Kristiana Farris O'Brien

Designing the Ground Lease Form

i. Landlord chooses an appraiser first who determines fair market value. Tenant can accept the first appraiser’s determination or select a second appraiser to do another fair market value determination. If the second appraisal is within a certain percentage of the first appraisal, the two are averaged and the average is the new rental rate. If the second appraisal and the first appraisal differ by more than a certain percentage, then a third appraiser is appointed. Either the third appraiser’s determination or a determination by agreement of two of three appraisers will serve as the fair market value.

ii. A variation of this is the “baseball” approach in which the third appraiser must select the decision of one of the first two appraisers.

iii. Another variation is for both the first and second appraiser to be selected at the same time and require them to mutually agree on the fair market value.

The appraisal processes can be time consuming and expensive, especially as the number of appraisers involved increases. Accordingly, a tenant will want to lengthen the intervals between which appraisals are required. Landlords and tenants also will attempt to shift the appraisal costs between them in the lease.

c. Completion of Improvements

The landlord will be particularly concerned with providing in the ground lease adequate safeguards to ensure that the tenant actually completes all of the tenant improvements so that the landlord is not left with a hole in the ground or a partial structure. A thorough investigation of the tenant’s financial strength and the terms of construction financing is necessary. A landlord should consider providing in the ground lease that construction cannot commence until the tenant delivers to the landlord: (i) an executed copy of the construction contract with a well-reputed contractor that provides for a fixed construction cost (to the extent possible), (ii) a commitment for a construction loan from a well-reputed lender, and (iii) a letter of credit or other security equal to the difference between the construction cost set forth in the construction contract and the amount of the construction loan. The extent to which the plans and drawings for the improvements must be pre-approved by the landlord is a matter of negotiation.

d. Protection From Liens and Liabilities

One of the risks of a ground lease to a landlord is the possibility that the tenant will cause liens to be placed on the property that could result in the landlord losing the fee interest or the improvements. Two common ways in which this could happen are failure to pay taxes or failure to pay for work in connection with the construction of improvements, resulting in mechanic’s or materialmen’s liens being placed on the property. In addition, the Comprehensive Environmental Liability Response Act of 1980 (CERCLA) (42 U.S.C. § 9601 et seq.) holds the landlord and tenant jointly and severally liable for contamination of the property when a hazardous substance is present on the property during the term of a lease. Landlords should insist upon such provisions in a ground lease as (i) affirmative covenants to pay all taxes on time, keep the property free and clear of all liens (other than a leasehold mortgage, described below) and to post a bond if the tenant has a bona fide dispute with respect to an assessment, (ii) restrictions on hazardous wastes, (iii) broad insurance requirements, and (vi) indemnification of the landlord from and against any and all third party claims.

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