This articlemay only be applicable in certain jurisdictions.
When lenders consider their real property security options, their analysis often goes beyond simply taking a mortgage from a debtor who owns real estate. A debtor's interest in real property leases (whether as landlord or tenant) means a lender often obtains either an Assignment of Lease or a Mortgage of Lease as additional security. Like any other specific security agreement, these agreements facilitate the orderly and more effective enforcement of the Lender's security in the underlying debtor asset.
Assignment of Lease.
In cases where the debtor owns real property but does not occupy it, the revenue stream from third party leases is a significant asset that should be secured. Although most mortgage standard charge terms include at least a brief paragraph related to assignment of leases, they do not provide the benefit of the more fulsome provisions typically contained in a stand alone specific Assignment of Lease (in cases where there may be a significant tenant) or a general Assignment of Lease (securing all present and future leases without reference to a specific tenant).
The debtor's interest as landlord is secured by registration against title to the debtor's real property, typically immediately following the registration of the mortgage of land. It should be noted that in order to register a specific Assignment of Lease, there first requires the registration of a Notice of Lease in respect of the lease that is being specifically assigned. The Assignment of Lease also has a personal property component that cannot be overlooked. The rents and leases that are secured by the Assignment of Lease fall within the definition of personal property under the personal property security legislation; and as such require the registration of a financing statement against the debtor.
An Assignment of Lease document includes certain generally accepted provisions.
The debtor assigns to the lender (as collateral security for the payment of principal and interest under the mortgage of land) all rents and other monies due to it by tenants and the benefit of all tenant covenants under all current and future leases.
The debtor typically covenants to not collect rent more than one month in advance (to ensure that the normal revenue stream is available to the lender on enforcement) and not amend any material terms of the leases without the lender's approval. In the case of a specific Assignment of Lease, it is prudent to also obtain similar covenants from the tenant itself and an acknowledgement that the tenant will attorn to the Lender in the event of default by the debtor.
The debtor is permitted to continue to collect rent according to the terms of the leases until an event of default occurs pursuant to the mortgage of land, after which the Lender may give notice to the tenants to pay all future rents to the lender directly.
Mortgage of Lease.
In cases where the debtor does not own real estate but rents space instead, the right to occupy the premises may be a key asset of the debtor that is secured. Although it is typical that a general security agreement includes a reference to leasehold interests in the description of the charged collateral, the general security agreement does not provide the benefit of the more complete language in a stand alone specific Mortgage of Lease document.
The debtor's interest as tenant is secured by registration against title to the debtor's leasehold interest in the real property. This requires the prior registration of a Notice of Lease in respect of the lease that is being secured.
It should be noted that if there is a real property mortgage on title granted by the owner/landlord to another lender prior to the lease, and if the tenant/debtor or tenant's lender has not obtained a non-disturbance agreement from the owner/landlord, the Mortgage of Lease will be no better security than the lease itself (i.e., subject to being terminated at the option of the prior mortgagee in the event of default under the real property mortgage). Most leases will contain a prohibition against mortgaging the lease, so it will be necessary to obtain the landlord's consent to a Mortgage of Lease.
A Mortgage of Lease document typically contains some basic standard provisions.
As in a mortgage of land, the Mortgage of Lease specifies a principal amount, interest rate, payment dates, and contains charging language whereby the debtor's leasehold interest is security for payment of the principal and interest.
Similarly, in the event of default, the lender has the ability to exercise a power of sale and sublease or assign the leasehold interest to a third party.
The debtor covenants to not pay rent more than one month in advance, to not amend any material terms of the leases without the lender's approval, to not terminate or surrender the term of the lease and to hold possession of the premises in trust for the lender.
Most lender mortgage standard charge terms contain flexible language that contemplates use of the terms for both cases where the chargor owns a freehold interest in the property or a leasehold interest in the property.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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Leasehold Mortgage vs. Collateral Assignment of Lease
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If loan proceeds are to be used to finance existing or new improvements on a leased interest in land, the SOP 50 10 5(F) contains rather specific requirements as to the clauses that need to appear in the borrower’s ground lease. In most instances, a tenant/borrower under a long-term ground lease that intends to secure financing for construction or major renovations to the leased premises will be cognizant that its long-term ground lease has to be financeable, and that the ground lease must therefore contain certain provisions to protect the interests of any leasehold mortgagee. In a ground lease situation, where the tenant/borrower is developing the land with significant improvements (such as ground-up construction of a new building), its landlord should also understand from the start (i) that an encumbrance or lien on tenant’s/borrower’s interest in the ground lease will be conveyed to a lender as collateral for a loan to the tenant/borrower and (ii) that a leasehold mortgage or deed of trust will be required to allow the tenant/borrower to develop the improvements to the leased premises without spending all of its available assets. If the parties to a ground lease are aware that tenant/borrower intends to secure financing for construction or major renovations, commercial ground leases will typically include a provision that specifically allows the tenant/borrower to encumber all or any portion of its interest in the lease and the leasehold estate by mortgage, deed of trust or other security instrument upon obtaining the prior written consent of the landlord. Consequently, in the context of a tenant/borrower developed property under a ground lease, it is appropriate and much more likely that a lender can obtain a ground lease that meets the requirements of the SOP 50 10 5(F) and secure the loan with a leasehold mortgage.
In direct contrast to the ground lease situation, there are many instances where loan proceeds are to be used to finance existing or new improvements on a leased interest in a commercial property that is already improved (or will be improved) with a building or buildings that have been (or will be) constructed by a landlord with the intent of leasing out the building or buildings to one or more commercial tenants. In this situation, where the financing is typically for less significant improvements that fall with in a narrower scope of tenant’s/borrower’s fit out work for its unique use of the leased premises, it most likely not appropriate or possible for a leasehold mortgage to be placed on commercial property that has been already been (or will be) developed by a landlord. In the context of a landlord developed property, most likely neither tenant/borrower, nor its landlord will have anticipated that tenant’s leasehold interest will be encumbered with a leasehold mortgage and, consequently, a lease for a landlord developed property will not likely contain any provisions that protect the interests of a leasehold mortgagee. In fact, more likely than not, tenant/borrower in this context will be prohibited from encumbering its leasehold interest with any lien or any other encumbrance. To go back after the fact and try to get such protections in the lease for the benefit of a leasehold mortgagee can be difficulty, if not impossible, to obtain. The lender will have higher likelihood of success if, in the connect of a landlord developed property, it obtains a collateral assignment of the tenant’s/borrower’s lease and a waiver of landlord’s statutory lien on tenant’s trade fixtures, furnishings and equipment. Landlord’s waiver will allow the lender to enter the leased premises in the event of a tenant/borrower default under its loan in order to repossess tenant’s trade fixtures, furnishings and equipment. When coupled with a collateral assignment of lease, the lender will also have the right to occupy the leased premises and to subsequently assign tenant’s/borrower’s leasehold interest to a new tenant.
For more information regarding leasehold mortgages, please contact Joe at (215) 542-7070 or firstname.lastname@example.org.