be attended to. In the context of a minimal offering, viewpoint purchasers of the bonds have leverage to request our suggested modifications to the ground lease. In those transactions, many proprietors belong parties that directly benefit from the conduit funded project. It would usually benefit proprietors for the jobs to prosper, and a failure to work out in excellent faith or a termination of the ground lease with a leasehold mortgage would adversely affect their track record and ranking in the bond market. If any of these protections are not included when the bonds are provided, it is crucial to acquire them in an exercise as a condition for forbearance or refinancing.