Why your ground lease should be financeable.

Leasing raw or unimproved land affords expanding or relocating companies the ability to improve their place of business. Whether you intend to build a crystal palace, a high-tech factory or a retro restaurant like L.A.'s former Brown Derby (which was as famous for its hat-like exterior as it was for its original chopped salad), you may lose your ability to finance your facility's improvements if your lease is improperly drafted.

Companies often unwittingly sacrifice their ability to make future improvements to their property by neglecting to make their ground lease financeable. A financeable ground lease is one that may be readily used by a tenant to secure needed or desired financing. Such financing is typically secured by a leasehold deed of trust or mortgage.

The provisions needed to make a ground lease financeable are often overlooked, particularly if the tenant doesn't need financing to construct its initial leasehold improvements. When such initial financing is needed, the lender will usually insist that the lease contain certain clauses, which serve to protect the lender's interest. If your company doesn't require a loan or other financing to construct its initial leasehold improvements, you should nonetheless make every effort to negotiate a financeable ground lease in order to give you sufficient flexibility to use its leasehold interest and leasehold improvements to obtain financing at a later date.

Lenders have a long list of requirements before approving any financing--especially when someone else owns the land. For example, an additional time period for a lender to cure a tenant's default under a lease may be a condition of a proposed loan. Perhaps it's a document, such as an estoppel certificate, that needs to be signed by the landlord before the desired loan can be funded. Both situations, however, can be problematic if such clauses were not included in the subject lease or leases, when executed.

Landlords may, and often will, simply ignore or shrug off any requests or obligations they are not legally compelled to undertake by the existing terms of their lease or leases. In negotiating leases, people sometimes just make mistakes and think that the smallest words in the lease don't have significant impact or meaning--but for lenders, virtually every word matters. Attempting to fix such problems after they have occurred is almost always more difficult than negotiating a lender-friendly lease in the first place.

Count on lenders to be exacting and detail-oriented (and sometimes humorless), which can make the financing process excruciating if you have not negotiated a lender-friendly lease. Most landlords aren't interested in amending a lease once it's been signed to satisfy the tenant's lender's requirements.

In virtually all instances, landlords are more willing to agree to lease provisions necessary to make a ground lease financeable before the lease is signed, when they still need a tenant. Your best defense is to be diligent in making sure that you sign a fair and financeable lease in the first place. You don't want to have to beg your company's lender or landlord to allow you to obtain financing in the future.

Without a financeable ground lease, moreover, companies may suffer increased costs or operational difficulties. It can be especially costly and aggravating when a financing package is held up because the lender wants its loan secured by leasehold improvements constructed by your company at numerous locations, and one improperly structured lease holds up the entire package. Among other things, financing delays may result in a lack of operating funds, missed construction deadlines and increased costs due to changes in interest rates or the expiration of loan commitments.

To establish financeable ground leases, you need to be aware of the various required provisions. In addition to a leasehold mortgage that a lender requires to secure a loan, most lenders will also require a lien under the Uniform Commercial Code (UCC) encumbering the company's equipment, trade fixtures, and other removable personal property located on the leased premises. The lease must include language that provides that such personal property is and will remain the property of the tenant, and may be removed from the premises by the tenant or its lender.

Other key clauses that are needed (in most instances) to make a ground lease financeable include:

Express Right to Encumber. A stipulation that the lessee may encumber its leasehold estate (use it for collateral when obtaining financing) without having to obtain the landlord's consent.

Senior Lien Protection. A clause that removes the possibility of a loan's security being eliminated by the foreclosure of a senior lien. If the title shows that the landlord has encumbered its fee interest, the tenant should obtain a non-disturbance agreement from the senior lienholder.

Ownership Rights. A clause that says the lessee will own any buildings or structures constructed by the tenant during the lease term.

Insurable Description. An exact legal description of the leased premises that allows a leasehold mortgage to be recorded. If no legal description exists because the premises are not designated as a legal parcel, a survey of the premises should be obtained from which the legal description can be created.

Standard Mortgage Protection. Clauses that grant the lessee's lender certain rights regarding tenant defaults, liabilities, foreclosures and liens.

Liberal Assignment and Subletting Rights. A provision that limits the landlord's control over the lessee's ability to assign the ground lease or sublet the premises.

Flexible Use. A use clause that gives the lessee the ability to operate a variety of different businesses or uses on the premises so as to enhance its transferability.

Tenant Control Over Off-Premise Areas. Grants the lessee the right to approve of any material changes to any common area or access to the leased premises that could impact the value and beneficial use of the lease.

Tenant-Oriented Casualty and Condemnation Provisions. Designates insurance proceeds or condemnation awards to the lessee, not the landlord.

Many landlords will, of course, refuse to include all of the provisions and clauses discussed here. Most sophisticated landlords, however, recognize that their tenants need certain leasehold rights to successfully operate their businesses, including the ability to obtain financing. As a result, the well-advised tenant will usually be able to negotiate a financeable ground lease if it insists on doing so prior to lease execution.

Michael E. Di Geronimo is an attorney with Miller, Starr & Regalia in Walnut Creek, Calif. He represents commercial developers, retail and office tenants, property owners and financial institutions. For more information, call 925.935.9400 or [e-mail]