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housingworks.org
Ground leases are a crucial - if rather uncommon - part of the realty finance market. Because they normally cover big pricey residential or commercial properties like Rockefeller Center and The Empire State Building, to call 2, and last a long period of time (99 years and approximately start) the likelihood of something unexpected or unintentional occurring is high. This possibility increases significantly if, as highlighted below, one or both of the lease parties' declare personal bankruptcy. Accordingly, property specialists should bear in mind and make sure when participating in any deal including a ground lease.

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nlihc.org
Ground leases have actually been around considering that the Middle Ages and personal bankruptcy laws have actually existed because at least Roman Times. Given this long history, it is not a surprise that a great deal of law has established on the interaction of personal bankruptcy and ground leases. This is particularly so considering that the advent of the "modern" United States Bankruptcy Act in 1898 and the comprehensive changes to title 11 of the United States Code implemented to it in 1978, when Chapter 11 of the United States Bankruptcy Code (the "Code") was enacted. [1] In specific, Section 365 of the Code provides special guidelines for the assumption or rejection of a ground lease-as well as its prospective sale and transfer by a debtor to a 3rd celebration.

Knowing these rules is critical to any real-estate professional. Here are the basics:

A ground lease, often described as a "land lease," is an unique mechanism for the development of industrial realty, enjoyed by those entrusted with establishing the Rockefeller Center and the Empire State Building, for example. The plan enables for prolonged lease terms frequently approximately 99 years (with the option of renewal) for the landowner to maintain ownership of the land and collect rent while the designer, in theory, might enhance upon the land to its advantage also. Both historically and currently, this irregular relationship in the realty space creates ample conversation weighing the structure's benefits and drawbacks, which naturally grow more made complex in the face of a ground lessor or ground lessee's bankruptcy.

According to most courts, including the Second Circuit, the limit concern in examining the previously mentioned possibilities regarding a ground lease in insolvency court is whether the ground lease in concern is a "true lease" for the purpose of Section 365. Section 365 uses, making the ground lease eligible for, assumption or rejection, just if it is a "true lease." [2] While just what constitutes a "true lease" will vary state by state, it is widely accepted that "the correct questions for a court in identifying whether § 365 [] governs an arrangement repairing residential or commercial property rights is whether 'the celebrations planned to impose commitments and give rights significantly different from those developing from the ordinary landlord/tenant relationship.'" Intl. Trade Ad. v. Rensselaer Polytechnic, 936 F. 2d 744 (2d Cir. 1991). This "intent" is figured out based upon that of the parties at the time of the lease's execution. In re Big Buck Brewery Steakhouse, Bkrptcy No. 04-56761-SWR, Case No. 05-CV-74866 (E.D. Mich. Mar. 9, 2006). Despite there being "a 'strong presumption that a deed and lease ... are what they purport to be,'" the financial substance of the lease is the primary determination of whether the lease is thought about "true" or not, and in some states (like California), is the only appropriate aspect to weigh. Liona Corp., N.V. v. PCH Associates (In re PCH Associates), 804 F. 2d 193 (2d Cir. 1986) pointing out Fox v. Peck Iron & Metal Co., 25 Bankr. 674, 688 (Bankr. S.D. Cal. 1982). Generally, the additional away those "economic realities" are from the normal landlord/tenant relationship, the less most likely a lease will be considered a "real lease" for the function of Section 365. Id. For instance, if residential or commercial property was acquired by the lessor particularly for the lessee's use or solely to secure tax advantages, or for a purchase rate unassociated to the land's value, it is less likely to be a real lease.

If the ground lease remains in truth determined to be a "true lease" (and subject to court approval), the designated trustee or debtor-in-possession in a bankruptcy case may then either assume or reject the lease as it would any other unexpired lease held by the debtor.

However, exceptions use. These heavily rely on a debtor's "appropriate guarantees" to the remaining parties to the contracts. Section 365 of the Code offers that if there has actually been a default on a debtor's unexpired lease, the DIP might not presume the abovementioned lease unless, at the time of presumption, the DIP: (i) remedies or offers "adequate guarantee" that they will in fact "without delay cure [] such default"; (ii) compensates or supplies "adequate assurance" that they will "immediately compensate" parties to the contracts (aside from the debtor) for any budgeting loss occurring from such default; and (iii) provides "sufficient assurance" of their under that lease. See 11 U.S.C. § 365(b).

Unrelated to "adequate guarantee" are the exceptions that even more bar project or assumption of leases in case relevant law excuses a celebration from accepting performance from a party aside from the DIP and they choose to exercise such right, see 11 U.S.C. § 365(c)( 1 ); the agreement's purpose is to produce a loan or financing to the debtor, see 11 U.S.C. § 365(c)( 2 ); or the lease at issue is of nonresidential real residential or commercial property and has been ended under other (non-bankruptcy) law prior to the order for relief, see 11 U.S.C. § 365(c)( 3 ).

If, on the other hand, a DIP does not want to assume or assign the lease, it can decline any existing unexpired agreements held by the debtor. The most generally mentioned provision governing rejection of a lease impacted by a personal bankruptcy case is Section 365(d)( 4 ), which provides:

"If the [DIP] does not presume or turn down an unexpired lease of nonresidential real residential or commercial property under which the debtor is the lessee within [sixty] 60 days after the date of the order for relief ... then such lease is considered declined, and the [DIP] shall right away give up such nonresidential real residential or commercial property to the lessor." See 11 U.S.C. § 365(d)( 4 ). [3]
Courts have recently held that this rejection "has the same repercussion as an agreement breach outside personal bankruptcy," offering the counterparty a claim for damages, "while leaving undamaged the rights the counterparty has actually gotten under the agreement." Mission Product Holdings, Inc. v. Tempnology, LLC, 587 U.S. ___ (2019 ). While this "breach-by-rejection" (a term coined by the courts) will typically result in the agreement's termination, it is crucial to keep in mind that rejection alone will not end the responsibilities enforced by the lease.

Real residential or commercial property is idiosyncratic, and also, realty financing alternatives are numerous and modification daily as the marketplace fluctuates. Ground leases are all special.

As can easily be recognized from the summary above, dealing with a particular ground lease in the context of a Chapter 11 personal bankruptcy can be lawfully and factually made complex. Therefore, when drafting or modifying ground leases, landlords, leasehold financiers, and mortgagees should seek advice from educated legal counsel and industrial property specialists who comprehend and can discuss what can happen to a specific lease in a Chapter 11 case.

For more details, contact Christopher F. Graham, Partner at grahamc@whiteandwilliams.com or 212.714.3066; or Morgan A. Goldstein, Associate at goldsteinm@whiteandwilliams.com or 475.977.8302. Or you might connect to another member of our Financial Restructuring and Bankruptcy Practice.

[1] "Apart from particular unique provisions, the Bankruptcy Code normally leaves the decision of residential or commercial property rights in the possessions of an insolvent's estate to state law." See Butner v. United States, 440 U.S. 48 (1979 ).

[2] If the lease taken a look at is not a "real lease," it will be thought about a "financing lease," in which the trustee or debtor-in-possession ("DIP") owns the land and the landlord is treated as the lender.

[3] Generally, "... a debtor in possession shall have all the rights ... and powers and will carry out all the functions and tasks ... of a trustee serving in a case under this chapter." See 11 U.S. Code § 1107(a).