Credit Enhancements
in Leases
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
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
• Cash security deposit
• Letter of credit
• Guaranty
• Lease bond
• Pledge of property
• Landlord’s lien
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
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
• Credit based on issuing bank’s financial
strength
• Focus on draw requirements
• Separate document (but attached to or
described in lease)
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
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 Cons
Cons for Landlord:
-not immediate cash
-drawing procedure
-transferability
-inadvertent expiration Cons for Tenant:
-may need collateral
-FDIC closure
-burden of renewals
-transfer to new LL
-faulty draws
III. Guaranties
• Typically issued by an affiliate
• Guaranty of payment not collection
• “Cap” vs. “burn-down” vs. “springing”
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
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 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
III. Guaranties – Case Study #1
NH 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
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)
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
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)
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
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)
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
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
• Surety underwriter – akin to insurance
• Limited to monetary, not performance,
obligation
• Uncommon
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
• Tenant’s personal property at
premises
• Contractual lien
– created in the lease
– definition of tenant’s personal property
– UCC financing statements
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
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 Cons
Cons for Landlord:
-low resale value of property
-liability for personal information
-risk of conversion
-lockout and recovery procedure
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 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 (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
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
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
• 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
Michael K. Kuhn
Jackson Walker L.L.P.
1401 McKinney Street, Suite 1900
Houston, Texas 77010
713-752-4309
mkuhn@jw.com