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MICHAEL K. KUHN Jackson Walker L.L.P. 1401 McKinney, Suite 1900 Houston, Texas CLE International 10th Annual Conference Negotiating Leases: Renegotiating in the Current Economic Climate January 25-26, 2010 Houston, Texas. Credit Enhancements in Leases. Is Credit Enhancement Necessary?.

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slide1

MICHAEL K. KUHN

Jackson Walker L.L.P.

1401 McKinney, Suite 1900

Houston, Texas

CLE International

10th Annual Conference

Negotiating Leases: Renegotiating in the Current Economic ClimateJanuary 25-26, 2010

Houston, Texas

Credit Enhancementsin Leases

is credit enhancement necessary
Is Credit Enhancement Necessary?

● Landlord’s investment in premises

● Tenant improvement allowance

● Tenant’s investment in premises

● Specialized tenant improvements

● Landlord’s ability to remarket premises

types of credit enhancement
Types of Credit Enhancement
  • Cash security deposit
  • Letter of credit
  • Guaranty
  • Lease bond
  • Pledge of property
  • Landlord’s lien
i security deposit
I. Security Deposit
  • Cash
  • Amount – function of rent or fixed amount
  • Held in separate account?
  • No documentation needed other than lease
  • No third party involved
  • Easily assignable to subsequent owner
  • Statutory provisions governing handling
i security deposit pros and cons
I. Security Deposit – Pros and Cons

Pros for Landlord:

-immediate cash

-easily transferable

Cons for Tenant:

-need to be able to pay cash

-cash is tied up

ii letters of credit
II. Letters of Credit
  • Credit based on issuing bank’s financial strength
  • Focus on draw requirements
  • Separate document (but attached to or described in lease)
ii letters of credit7
II. Letters of Credit
  • Typically 12-month term (but typically “evergreen”)
  • Last renewal should extend past lease term
ii letters of credit pros and cons
II. Letters of Credit– Pros and Cons

Pros for Landlord:

-bank’s credit

-no tenant involvement

Pros for Tenant:

-does not tie up cash

-automatic expiration

ii letters of credit pros and cons9
II. Letters of Credit– Pros and Cons

Cons for Landlord:

-not immediate cash

-drawing procedure

-transferability

-inadvertent expiration

-FDIC closure

Cons for Tenant:

-may need collateral

-burden of renewals

-transfer to new LL

-faulty draws

iii guaranties
III. Guaranties
  • Typically issued by an affiliate
  • Guaranty of payment not collection
  • “Cap” vs. “burn-down” vs. “springing”
iii guaranties11
III. Guaranties
  • “Cap”: first or last dollar? Does limitation describe a time period or dollar amount?
  • Waiver of defenses to payment
  • Must be supported by consideration
iii guaranties pros and cons
III. Guaranties – Pros and Cons

Pros for Landlord:

-covers all of tenant’s obligations

-adaptable to specifics of deal

Pros for Tenant:

-easy to obtain

-expires with lease

iii guaranties pros and cons13
III. Guaranties – Pros and Cons

Cons for Landlord:

-guarantor’s credit may change

-risk of guarantor bankruptcy

-collection issues

Cons for Tenant:

-need guarantor’s cooperation

-issue of assignment of lease & release of guarantor

slide14
III. Guaranties–Case Study #1NH Texas Properties Limited Partnership v. Mittleider, 267 Fed.Appx. 375 (5th Cir. (Tex.) 2008).

Facts:

  • Guaranty language: “in the amount of $1,236,180 due under the lease … payable from the date hereof until February 1, 2006….”
  • Guarantor argued only guaranteed first $1,236,180 payable under lease
iii guaranties case study 1
III. Guaranties– Case Study #1

Holding/Lessons learned:

  • Guaranty not limited to first $1,236,180
  • Feb. 1 outside date not necessary if limited to first $1,236,180
  • Should specify “only the first $1,236,180” if that was intent
iii guaranties case study 2 moffitt v dsc finance corp 797 s w 2d 661 tex app dallas 1990
III. Guaranties – Case Study #2Moffitt v. DSC Finance Corp.,797 S.W.2d 661 (Tex.App.—Dallas 1990)

Facts:

  • Guaranty language: “[75%] of the outstanding balance…during the first [12] months of the Lease, then [50%]…during the remaining [48] months of the Lease.”
  • Default occurred during the second month of the lease
iii guaranties case study 2
III. Guaranties – Case Study #2

Holding/Lessons learned:

  • Guarantor liable for 75% of first year’s rent and 50% of remaining four years’ rent (not 75% of all rent if default occurs in first 12 months)
  • Timing of default is not factor
  • Rule of construction: whichever is more favorable to guarantor
iii guaranties case study 3 sunset center v associated med hlt 585 so 2d 977 fla app 3 dist 1991
III. Guaranties – Case Study #3Sunset Center v. Associated Med. Hlt.,585 So.2d 977 (Fla.App. 3 Dist. 1991)

Facts:

  • Guarantor’s obligation limited to the first 12 month period of the lease
  • Tenant defaults during first 12 months
  • Landlord argues Guarantor is fully liable for all unpaid rent until expiration
  • Guarantor argues limitation on amount
iii guaranties case study 3
III. Guaranties – Case Study #3

Holding/Lessons learned:

  • Guaranty limits amount for which Guarantor is liable (not a timing issue)
  • Because lease was prepared by Landlord, the Court construed ambiguity against Landlord
iii guaranties case study 4 windham v cal tim 47 s w 3d 846 tex app beaumont 2001
III. Guaranties– Case Study #4Windham v. Cal-Tim,47 S.W.3d 846 (Tex.App.—Beaumont, 2001)

Facts:

  • Lease signed in 1994; did not expressly reference a guaranty
  • Guaranty signed in 1995 without independent consideration, but contained consideration recital
  • Issue of whether there is consideration for guaranty
iii guaranties case study 4
III. Guaranties– Case Study #4

Holding/Lessons learned:

  • There was consideration for the guaranty
  • Evidence that guaranty contemplated in base transaction
  • Discrepancy in timing alone not enough to rebut presumption that guaranty has consideration
iv lease bond
IV. Lease Bond
  • Surety underwriter – akin to insurance
  • Limited to monetary, not performance, obligation
  • Uncommon
v pledge of property
V. Pledge of Property
  • Security interest - perfection issues
  • Documented by security agreement and/or stock power
  • Governed by UCC
  • Uncommon due to procedural aspects
vi landlord s lien
VI. Landlord’s Lien
  • Tenant’s personal property at premises
  • Contractual lien
    • created in the lease
    • definition of tenant’s personal property
    • UCC financing statements
vi landlord s lien25
VI. Landlord’s Lien
  • Statutory lien (Tex. Prop. Code §54.021)
    • foreclosure requires judicial action
    • limited in time to a period of rent
    • automatically perfected security interest
vi contractual landlord s lien pros and cons
VI. Contractual Landlord’s Lien – Pros and Cons

Pros for Landlord:

-control FF&E in leased space, making it easier to relet following tenant default

-valuable for restaurant, medical or industrial use

vi contractual landlord s lien pros and cons27
VI. Contractual Landlord’s Lien – Pros and Cons

Cons for Landlord:

-low resale value of property

-liability for personal information

-risk of conversion

-lockout and recovery procedure

vii tenant bankruptcy
VII. Tenant Bankruptcy
  • Security Deposit
    • Timing for applying
    • Landlord has perfected security interest in deposit
    • Landlord may be compelled to turn over excess
  • Letter of Credit
    • “Independence doctrine” for Letter of Credit
    • Automatic stay will bar sending of default notice
    • Section 502 cap on lease rejection damages
vii tenant bankruptcy29
VII. Tenant Bankruptcy
  • Guaranty
    • No bar to proceeding against guarantor unless guarantor also in bankruptcy
    • No Section 502 cap applies
  • Contractual landlord’s lien
    • Enforcement barred by automatic stay
vii tenant bankruptcy case study in re stonebridge tech inc 430 f 3d 260 5 th cir 2005
VII. Tenant Bankruptcy– Case StudyIn re Stonebridge Tech., Inc., 430 F.3d 260 (5th Cir. 2005)

Facts:

  • Tenant files bankruptcy
  • Lease definition of security deposit is cash and letter of credit
  • Tenant draws over bankruptcy cap on LoC
vii tenant bankruptcy case study
VII. Tenant Bankruptcy– Case Study

Holding/Lessons learned:

  • Consistent with independence doctrine, LoC is not subject to bankruptcy cap
  • Landlord did not file Proof of Claim; stayed out of bankruptcy proceeding
viii landlord bankruptcy
VIII. Landlord Bankruptcy

Security Deposit

  • Commingling of cash – tenant risks losing security deposit if lease is rejected by landlord
    • but tenant may be able to offset final rent payments to equal lost deposit
  • Tenant’s claim to security deposit takes priority over other claims – Tex. Prop. Code §93.005(b)

Letter of Credit

  • No issue with letters of credit - triggered by tenant default
practice tips
Practice Tips
  • Choose the appropriate form of credit enhancements
  • Consider the limitations
  • Words matter
    • Draft carefully, especially:
        • Draw requirements for Letter of Credit
        • Cap on guaranty (use example)
  • FDIC surprise on Letters of Credit
  • Bankruptcy surprises
slide34

Michael K. Kuhn

Jackson Walker L.L.P.

1401 McKinney Street, Suite 1900

Houston, Texas 77010

713-752-4309

mkuhn@jw.com