Ground leases are a crucial - if rather unusual - part of the genuine estate finance industry. Because they usually cover big costly residential or commercial properties like Rockefeller Center and The Empire State Building, to name 2, and last a very long time (99 years and approximately start) the possibility of something unforeseen or unexpected occurring is high. This likelihood increases drastically if, as highlighted listed below, one or both of the lease celebrations' declare bankruptcy. Accordingly, property professionals should take note and make sure when getting in into any transaction involving a ground lease.

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Ground leases have been around because the Middle Ages and personal bankruptcy laws have existed since a minimum of Roman Times. Given this long history, it is not a surprise that a lot of law has established on the interaction of bankruptcy and ground leases. This is particularly so given that the development of the "modern-day" United States Bankruptcy Act in 1898 and the extensive modifications to title 11 of the United States Code carried out to it in 1978, when Chapter 11 of the United States Bankruptcy Code (the "Code") was enacted. [1] In specific, Section 365 of the Code offers unique rules for the assumption 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 important to any real-estate expert. Here are the fundamentals:

A ground lease, in some cases referred to as a "land lease," is an unique system for the development of industrial property, taken pleasure in by those charged with developing the Rockefeller Center and the Empire State Building, for instance. The arrangement permits prolonged lease terms frequently approximately 99 years (with the choice of renewal) for the landowner to maintain ownership of the land and gather rent while the designer, in theory, might enhance upon the land to its benefit too. Both traditionally and presently, this irregular relationship in the property space produces sufficient discussion weighing the structure's benefits and drawbacks, which inherently grow more made complex in the face of a ground lessor or ground lessee's personal bankruptcy.

According to a lot of courts, including the Second Circuit, the limit question in examining the abovementioned possibilities concerning a ground lease in bankruptcy court is whether the ground lease in question is a "real lease" for the purpose of Section 365. Section 365 uses, making the ground lease eligible for, presumption or rejection, just if it is a "real lease." [2] While what exactly makes up a "real lease" will vary state by state, it is widely accepted that "the correct inquiry for a court in identifying whether § 365 [] governs a contract repairing residential or commercial property rights is whether 'the parties intended to enforce commitments and confer rights substantially different from those developing from the common 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 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 anticipation that a deed and lease ... are what they claim to be,'" the financial compound of the lease is the main determination of whether the lease is considered "real" or not, and in some states (like California), is the only appropriate aspect 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 more away those "economic truths" are from the common landlord/tenant relationship, the less likely a lease will be thought about a "real lease" for the function of Section 365. Id. For instance, if residential or commercial property was acquired by the lessor specifically for the lessee's usage or entirely to secure tax benefits, or for a purchase rate unrelated to the land's value, it is less most likely to be a true lease.

If the ground lease is in fact identified to be a "real lease" (and based on court approval), the appointed trustee or debtor-in-possession in a personal bankruptcy case might then either assume or reject the lease as it would any other unexpired lease held by the debtor.

However, exceptions use. These heavily depend on a debtor's "appropriate guarantees" to the staying parties to the agreements. Section 365 of the Code provides that if there has actually been a default on a debtor's unexpired lease, the DIP may not assume the abovementioned lease unless, at the time of presumption, the DIP: (i) treatments or offers "sufficient assurance" that they will in reality "without delay cure [] such default"; (ii) compensates or provides "sufficient guarantee" that they will "quickly compensate" celebrations to the agreements (aside from the debtor) for any pecuniary loss developing from such default; and (iii) offers "adequate assurance" of their future efficiency under that lease. See 11 U.S.C. § 365(b).

Unrelated to "sufficient guarantee" are the exceptions that further bar assignment or assumption of leases on the occasion that relevant law excuses a celebration from accepting efficiency from a party other than the DIP and they opt to work out such right, see 11 U.S.C. § 365(c)( 1 ); the agreement's purpose is to create a loan or financing to the debtor, see 11 U.S.C. § 365(c)( 2 ); or the lease at issue is of nonresidential real residential or commercial property and has been ended 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 wish to presume or appoint the lease, it can reject any existing unexpired agreements held by the debtor. The most generally pointed out arrangement governing rejection of a lease impacted by an insolvency case is Section 365(d)( 4 ), which provides:

"If the [DIP] does not assume or turn down an unexpired lease of nonresidential genuine 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 instantly surrender such nonresidential genuine residential or commercial property to the lessor." See 11 U.S.C. § 365(d)( 4 ). [3]

Courts have recently held that this rejection "has the same effect as a contract breach outside bankruptcy," providing the counterparty a claim for damages, "while leaving intact the rights the counterparty has actually 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 typically result in the agreement's termination, it is essential to keep in mind that rejection alone will not terminate the responsibilities enforced by the lease.

Real residential or commercial property is idiosyncratic, and likewise, real estate funding alternatives are countless and change daily as the marketplace changes. Ground leases are all special.

As can readily be recognized from the summary above, handling a specific ground lease in the context of a Chapter 11 personal bankruptcy can be legally and factually made complex. Therefore, when drafting or changing ground leases, proprietors, leasehold investors, and mortgagees must consult knowledgeable legal counsel and business genuine estate specialists who understand and can discuss what can take place to a specific lease in a Chapter 11 case.

For more details, 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 reach out to another member of our Financial Restructuring and Bankruptcy Practice.

[1] "Apart from particular special provisions, the Bankruptcy Code typically leaves the decision of residential or commercial property rights in the properties of an insolvent'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 landlord is dealt with as the lending institution.

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