Jay Melnick Published in Commercial Leasing Law & Strategy
"Leasehold Financing: It's Good to Have Options"

Jay Melnick's article, "Leasehold Financing: It's Good to Have Options," was published in the August 2009 issue of Commercial Leasing Law & Strategy. His article discusses one particular concept in commercial leasing, which, if properly addressed and negotiated up front, is likely to benefit both the landlord and the tenant by providing greater security and increased credit possibilities in the years to come; namely, leasehold financing. Jay explains that "Leasehold financing is secured by a mortgage on the tenant's interest under a lease…. In the case of leasehold financing, should the borrower default on the loan, the lender's primary remedy will be to 'foreclose' on the leasehold mortgage by stepping into the borrower's shoes and becoming the tenant under the lease."

In his article, Jay explains that there are several scenarios in which a lender might accept a mortgage of a tenant's interest under a lease as security for a loan. For example, he notes, "…If a tenant under a ground lease for unimproved property has subsequently constructed improvements, not only will the improvements themselves be valuable to a lender as collateral for the loan, but depending on the assignment and subleasing provisions of the lease, the improvements might also have created additional value by increasing the amount of rent that an outside party would reasonably be expected to pay." Jay also explains that "the lender of a leasehold financing transaction will need to exercise a certain degree of oversight and control over the collateral to ensure that the value of that collateral is not impaired."

Jay describes why it's important to have a nondistrubance agreement in favor of the tenant, so that the leasehold mortgagee can feel comfortable that, "should the landlord default on its loan and the landlord's mortgagee take possession of the property, the mortgagee in possession will not be able to terminate the lease or vacate the tenant and thereby destroy the value of the leasehold mortgagee's collateral." He also discusses a few other provisions that should be addressed when securing leasehold financing, such as how a lender has the right to foreclosure without dealing with the landlord and how "the lender on a leasehold estate will need to know that, should the borrower become delinquent and/or default in its obligations to the landlord under the lease, the lender will be able to cure such deficiencies and preserve the value of its collateral."

Jay concludes that "...it is best to address these key items in a leasehold financing provision in the original lease. While the absence of such a provision will not necessarily preclude the tenant from obtaining leasehold financing, it will require the tenant to go back to the landlord and obtain the rights necessary for leasehold financing in an estoppel, a lease amendment, or the like." He continues, "If, on the other hand, the leasehold financing rights are clearly set forth in the original lease, the parties should be able to avoid the vast majority of such costs and inconvenience and accomplish the leasehold financing transaction smoothly and efficiently."