Ground leases are an important - if rather uncommon - part of the genuine estate financing industry. Because they usually cover big expensive residential or commercial properties like Rockefeller Center and The Empire State Building, to call 2, and last a long time (99 years and as much as begin) the likelihood of something unforeseen or unintentional occurring is high. This likelihood increases drastically if, as highlighted below, one or both of the lease parties' apply for insolvency. Accordingly, property specialists must keep in mind and make sure when participating in any transaction including a ground lease.
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Ground leases have actually been around given that the Middle Ages and personal bankruptcy laws have actually existed considering that at least Roman Times. Given this long history, it is not a surprise that a great deal of law has actually established on the interaction of insolvency and ground leases. This is especially so since the advent of the "contemporary" United States Bankruptcy Act in 1898 and the substantial modifications to title 11 of the United States Code executed 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 supplies unique guidelines for the assumption or rejection of a ground lease-as well as its potential sale and transfer by a debtor to a 3rd celebration.

Knowing these guidelines is important to any real-estate specialist. Here are the fundamentals:

A ground lease, sometimes described as a "land lease," is a distinct mechanism for the advancement of industrial realty, taken pleasure in by those entrusted with establishing the Rockefeller Center and the Empire State Building, for example. The plan permits prolonged lease terms typically up to 99 years (with the option of renewal) for the landowner to retain ownership of the land and collect rent while the developer, in theory, may surpass the land to its advantage too. Both historically and currently, this irregular relationship in the genuine estate space creates sufficient discussion weighing the structure's pros and cons, which naturally grow more made complex in the face of a ground lessor or ground lessee's bankruptcy.

According to most courts, consisting of the Second Circuit, the limit concern in examining the abovementioned possibilities concerning a ground lease in personal bankruptcy court is whether the ground lease in question is a "true lease" for the function of Section 365. Section 365 applies, making the ground lease eligible for, presumption or rejection, just if it is a "real lease." [2] While exactly what constitutes a "real lease" will vary state by state, it is commonly accepted that "the correct inquiry for a court in figuring out whether § 365 [] governs a contract fixing residential or commercial property rights is whether 'the celebrations meant to impose commitments and provide rights significantly different from those emerging from the common 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 economic compound of the lease is the main decision of whether the lease is considered "true" or not, and in some states (like California), is the only appropriate element to weigh. Liona Corp., N.V. v. PCH Associates (In re PCH Associates), 804 F. 2d 193 (2d Cir. 1986) mentioning Fox v. Peck Iron & Metal Co., 25 Bankr. 674, 688 (Bankr. S.D. Cal. 1982). Generally, the more away those "financial truths" are from the regular landlord/tenant relationship, the less most likely a lease will be thought about a "real lease" for the function of Section 365. Id. For example, if residential or commercial property was bought by the lessor particularly for the lessee's usage or entirely to secure tax benefits, or for a purchase price unassociated to the land's worth, it is less likely to be a true lease.

If the ground lease remains in fact determined to be a "real lease" (and subject to court approval), the appointed trustee or debtor-in-possession in a personal bankruptcy case might then either assume or turn down the lease as it would any other unexpired lease held by the debtor.

However, exceptions apply. These heavily count on a debtor's "sufficient guarantees" to the staying parties to the arrangements. 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 previously mentioned lease unless, at the time of assumption, the DIP: (i) remedies or offers "sufficient assurance" that they will in truth "promptly treat [] such default"; (ii) compensates or offers "appropriate guarantee" that they will "immediately compensate" celebrations to the arrangements (besides the debtor) for any pecuniary loss occurring from such default; and (iii) offers "appropriate guarantee" of their future performance under that lease. See 11 U.S.C. § 365(b).

Unrelated to "sufficient assurance" are the exceptions that even more disallow assignment or assumption of leases on the occasion that appropriate law excuses a party from accepting efficiency from a party besides the DIP and they opt to exercise such right, see 11 U.S.C. § 365(c)( 1 ); the agreement's purpose is to create a loan or funding 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 appoint the lease, it can turn down any existing unexpired contracts held by the debtor. The most usually mentioned arrangement governing rejection of a lease impacted by a personal bankruptcy case is Section 365(d)( 4 ), which provides:

"If the [DIP] does not assume or turn down an unexpired lease of nonresidential genuine 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 deemed declined, and the [DIP] shall immediately give up such nonresidential real residential or commercial property to the lessor." See 11 U.S.C. § 365(d)( 4 ). [3]
Courts have actually recently held that this rejection "has the very same consequence as an agreement breach outside personal bankruptcy," offering the counterparty a claim for damages, "while leaving intact the rights the counterparty has received 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 frequently cause the contract's termination, it is essential to keep in mind that rejection alone will not end the duties enforced by the lease.

Real residential or commercial property is distinctive, and also, genuine estate funding choices are many and change daily as the market varies. Ground leases are all unique.

As can easily be recognized from the summary above, handling a specific ground lease in the context of a Chapter 11 bankruptcy can be lawfully and factually complicated. Therefore, when drafting or modifying ground leases, proprietors, leasehold financiers, and mortgagees need to consult educated legal counsel and commercial genuine estate experts who comprehend and can explain what can occur to a specific lease in a Chapter 11 case.

For additional information, 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 may connect to another member of our Financial Restructuring and Bankruptcy .

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

[2] If the lease examined is not a "true lease," it will be considered a "financing lease," in which the trustee or debtor-in-possession ("DIP") owns the land and the proprietor is dealt with as the lender.

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