The majority of the tasks include tax-exempt lessor structures. Since federal government entities and not-for-profit 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 opportunity to either be exempt from residential or commercial property taxes or subject to a payment-in-lieu of taxes plan, both of which can provide considerable cost savings over the life of a task.

In college, universities generally make use of channel financed ground lease structures to construct trainee housing projects. These jobs include a ground lease in between a university, as property owner, and the borrower-sponsor, as renter. The university agrees to the ground lease because, given that the borrower-sponsor is accountable for repayment of the bonds and the mortgage is on the leasehold, the university can develop a project on school without sustaining financial obligation and keep the task totally free once the ground lease is terminated. During the term of the ground lease, the provisions of the ground lease provides a means for the university to control or supervise the job and get an annual ground lease rent.

In other markets, the issuer often owns the land and ground rents the arrive on which the task is to be developed to the borrower-sponsor, who constructs the project and subleases it back to the company. Such a task receives a real residential or commercial property tax exemption because it is owned by a government entity, and because the government entity is also occupant under the sublease, the job receives sales tax exemptions on materials throughout construction. The provider, as renter under the sublease, is accountable for payment of the bonds, while the borrower-sponsor establishes and operates the job pursuant to terms and conditions of agreements with the issuer. The borrower-sponsor generally has a chance to buy the land and job as soon as the bonds are paid.

These structures present distinct threats to bond purchasers. The bonds are usually secured by mortgages on the leasehold and/or subleasehold estates. Bondholders ought to be conscious 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 possession of the project, the matching lien on the physical task is extinguished and the security bundle has no worth.

With that in mind, bondholders ought to look for the following securities in any ground lease that belongs to a municipal bond financing:

Term - the regard to the ground lease ought to be at least 5 years beyond the maturity date of the bonds, and bondholders ought to push for more if at all possible. The additional 5 or more years allows for an exercise and extension of the term of the bonds in case it is required to permit the job to capital to cover business expenses and financial obligation service. If the bonds on a job have a bullet maturity, the regard to the must be at least double the regard to the bonds to permit for a refunding of the growing 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 think about the lien on the leasehold estate void.

Transfer and Assignment - the ground lease must be assignable by the trustee without restrictions. Failure to include such arrangements might avoid a mortgagee from offering or transferring the leasehold estate (by sale or otherwise) upon foreclosure or the execution of an assignment-in-lieu of foreclosure. It is crucial for the arrangements to permit for the trustee to designate another entity to take position in lieu of the trustee since the funding structure may depend on the status of borrower-sponsor to maintain the tax-exempt status of the bonds and/or supply other tax benefits. Additionally, such designee needs to be entitled to a brand-new lease to aid in the restructuring of the task upon foreclosure or assignment-in-lieu of foreclosure.

Notice and Opportunity to Cure - any notification of default by the tenant under the ground lease ought to be supplied to the trustee, and the trustee needs to have an opportunity to remedy of a minimum of one month. An uncured event of default of tenant under the ground lease normally grants the lessor the right to terminate the ground lease, which would remove the trustee's collateral. A notice and opportunity to cure enables the trustee to preserve its collateral and later look for reimbursement for such costs of debtor under the leasehold mortgage, trust indenture or other bond files.

New Lease - if the ground lease is terminated for any reason, like termination upon default, or is rejected in bankruptcy, the trustee must have the chance to get in into a brand-new lease on the very same terms.

No Modification - the ground lease should not be permitted to be customized without the permission of mortgagee, otherwise the landlord and debtor could customize mortgagee rights and solutions without mortgagee's knowledge or permission.

In our experience representing bondholders, the majority of the ground leases we have evaluated have consisted of the foregoing arrangements. As we have experienced more intricate financings, we have actually seen the following serious problems:

Cross-Default - the ground lease and sublease must 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 chance to exercise solutions, not give the property owner the opportunity to get rid of the leasehold estate and, as a result, the collateral, 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 an arrangement that designates any leasehold mortgagee as a third-party beneficiary that can implement the contract against the property manager and the renter. Leasehold mortgagees are not parties to the ground lease, so a third-party beneficiary designation is required to implement mortgagee defenses in the ground lease and sublease versus the property owner and occupant in court. Additionally, if success of the project depends on the property manager and borrower-sponsor meeting certain requirements or using specific services under the ground lease or sublease, the third-party beneficiary designation is necessary for the leasehold mortgagee to enforce those arrangements versus the celebrations if they fail to meet expectations.

Borrower Notices and Consents - if the task is a lease-sublease structure where the borrower-sponsor is the tenant under the ground lease and the landlord under the sublease, the borrower-sponsor needs to have no permission rights on any mortgagee matters under the ground lease or the sublease. The borrower-sponsor as ground lease occupant and sublease property owner is more of a passthrough entity for the project up until the bonds are paid, while the borrower-sponsor as developer and supervisor is a real party-in-interest to the project. Just as designers and supervisors normally do not have authorization rights to adjustments of the security, the borrower-sponsor must not have those approval rights to the mortgage in the project. It approves the borrower-sponsor major utilize in an exercise against bondholders. If the borrower-sponsor has permission rights over mortgages in the sublease, for example, it could prevent the execution of a mortgage on the subleasehold estate over overdue management and designer fees that are secondary to debt service.

Shared Parcels - the ground lease and sublease should be on their own partitioned plot, not part of a larger cost estate parcel. When ground lease tasks belong to a bigger cost estate parcel, the task is at threat of unassociated actions and charges on the cost estate. For example, if a property manager that has actually ground leased part of the charge residential or commercial property to a task, moneyed by bonds and secured by a leasehold mortgage, decides to develop the remainder of the residential or commercial property on the cost estate and protect it by a charge mortgage, a foreclosure of that cost mortgage would extinguish the leasehold and subleasehold estates. Similarly, if the landlord's charge project sustains taxes, energy charges, homeowners association charges or other costs that have the potential 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 should be part of a larger cost parcel, the ground lease and sublease need to (a) need that any mortgage or lien put on the fee interest is subordinate to the ground lease, (b) require that the property owner quickly pays any charges or costs that runs the risk of the leaseholds, and (c) permit the borrower-sponsor and the leasehold mortgagee to cure charges on the fee estate and look for compensation from the proprietor.
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Multiple Mortgagees - The ground lease ought to acknowledge the potential for several mortgagees and prioritize the most senior mortgagee. We have come across projects with numerous mortgagees where the mortgagees do not have an intercreditor arrangement. In those cases, either the subordinate 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 attaches when the senior bonds are paid off. Because there is no intercreditor arrangement, the deal is quiet regarding settlement treatments upon an occasion of default. Subordinate mortgagees, who usually have a closer relationship with the borrower-sponsor and misaligned interest with the senior mortgagees, frequently take the reins negotiating with property managers in an exercise without notifying or speaking with the senior mortgagees. Either the ground lease ought to clarify that the landlord will focus on the most senior protected mortgagee in settlement and conflict resolution, and/or an intercreditor arrangement with clear guidelines should be recorded on the job.

Before purchasing a ground lease project, bondholders should fully comprehend the task and its risks. While examining the official statement and engaging with the underwriter, this client alert should act as a thorough list of problems that should be addressed. In the context of a limited offering, perspective purchasers of the bonds have take advantage of to request our suggested changes to the ground lease. In those deals, the majority of landlords relate parties that directly gain from the conduit financed project. It would generally benefit landlords for the jobs to be successful, and a failure to work out in good faith or a termination of the ground lease with a leasehold mortgage would negatively affect their reputation and rating in the bond market. If any of these protections are not included when the bonds are released, it is vital to acquire them in an exercise as a condition for forbearance or refinancing.