Ground leases are an essential - if somewhat uncommon - part of the real estate finance market. Because they typically cover large expensive residential or commercial properties like Rockefeller Center and The Empire State Building, to name 2, and last a long time (99 years and approximately start) the possibility of something unforeseen or unintended happening is high. This likelihood increases drastically if, as highlighted below, one or both of the lease parties' files for insolvency. Accordingly, property specialists ought to remember and make sure when entering into any transaction including a ground lease.

* * * *

Ground leases have been around since the Middle Ages and bankruptcy laws have existed given that at least Roman Times. Given this long history, it is not a surprise that a lot of law has actually developed on the interaction of insolvency and ground leases. This is particularly so because the introduction of the "modern" United States Bankruptcy Act in 1898 and the extensive modifications to title 11 of the United States Code implemented 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 supplies 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 vital to any real-estate specialist. Here are the essentials:

A ground lease, often described as a "land lease," is a distinct system for the advancement of commercial property, delighted in by those charged with developing the Rockefeller Center and the Empire State Building, for instance. The arrangement enables extended lease terms often approximately 99 years (with the choice of renewal) for the landowner to retain ownership of the land and gather rent while the designer, in theory, may enhance upon the land to its benefit too. Both historically and currently, this atypical relationship in the property space creates ample conversation weighing the structure's benefits and drawbacks, which naturally grow more made complex in the face of a ground lessor or ground lessee's insolvency.

According to a lot of courts, consisting of the Second Circuit, the limit concern in examining the previously mentioned possibilities concerning a ground lease in personal bankruptcy court is whether the ground lease in concern is a "real lease" for the function of Section 365. Section 365 applies, making the ground lease eligible for, assumption or rejection, only 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 query for a court in figuring out whether § 365 [] governs an agreement repairing residential or commercial property rights is whether 'the celebrations meant to enforce responsibilities and provide rights considerably various from those arising from the ordinary landlord/tenant relationship.'" Intl. Trade Ad. v. Rensselaer Polytechnic, 936 F. 2d 744 (2d Cir. 1991). This "intent" is figured out based upon that of the parties 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 presumption that a deed and lease ... are what they claim to be,'" the financial compound of the lease is the main decision of whether the lease is considered "true" or not, and in some states (like California), is the only appropriate factor to weigh. Liona Corp., N.V. v. PCH Associates (In re PCH Associates), 804 F. 2d 193 (2d Cir. 1986) pointing out Fox v. Peck Iron & Metal Co., 25 Bankr. 674, 688 (Bankr. S.D. Cal. 1982). Generally, the further away those "financial truths" are from the ordinary landlord/tenant relationship, the less most likely a lease will be considered a "true lease" for the purpose of Section 365. Id. For instance, if residential or commercial property was purchased by the lessor particularly for the lessee's use or solely to protect tax advantages, or for a purchase rate unrelated to the land's worth, it is less likely to be a real lease.

If the ground lease remains in reality identified to be a "real lease" (and based on court approval), the selected trustee or debtor-in-possession in a personal bankruptcy case might then either presume or turn down the lease as it would any other unexpired lease held by the debtor.

However, exceptions apply. These heavily count on a debtor's "adequate guarantees" to the remaining celebrations to the agreements. Section 365 of the Code supplies 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 assumption, the DIP: (i) remedies or provides "adequate assurance" that they will in fact "without delay cure [] such default"; (ii) compensates or offers "sufficient guarantee" that they will "immediately compensate" parties to the contracts (besides the debtor) for any monetary loss arising from such default; and (iii) offers "adequate guarantee" of their future performance under that lease. See 11 U.S.C. § 365(b).

Unrelated to "appropriate assurance" are the exceptions that further bar project or presumption of leases in case suitable law excuses a celebration from accepting efficiency from a party besides the DIP and they decide to work out such right, see 11 U.S.C. § 365(c)( 1 ); the contract's purpose is to develop a loan or financing to the debtor, see 11 U.S.C. § 365(c)( 2 ); or the lease at problem is of nonresidential real residential or commercial property and has been terminated under other (non-bankruptcy) law prior to the order for relief, see 11 U.S.C. § 365(c)( 3 ).

If, on the other hand, a DIP does not desire to presume or assign the lease, it can reject any existing unexpired agreements held by the debtor. The most generally pointed out provision governing rejection of a lease affected by a bankruptcy case is Section 365(d)( 4 ), which offers:

"If the [DIP] does not presume or reject an unexpired lease of nonresidential real residential or commercial property under which the debtor is the lessee within [sixty] 60 days after the date of the order for relief ... then such lease is considered turned down, and the [DIP] shall right away give up such nonresidential real residential or commercial property to the lessor." See 11 U.S.C. § 365(d)( 4 ). [3]

Courts have just recently held that this rejection "has the very same repercussion as an agreement breach outside insolvency," supplying the counterparty a claim for damages, "while leaving undamaged the rights the counterparty has gotten under the contract." Mission Product Holdings, Inc. v. Tempnology, LLC, 587 U.S. ___ (2019 ). While this "breach-by-rejection" (a term coined by the courts) will often cause the agreement's termination, it is very important to keep in mind that rejection alone will not end the responsibilities imposed by the lease.

Real residential or commercial property is distinctive, and also, property funding choices are countless and modification daily as the market varies. Ground leases are all unique.

As can easily be recognized from the summary above, dealing with a particular ground lease in the context of a Chapter 11 insolvency can be lawfully and factually complicated. Therefore, when drafting or amending ground leases, proprietors, leasehold investors, and mortgagees must consult knowledgeable legal counsel and industrial realty experts who understand and can explain what can take place to a particular lease in a Chapter 11 case.

For more info, contact Christopher F. Graham, Partner at grahamc@whiteandwilliams.com or 212.714.3066; or Morgan A. Goldstein, Associate at goldsteinm@whiteandwilliams.com or 475.977.8302. Or you may connect to another member of our Financial Restructuring and Bankruptcy Practice.

[1] "Apart from particular unique arrangements, the Bankruptcy Code normally leaves the decision of residential or commercial property rights in the possessions of a bankrupt's estate to state law." See Butner v. United States, 440 U.S. 48 (1979 ).

[2] If the lease analyzed is not a "real lease," it will be considered a "financing lease," in which the trustee or debtor-in-possession ("DIP") owns the land and the property manager is dealt with as the loan provider.

[3] Generally, "... a debtor in ownership shall have all the rights ... and powers and shall carry out all the functions and tasks ... of a trustee serving in a case under this chapter." See 11 U.S. Code § 1107(a).