Kristiana Farris O'Brien

Designing the Ground Lease Form

e. Subleases

A tenant will want the ability to sublease the property freely. This is a reasonable expectation since subleasing will provide the return on the tenant’s investment in the improvements. A landlord is advised, however, to ensure that the ground lease requires that any sublease obligate the subtenant to, at the election of the landlord, attorn to the landlord and continue to perform all of its obligations under the sublease upon the termination or expiration of the ground lease. This is essential to the value of the property to revert to the landlord upon termination of the ground lease.

f. Mortgagee Protection Clauses

One of the most critical parts of a ground lease, and often one of the most heavily negotiated, is the mortgagee protection clause. A tenant will need to obtain financing secured by its leasehold interest in the property. As a condition to providing such financing, a lender/mortgagee often requires extensive mortgagee protection provisions in the ground lease. These can include:

• Broad permitted use provisions so that, if the mortgagee has to step in and take over an unsuccessful project, it can convert it into a successful one;
• No limitation on subletting and assignment of the ground lease and a required release of each tenant from further liability under the ground lease upon assignment;
• Insurance and condemnation proceeds to be paid to the lender or to a trustee for use only for restoration of the building;
• Required notice to the mortgagee and liberal opportunity to cure any tenant default;
• The right of the mortgagee to take over the lease upon foreclosure;
• If the landlord has the right to terminate the lease, the right of the mortgagee to receive notice of termination and to receive a new lease on all of the same terms for a designated period of time; and
• Requirement of obtaining the mortgagee’s prior written consent to any termination, cancellation or amendment of the lease.

g. Subordination of the Fee

It is not uncommon for a leasehold mortgagee to require the landlord to subordinate the landlord’s fee interest in the property, and any fee mortgage, to the ground lease and the leasehold mortgage. If the fee mortgage is not subordinated to the ground lease and the leasehold mortgage, then a successful foreclosure of the fee mortgage will operate to terminate the ground lease. Although landlords and their lenders often balk initially, a request for such a subordination is not unreasonable. It is the leasehold mortgagee’s funds that are being used to improve and add value to the property. The landlord is not bearing the risk, but reaping ultimately the gain of such improvement. Moreover, any fee mortgage is just an added bonus to the landlord, enabling the landlord to take a portion of the present value of the rental stream early and tax free. Moreover, the ground lease is generally valuable to the fee mortgagee who, under most circumstances, should desire to keep it in place following foreclosure.

h. Recourse Versus Nonrecourse Leases

A tenant will want to insist that a lease be absolutely nonrecourse such that the tenant’s obligations under the lease are secured solely by the tenant’s business on the premises. This is not an unreasonable position since the value of the project is generally of more interest to the landlord than the credit worthiness of a particular individual. A landlord, in some circumstances, may succeed in securing certain nonrecourse “carve outs” – a type of limited personal guaranty by the principals of the tenant upon the occurrence of certain defaults, such wrongful diversion by the tenant of rent from subleases.

Last Page