Ground leases are an essential - if somewhat uncommon - part of the property finance market. Because they usually cover large costly 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 up to start) the possibility of something unanticipated or unintentional happening is high. This probability increases drastically if, as highlighted listed below, one or both of the lease parties' declare insolvency. Accordingly, property specialists need to remember and take care when participating in any transaction including a ground lease.

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Ground leases have actually been around because 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 established on the interaction of insolvency and ground leases. This is especially so since the development of the "modern" United States Bankruptcy Act in 1898 and the substantial changes to title 11 of the United States Code carried out 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 rules for the presumption or rejection of a ground lease-as well as its prospective sale and transfer by a debtor to a 3rd party.

Knowing these rules is important to any real-estate specialist. Here are the basics:

A ground lease, sometimes referred to as a "land lease," is a distinctive system for the development of business real estate, delighted in by those tasked with developing the Rockefeller Center and the Empire State Building, for instance. The arrangement enables prolonged lease terms frequently as much as 99 years (with the alternative of renewal) for the landowner to retain ownership of the land and gather rent while the developer, in theory, may surpass the land to its advantage also. Both traditionally and presently, this irregular relationship in the property space generates adequate conversation weighing the structure's advantages and disadvantages, which inherently grow more complicated in the face of a ground lessor or ground lessee's insolvency.

According to a lot of courts, consisting of the Second Circuit, the threshold concern in analyzing the abovementioned possibilities concerning a ground lease in personal bankruptcy court is whether the ground lease in question is a "true lease" for the purpose of Section 365. Section 365 applies, making the ground lease eligible for, presumption or rejection, only if it is a "real lease." [2] While what exactly constitutes a "true lease" will differ state by state, it is widely accepted that "the proper inquiry for a court in figuring out whether § 365 [] governs an agreement fixing residential or commercial property rights is whether 'the parties planned to enforce obligations and give rights significantly various from those arising from the ordinary landlord/tenant relationship.'" Intl. Trade Ad. v. Rensselaer Polytechnic, 936 F. 2d 744 (2d Cir. 1991). This "intent" is identified 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 anticipation 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 "real" 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 additional away those "financial realities" are from the regular landlord/tenant relationship, the less likely a lease will be considered a "true lease" for the function of Section 365. Id. For instance, if residential or commercial property was purchased by the lessor specifically for the lessee's usage or exclusively to secure tax benefits, or for a purchase price unrelated to the land's value, it is less most likely to be a real lease.

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

However, exceptions apply. These greatly count on a debtor's "appropriate assurances" to the remaining parties to the contracts. Section 365 of the Code supplies that if there has actually been a default on a debtor's unexpired lease, the DIP may not presume the aforementioned lease unless, at the time of assumption, the DIP: (i) remedies or supplies "sufficient guarantee" that they will in fact "immediately treat [] such default"; (ii) compensates or provides "appropriate guarantee" that they will "quickly compensate" celebrations to the agreements (aside from the debtor) for any budgeting loss emerging from such default; and (iii) uses "adequate assurance" of their future performance under that lease. See 11 U.S.C. § 365(b).

Unrelated to "sufficient guarantee" are the exceptions that further disallow project or presumption of leases in the event that suitable law excuses a celebration from accepting performance from a party other than the DIP and they choose to exercise such right, see 11 U.S.C. § 365(c)( 1 ); the agreement's purpose is to create a loan or financing to the debtor, see 11 U.S.C. § 365(c)( 2 ); or the lease at problem is of nonresidential real residential or commercial property and has actually 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 desire to presume or designate the lease, it can reject any existing unexpired arrangements held by the debtor. The most generally pointed out provision governing rejection of a lease impacted by an insolvency case is Section 365(d)( 4 ), which offers:

"If the [DIP] does not presume or reject 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 considered rejected, and the [DIP] will instantly give up such nonresidential real residential or commercial property to the lessor." See 11 U.S.C. § 365(d)( 4 ). [3]

Courts have actually just recently held that this rejection "has the very same repercussion as a contract breach outside personal bankruptcy," offering the counterparty a claim for damages, "while leaving undamaged the rights the counterparty has received under the contract." Mission Product Holdings, Inc. v. Tempnology, LLC, 587 U.S. ___ (2019 ). While this "breach-by-rejection" (a term created by the courts) will frequently cause the contract's termination, it is essential to note that rejection alone will not end the obligations enforced by the lease.

Real residential or commercial property is distinctive, and similarly, realty funding options are many and change daily as the market varies. Ground leases are all unique.

As can easily be recognized from the summary above, dealing with a specific ground lease in the context of a Chapter 11 personal bankruptcy can be lawfully and factually complicated. Therefore, when preparing or modifying ground leases, proprietors, leasehold financiers, and mortgagees ought to speak with knowledgeable legal counsel and business realty professionals who understand and can describe what can take place to a specific lease in a Chapter 11 case.

To find out more, 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 reach out to another member of our Financial Restructuring and Bankruptcy Practice.

[1] "Apart from particular special provisions, the Bankruptcy Code typically leaves the determination of residential or commercial property rights in the assets of a bankrupt'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 thought about a "financing lease," in which the trustee or debtor-in-possession ("DIP") owns the land and the property manager is treated as the lender.

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