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Reducing risk of front-end concessions.

Extensive tenant concessions are a way of life today. For tenants signing long-term leases for large blocks of New York Class A office space, concession packages worth up to three years of fixed rent (apportioned between work letters, work allowances and free rent periods) are not uncommon. Such packages are clearly high cost.

To compound the owner's risk, the rate of tenant defaults has perhaps never been greater than in this economy.

However, the lease transaction may be structured to reduce the owner's risk created by large front-end concession packages. This can be accomplished by maximizing the owner's security and properly timing the implementation of the tenant concessions. The extent to which this can be effected, however, is a function of the dynamics of the particular negotiation and the cash position of the tenant.

Maximizing Owner's Security

Letters of Credit. Tenants generally deplore posting significant cash security deposits, even though New York law requires they be deposited in a separate account and not commingled with the owner's general funds. However, a tenant who balks at posting even a small cash security deposit may be receptive to delivering as security a clean, irrevocable letter of credit ("LC') in an even larger amount.

Some owners are reluctant to accept an LC because of their fear that the issuing bank will deny payment upon receipt of instructions to that effect from the tenant with whom it may have a long-standing relationship. However, a good owner's attorney can minimize this risk by carefully circumscribing in the LC (which would be attached as an exhibit to the lease) the requirements for a draw down; this prevents the bank from "going beyond the four comers of the document" to ascertain grounds upon which to deny payment. From our experience, few banks are willing to risk liability to the owner-beneficiary for refusing to honor a draft drawn and tendered in strict accordance with the terms of an LC.

If the tenant resists posting an LC in the desired amount for the entire lease term (which may require the tenant to pledge collateral to the issuing bank for such period), the owner should allow the tenant to reduce the LC at one or more intervals during the term, if not then in default. This technique provides the owner with the maximum security when it is most critical to him, i.e., when he has not yet been able to amortize most (or perhaps any) of the concession package. Whether or not the lease permits the tenant to reduce the LC, so long as the LC is to be effective, it should provide for automatic renewal by the issuing, bank. The owner must have the right to immediately draw down the LC if not timely renewed well in advance of its scheduled expiration.

Guaranties. Given the attractiveness of the rental and concession package, an owner can increase its leverage upon a tenant's default by obtaining at lease execution an unconditional guaranty from the principal of a closely held tenant or the parent of a corporate subsidiary. If an unlimited guaranty is rejected, the owner should press for a guaranty limited either with respect to the amount guaranteed or the time period it will remain in effect.

Should even a limited unconditional guaranty be refused, as a last resort an owner should request a guaranty which would be effective immediately, but only be enforceable if the tenant should file bankruptcy. This is preferable to no guaranty at all.
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Copyright 1992, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:reducing risk of lease default when negotiating tenant concessions on long-term leases for office space
Author:Sacks, Warren S.
Publication:Real Estate Weekly
Date:Jul 22, 1992
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