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Letters of credit more critical today.

As landlords grant greater and greater concessions to attract tenants in an increasingly competitive market, the greater the need to secure these concessions in the event of a default by the tenant. However, with "free rent" commonly exceeding one year and construction allowances routinely exceeding $40 per square foot, it is often impractical for a tenant to tie up so much cash in a conventional security deposit account. And personal and corporate guarantees, once considered viable alternates to cash deposits, have lately fallen out of favor with landlords and their lenders.

As a result, more and more tenants are turning to letters of credit to provide the landlord with the security it requires. Traditionally used as a payment mechanism for the purchase of physical commodities, letters of credit are increasingly being used in place of cash security deposits and guarantees in commercial leases.

Advantages or Letter

or Credit

The main advantage of a letter of credit to a tenant is that it will not have to deposit the full amount of cash with the landlord. As tenant security deposit accounts pay less than 3 percent these days and, in some states like New York, the landlord is entitled to retain 1 percent of the principal amount deposited as an administrative fee, the return on a cash security deposit is almost nil. In contrast, a tenant usually pays its bank a fee of 1 percent per annum of the face amount of the letter of credit to maintain a letter of credit, and this fee is often payable in quarterly installments. The tenant should bear in mind, however, that its bank will probably require that some security be provided to maintain the letter of credit, and, if the tenant must maintain dollar-for-dollar cash security, the purpose of maintaining a letter of credit may be defeated.

From the landlord's point of view, the main advantage of holding a letter of credit instead of cash security is that, in the event the tenant files for bankruptcy, a landlord may still draw on the letter of credit, whereas a landlord holding cash security would be prevented from applying such cash unless and until the landlord asks the bankruptcy court's permission to do so and the court rants such request, which process may take several months. This is because the letter of credit is an obligation issued by a third party (the tenant's bank), and thus drawing on the letter of credit does not diminish the tenant's estate in bankruptcy.

Letter or Credit

as Security Deposit

When a letter of credit is posted in lieu of a cash security deposit, the letter of credit provides that the landlord will be entitled to be paid by the tenant's bank up to the face amount of the letter of credit upon presenting to that bank (1) the original letter of credit; (2) a sight draft, which merely directs the bank to pay the proceeds of the letter of credit to the landlord; and, in most cases, (3) a statement signed by the landlord specifying why the landlord is drawing on the letter of credit (i.e., because the tenant is in default under the lease).

Although it is a basic principle of letter of credit law that a bank must honor a properly presented letter of credit over the protestations of the applicant and that a court will not enjoin the obligation of the bank to honor such letter of credit absent a clear showing of fraud, it is a good idea to provide in the letter of credit that the bank will pay on the letter of credit without inquiry into the accuracy of the accompanying statement and notwithstanding that the applicant may be disputing the contents of the statement.

As a rule of thumb, a bank must pay on the letter of credit within 72 hours after it has been presented, and the letter of credit should specify where it must be presented (e. g., "at our letter of credit counter at Two World Trade Center, New York, New York"). The letter of credit should also specify that it is payable in U.S. currency and that the landlord may draw all or any portion of the face amount of the letter of credit. The letter of credit should also state on its face that it is "irrevocable" so that the obligation to pay cannot be revoked by the issuing bank.

Expiration of letter of Credit

Although a letter of credit may be irrevocable, it will contain an expiration date, after which it will not be honored by the bank. Banks are usually unwilling to issue a letter of credit for a term longer than one year. How, then, does a landlord use a letter of credit to secure a 10-year lease without having to remember each year to obtain a new a letter of credit before the existing letter of credit expires? The customary solution is to provide in the letter of credit that "it shall automatically be extended for periods of at least one year from the present and each future expiration date unless the bank gives to the landlord, by certified mail, return receipt requested, no later than 30 days prior to the relevant expiration date, notice that the bank elects not to renew this irrevocable letter of credit." Presumably, upon receipt of such notice, the landlord will instruct the tenant to renew the current letter of credit before it expires, and if the tenant does not do so, the landlord will be able to draw on the existing letter of credit before it expires.

From a practical point of view, however, how can the landlord prove that he did not receive such 30-day notice? The solution to this problem is to require that the bank give written notice (commonly called an "advise of credit") stating that the letter of credit has been renewed for an additional one-year period.

Transfer of Letter of Credit

When a landlord transfers ownership of the building, the letter of credit must also be transferred to the new owner. It is best to provide that it is transferable and to spell out the mechanics of such transfer.

Irwin I. Wikler is an attorney with the law firm of Fink Weinberger p. c. with offices in New York City, White Plains, Great Neck, Albany, Clifton, New Jersey and Zurich, Switzerland.
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Title Annotation:advice on advantages of letters of credit
Author:Wikkler, Irwin I.
Publication:Real Estate Weekly
Date:Jul 22, 1992
Previous Article:Capital National Bank Bldg. sold.
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