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1 A Funny Thing Happened to my Ground Lease In Bankruptcy Court

Ground leases are an important - if rather uncommon - part of the realty finance market. Because they normally cover big costly residential or commercial properties like Rockefeller Center and The Empire State Building, to call 2, and last a very long time (99 years and approximately start) the likelihood of something unexpected or unintended happening is high. This probability increases considerably if, as highlighted below, one or both of the lease parties' declare personal bankruptcy. Accordingly, realty experts should bear in mind and make sure when participating in any transaction including a ground lease.

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Ground leases have actually been around given that the Middle Ages and personal bankruptcy laws have actually existed because a minimum of Roman Times. Given this long history, it is not a surprise that a great deal of law has actually established on the interplay of bankruptcy and ground leases. This is especially so because the advent of the "modern" United States Bankruptcy Act in 1898 and the comprehensive 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 offers unique guidelines 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 critical to any real-estate specialist. Here are the basics:

A ground lease, often described as a "land lease," is a distinct system for the advancement of industrial property, enjoyed by those charged with developing the Rockefeller Center and the Empire State Building, for example. The arrangement enables for prolonged lease terms frequently as much as 99 years (with the option of renewal) for the landowner to maintain ownership of the land and gather rent while the developer, in theory, might surpass the land to its benefit as well. Both traditionally and presently, this irregular relationship in the realty area generates adequate discussion weighing the structure's advantages and disadvantages, which inherently grow more made complex in the face of a ground lessor or ground lessee's bankruptcy.

According to a lot of courts, consisting of the Second Circuit, the threshold question in evaluating the previously mentioned 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, just if it is a "true lease." [2] While exactly what makes up a "real lease" will vary state by state, it is commonly accepted that "the appropriate questions for a court in figuring out whether § 365 [] governs an arrangement fixing residential or commercial property rights is whether 'the celebrations planned to impose commitments and provide rights considerably various from those emerging from the ordinary landlord/tenant relationship.'" Intl. Trade Ad. v. Rensselaer Polytechnic, 936 F. 2d 744 (2d Cir. 1991). This "intent" is determined based upon that of the celebrations 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 claim to be,'" the financial substance of the lease is the main decision of whether the lease is thought about "real" or not, and in some states (like California), is the only suitable aspect 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 more away those "economic truths" 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 acquired by the lessor particularly for the lessee's use or exclusively to protect tax advantages, or for a purchase cost unrelated to the land's value, it is less most likely to be a true lease.

If the ground lease remains in truth identified to be a "true lease" (and subject to court approval), the selected trustee or debtor-in-possession in a 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 depend on a debtor's "sufficient assurances" to the remaining parties to the agreements. Section 365 of the Code provides that if there has been a default on a debtor's unexpired lease, the DIP might not assume the aforementioned lease unless, at the time of presumption, the DIP: (i) treatments or provides "appropriate guarantee" that they will in truth "quickly cure [] such default"