Ground leases are an essential - if rather unusual - part of the realty financing market. Because they typically cover big expensive residential or commercial properties like Rockefeller Center and The Empire State Building, to name 2, and last a very long time (99 years and approximately begin) the possibility of something unanticipated or unexpected occurring is high. This possibility increases considerably if, as highlighted listed below, one or both of the lease parties' files for insolvency. Accordingly, genuine estate experts must bear in mind and take care when getting in into any transaction including a ground lease.

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Ground leases have been around since the Middle Ages and bankruptcy laws have actually existed given that at least Roman Times. Given this long history, it is not a surprise that a great deal of law has developed on the interaction of insolvency and ground leases. This is particularly so considering that the introduction of the "contemporary" United States Bankruptcy Act in 1898 and the extensive changes 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 particular, Section 365 of the Code supplies unique rules for the assumption 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 vital to any real-estate specialist. Here are the basics:

A ground lease, often referred to as a "land lease," is a distinct system for the advancement of business real estate, enjoyed by those tasked with developing the Rockefeller Center and the Empire State Building, for example. The plan permits extended lease terms often up to 99 years (with the option of renewal) for the landowner to keep ownership of the land and gather lease while the developer, in theory, may enhance upon the land to its advantage too. Both traditionally and currently, this atypical relationship in the genuine estate area produces adequate conversation weighing the structure's benefits and drawbacks, which inherently grow more made complex in the face of a ground lessor or ground lessee's personal bankruptcy.

According to a lot of courts, consisting of the Second Circuit, the limit question in analyzing the abovementioned possibilities regarding a ground lease in insolvency court is whether the ground lease in concern is a "true lease" for the function of Section 365. Section 365 applies, making the ground lease eligible for, assumption or rejection, just if it is a "true lease." [2] While just what makes up a "real lease" will vary state by state, it is widely accepted that "the appropriate questions for a court in figuring out whether § 365 [] governs an agreement repairing residential or commercial property rights is whether 'the parties planned to enforce responsibilities and provide rights considerably different from those occurring from the common 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 presumption that a deed and lease ... are what they claim to be,'" the economic compound of the lease is the primary decision of whether the lease is considered "real" or not, and in some states (like California), is the only appropriate factor to weigh. Liona Corp., N.V. v. PCH Associates (In re PCH Associates), 804 F. 2d 193 (2d Cir. 1986) citing Fox v. Peck Iron & Metal Co., 25 Bankr. 674, 688 (Bankr. S.D. Cal. 1982). Generally, the more away those "financial realities" are from the ordinary landlord/tenant relationship, the less 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 purchased by the lessor specifically for the lessee's use or entirely to protect tax advantages, or for a purchase price unassociated to the land's value, it is less likely to be a real lease.

If the ground lease is in reality figured out to be a "real lease" (and based on court approval), the appointed trustee or debtor-in-possession in an insolvency case may then either presume or reject the lease as it would any other unexpired lease held by the debtor.

However, exceptions apply. These heavily count on a debtor's "adequate 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 may not presume the aforementioned lease unless, at the time of assumption, the DIP: (i) remedies or supplies "appropriate assurance" that they will in reality "quickly treat [] such default"; (ii) compensates or offers "appropriate assurance" that they will "immediately compensate" celebrations to the contracts (other than the debtor) for any pecuniary loss occurring from such default; and (iii) provides "adequate guarantee" of their future efficiency under that lease. See 11 U.S.C. § 365(b).

Unrelated to "appropriate assurance" are the exceptions that further bar task or presumption of leases in case relevant law excuses a celebration from accepting performance from a party besides the DIP and they opt to exercise such right, see 11 U.S.C. § 365(c)( 1 ); the contract's function is to create a loan or funding to the debtor, see 11 U.S.C. § 365(c)( 2 ); or the lease at concern is of nonresidential real residential or commercial property and has actually been terminated 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 assume or assign the lease, it can decline any existing unexpired agreements held by the debtor. The most usually cited provision governing rejection of a lease affected by a personal bankruptcy case is Section 365(d)( 4 ), which offers:

"If the [DIP] does not presume 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 considered declined, and the [DIP] shall right away surrender 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 exact same repercussion as a contract breach outside bankruptcy," providing the counterparty a claim for damages, "while leaving intact the rights the counterparty has gotten 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 result in the agreement's termination, it is very important to note that rejection alone will not terminate the duties enforced by the lease.

Real residential or commercial property is distinctive, and likewise, real estate financing choices are countless and modification daily as the market changes. Ground leases are all unique.

As can readily be acknowledged from the summary above, handling a particular ground lease in the context of a Chapter 11 insolvency can be lawfully and factually made complex. Therefore, when preparing or amending ground leases, property managers, leasehold investors, and mortgagees must seek advice from educated legal counsel and industrial property specialists who comprehend and can discuss what can occur 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 certain special arrangements, the Bankruptcy Code typically leaves the determination of residential or commercial property rights in the possessions of a bankrupt'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 "finance lease," in which the trustee or debtor-in-possession ("DIP") owns the land and the property owner is treated as the lending institution.

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