The bulk of the projects involve tax-exempt lessor structures. Since federal government entities and nonprofit companies are exempt from genuine residential or commercial property taxes in a lot of jurisdictions, a ground lease between such entities and a borrower-sponsor offers a project the chance to either be exempt from residential or commercial property taxes or subject to a payment-in-lieu of taxes arrangement, both of which can offer substantial cost savings over the life of a project.

In college, universities normally make use of conduit financed ground lease structures to build trainee housing projects. These tasks include a ground lease between a university, as landlord, and the borrower-sponsor, as occupant. The university agrees to the ground lease due to the fact that, because the borrower-sponsor is accountable for repayment of the bonds and the mortgage is on the leasehold, the university can build a job on campus without incurring financial obligation and keep the project for complimentary once the ground lease is terminated. During the term of the ground lease, the provisions of the ground lease offers a way for the university to regulate or supervise the job and get an annual ground lease rent.

In other industries, the company typically owns the land and ground rents the land on which the project is to be developed to the borrower-sponsor, who constructs the task and subleases it back to the issuer. Such a task certifies for a genuine residential or commercial property tax exemption since it is owned by a federal government entity, and given that the federal government entity is likewise occupant under the sublease, the project qualifies for sales tax exemptions on products throughout building and construction. The issuer, as tenant under the sublease, is responsible for payment of the bonds, while the borrower-sponsor develops and runs the task pursuant to terms and conditions of contracts with the provider. The borrower-sponsor generally has a chance to acquire the land and project once the bonds are paid.

These structures present unique threats to bond purchasers. The bonds are generally secured by mortgages on the leasehold and/or subleasehold estates. Bondholders must be mindful of the rights of parties to terminate the ground lease or hinder their capability to work out treatments. If the ground lease is ended or the trustee can not take ownership of the task, the matching lien on the physical job is extinguished and the collateral bundle has no value.

With that in mind, shareholders ought to seek the following defenses in any ground lease that is part of a local bond funding:
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Term - the regard to the ground lease must be at least five years beyond the maturity date of the bonds, and bondholders should press for more if at all possible. The extra five or more years enables for a workout and extension of the term of the bonds in case it is required to permit the task to money flow to cover operating expenses and debt service. If the bonds on a project have a bullet maturity, the regard to the ground lease should be at least double the regard to the bonds to enable for a refunding of the growing bonds.

Authorization - the ground lease should explicitly authorize the borrower-sponsor to sustain 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 must be assignable by the trustee without limitations. Failure to include such provisions might prevent a mortgagee from selling or transferring the leasehold estate (by sale or otherwise) upon foreclosure or the execution of an assignment-in-lieu of foreclosure. It is essential for the arrangements to enable the trustee to designate another entity to take position in lieu of the trustee considering that the funding structure may count on the status of borrower-sponsor to protect the tax-exempt status of the bonds and/or offer other tax benefits. Additionally, such designee ought to be entitled to a brand-new lease to aid in the restructuring of the job upon foreclosure or assignment-in-lieu of foreclosure.

Notice and Opportunity to Cure - any notice of default by the tenant under the ground lease ought to be supplied to the trustee, and the trustee must have an opportunity to treatment of a minimum of 30 days. An uncured event of default of tenant under the ground lease usually grants the lessor the right to end the ground lease, which would the trustee's collateral. A notice and opportunity to treat enables the trustee to protect its security and later on seek reimbursement for such expenditures of debtor under the leasehold mortgage, trust indenture or other bond documents.

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

No Modification - the ground lease must not be allowed to be customized without the approval of mortgagee, otherwise the proprietor and customer could modify mortgagee rights and remedies without mortgagee's understanding or approval.

In our experience representing shareholders, the majority of the ground leases we have actually evaluated have included the foregoing provisions. As we have encountered more complex fundings, we have actually seen the following major concerns:

Cross-Default - the ground lease and sublease need to not cross-default with the trust indenture, loan agreement or any other bond document (Example: "A default under the Trust Indenture is a default under this Lease ..."). Any event of default under the bond files need to offer the trustee the possibility to work out solutions, not give the property owner the chance to eliminate the leasehold estate and, as a result, the security, unless the trustee cures borrower-sponsor's default.

Third Party Beneficiary - the ground lease and sublease ought to acknowledge the trustee and any follower trustee as third-party beneficiaries. This can be done by consisting of a provision that designates any leasehold mortgagee as a third-party recipient that can impose the contract against the property manager and the occupant. Leasehold mortgagees are not celebrations to the ground lease, so a third-party recipient classification is required to enforce mortgagee securities in the ground lease and sublease versus the proprietor and renter in court. Additionally, if success of the job depends on the landlord and borrower-sponsor meeting specific requirements or providing particular services under the ground lease or sublease, the third-party beneficiary designation is necessary for the leasehold mortgagee to impose those arrangements versus the celebrations if they stop working to satisfy expectations.

Borrower Notices and Consents - if the task is a lease-sublease structure where the borrower-sponsor is the occupant under the ground lease and the property owner under the sublease, the borrower-sponsor needs to have no approval rights on any mortgagee matters under the ground lease or the sublease. The borrower-sponsor as ground lease renter and sublease property manager is more of a passthrough entity for the project up until the bonds are paid, while the borrower-sponsor as designer and supervisor is a true party-in-interest to the project. Just as developers and supervisors usually do not have permission rights to adjustments of the collateral, the borrower-sponsor ought to not have those consent rights to the mortgage in the project. It grants the borrower-sponsor severe leverage in a workout against shareholders. If the borrower-sponsor has authorization rights over mortgages in the sublease, for instance, it might avoid the execution of a mortgage on the subleasehold estate over overdue management and developer charges that are secondary to financial obligation service.

Shared Parcels - the ground lease and sublease need to be on their own subdivided plot, not part of a bigger cost estate parcel. When ground lease tasks belong to a bigger charge estate parcel, the job is at risk of unassociated actions and charges on the fee estate. For circumstances, if a landlord that has ground leased part of the charge residential or commercial property to a task, moneyed by bonds and secured by a leasehold mortgage, decides to establish the rest of the residential or commercial property on the fee estate and secure it by a cost mortgage, a foreclosure of that fee mortgage would snuff out the leasehold and subleasehold estates. Similarly, if the property owner's charge project sustains taxes, utility charges, house owners association costs or other costs that have the possible to end up being "very liens" superior to the leasehold estate, a foreclosure of those liens would end the ground lease and sublease. If the ground lease and sublease must belong to a larger charge parcel, the ground lease and sublease must (a) require that any mortgage or lien placed on the charge interest is subordinate to the ground lease, (b) require that the landlord immediately pays any charges or costs that risks the leaseholds, and (c) enable the borrower-sponsor and the leasehold mortgagee to treat charges on the charge estate and look for reimbursement from the property owner.

Multiple Mortgagees - The ground lease must acknowledge the potential for multiple mortgagees and prioritize the most senior mortgagee. We have come across jobs with multiple mortgagees where the mortgagees do not have an intercreditor arrangement. In those cases, either the secondary mortgagees are secondary to the senior mortgagees based on time of recording and the other bond documents, or the secondary mortgagees have a springing security interest that connects once the senior bonds are paid off. Because there is no intercreditor arrangement, the deal is quiet as to negotiation treatments upon an occasion of default. Subordinate mortgagees, who normally have a closer relationship with the borrower-sponsor and misaligned interest with the senior mortgagees, frequently take the reins negotiating with property managers in a workout without informing or seeking advice from the senior mortgagees. Either the ground lease should clarify that the proprietor will focus on the most senior protected mortgagee in settlement and dispute resolution, and/or an intercreditor agreement with clear guidelines must be taped on the project.

Before buying a ground lease job, shareholders should completely understand the task and its threats. While evaluating the main statement and engaging with the underwriter, this customer alert need to function as a detailed list of problems that should be attended to. In the context of a minimal offering, perspective buyers of the bonds have leverage to request our recommended changes to the ground lease. In those deals, many property managers are related celebrations that straight take advantage of the conduit financed task. It would normally benefit property owners for the jobs to prosper, and a failure to negotiate in good faith or a termination of the ground lease with a leasehold mortgage would negatively impact their credibility and ranking in the bond market. If any of these protections are not consisted of when the bonds are released, it is important to acquire them in an exercise as a condition for forbearance or refinancing.