The majority of the tasks include tax-exempt lessor structures. Since federal government entities and not-for-profit organizations are exempt from real residential or commercial property taxes in a lot of jurisdictions, a ground lease in between such entities and a borrower-sponsor supplies a job the opportunity to either be exempt from residential or commercial property taxes or based on a payment-in-lieu of taxes arrangement, both of which can supply substantial savings over the life of a job.

In college, universities generally utilize conduit funded ground lease structures to develop trainee housing tasks. These tasks include a ground lease between a university, as property owner, and the borrower-sponsor, as occupant. The university agrees to the ground lease since, because the borrower-sponsor is accountable for payment of the bonds and the mortgage is on the leasehold, the university can build a project on school without incurring financial obligation and keep the job free of charge once the ground lease is terminated. During the regard to the ground lease, the arrangements of the ground lease provides a means for the university to control or monitor the task and receive a yearly ground lease rent.

In other markets, the issuer frequently owns the land and ground leases the land on which the task is to be built to the borrower-sponsor, who constructs the job and subleases it back to the provider. Such a task gets approved for a real residential or commercial property tax exemption due to the fact that it is owned by a government entity, and since the government entity is also tenant under the sublease, the task gets approved for sales tax exemptions on products throughout construction. The company, as occupant under the sublease, is responsible for payment of the bonds, while the borrower-sponsor develops and operates the task pursuant to terms of contracts with the issuer. The borrower-sponsor generally has an opportunity to purchase the land and task when the bonds are paid.

These structures present distinct risks to bond buyers. The bonds are usually protected by mortgages on the leasehold and/or subleasehold estates. Bondholders need to be mindful of the rights of celebrations to end the ground lease or hinder their ability to exercise treatments. If the ground lease is terminated or the trustee can not take ownership of the task, the corresponding lien on the physical project is extinguished and the security bundle has no worth.

With that in mind, shareholders ought to seek the following protections in any ground lease that becomes part of a community bond financing:

Term - the regard to the ground lease must be at least 5 years beyond the maturity date of the bonds, and shareholders should promote more if at all possible. The additional five or more years permits an exercise and extension of the term of the bonds in case it is required to permit the job to capital to cover operating costs and debt service. If the bonds on a project have a bullet maturity, the regard to the ground lease ought to be at least double the term of the bonds to enable a refunding of the maturing bonds.

Authorization - the ground lease ought to explicitly license the borrower-sponsor to incur a mortgage on the ground lease or else a court would consider the lien on the leasehold estate invalid.

Transfer and Assignment - the ground lease ought to be assignable by the trustee without limitations. Failure to consist of such arrangements could avoid a mortgagee from offering or moving 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 permit the trustee to designate another entity to take position in lieu of the trustee because the financing structure may depend on the status of borrower-sponsor to maintain the tax-exempt status of the bonds and/or supply other tax advantages. Additionally, such designee needs to be entitled to a new lease to aid in the restructuring of the project upon foreclosure or assignment-in-lieu of foreclosure.

Notice and Opportunity to Cure - any notice of default by the renter under the ground lease must be provided to the trustee, and the trustee ought to have an opportunity to cure of at least one month. An uncured occasion of default of renter under the ground lease generally grants the lessor the right to terminate the ground lease, which would remove the trustee's security. A notice and chance to treat allows the trustee to preserve its security and later on seek compensation for such expenses of borrower under the leasehold mortgage, trust indenture or other bond files.

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

No Modification - the ground lease ought to not be allowed to be customized without the approval of mortgagee, otherwise the proprietor and borrower might modify mortgagee rights and treatments without mortgagee's understanding or permission.

In our experience representing bondholders, most of the ground rents we have actually evaluated have actually included the foregoing provisions. As we have actually experienced more complex financings, we have seen the following major 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 documents ought to provide the trustee the opportunity to exercise treatments, not give the landlord the chance to remove the leasehold estate and, as an outcome, the collateral, unless the trustee cures borrower-sponsor's default.

Third Party Beneficiary - the ground lease and sublease should recognize the trustee and any successor trustee as third-party recipients. This can be done by including an arrangement that designates any leasehold mortgagee as a third-party recipient that can impose the arrangement versus the property manager and the tenant. Leasehold mortgagees are not parties to the ground lease, so a third-party recipient classification is required to enforce mortgagee defenses in the ground lease and sublease versus the property manager and occupant in court. Additionally, if success of the task depends on the property manager and borrower-sponsor meeting specific requirements or providing specific services under the ground lease or sublease, the third-party beneficiary designation is required for the leasehold mortgagee to implement those provisions versus the parties if they stop working to satisfy expectations.

Borrower Notices and Consents - if the project is a lease-sublease structure where the borrower-sponsor is the tenant under the ground lease and the proprietor under the sublease, the borrower-sponsor ought to have no consent rights on any mortgagee matters under the ground lease or the sublease. The borrower-sponsor as ground lease tenant and sublease proprietor is more of a passthrough entity for the job till the bonds are paid, while the borrower-sponsor as designer and manager is a real party-in-interest to the job. Just as developers and supervisors typically do not have permission rights to adjustments of the security, the borrower-sponsor should not have those approval rights to the mortgage in the project. It approves the borrower-sponsor major take advantage of in an exercise versus bondholders. If the borrower-sponsor has authorization rights over mortgages in the sublease, for instance, it might prevent the execution of a mortgage on the subleasehold estate over overdue management and developer fees that are secondary to financial obligation service.

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

Multiple Mortgagees - The ground lease ought to recognize the capacity for numerous 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 subordinate mortgagees are secondary 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 as soon as the senior bonds are paid off. Because there is no intercreditor agreement, the deal is silent regarding negotiation treatments upon an event of default. Subordinate mortgagees, who normally have a closer relationship with the borrower-sponsor and misaligned interest with the senior mortgagees, too often take the reins working out with landlords in an exercise without alerting or seeking advice from the senior mortgagees. Either the ground lease need to clarify that the property manager will focus on the most senior protected mortgagee in negotiation and disagreement resolution, and/or an intercreditor arrangement with clear standards ought to be recorded on the job.

Before buying a ground lease task, bondholders should completely comprehend the job and its risks. While examining the main declaration and engaging with the underwriter, this client alert ought to act as a thorough checklist of issues that need to be resolved. In the context of a minimal offering, point of view purchasers of the bonds have leverage to request our suggested modifications to the ground lease. In those deals, many proprietors belong parties that directly take advantage of the channel funded task. It would typically benefit property owners for the tasks to be successful, and a failure to negotiate in great faith or a termination of the ground lease with a leasehold mortgage would adversely affect their reputation and rating in the bond market. If any of these defenses are not consisted of when the bonds are provided, it is vital to acquire them in an exercise as a condition for forbearance or refinancing.