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Ground leases are a crucial - if somewhat unusual - part of the real estate finance industry. Because they usually cover big pricey residential or commercial properties like Rockefeller Center and The Empire State Building, to name 2, and last a long time (99 years and as much as start) the probability of something unexpected or unintended occurring is high. This possibility increases significantly if, as highlighted listed below, one or both of the lease parties' apply for bankruptcy. Accordingly, genuine estate experts need to remember and take care when entering into any transaction including a ground lease.

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Ground leases have been around because the Middle Ages and insolvency laws have existed since at least Roman Times. Given this long history, it is not a surprise that a great deal of law has established on the interaction of personal bankruptcy and ground leases. This is particularly so since the arrival of the "modern-day" 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 specific, Section 365 of the Code supplies unique guidelines for the presumption or rejection of a ground lease-as well as its potential sale and transfer by a debtor to a 3rd party.

Knowing these guidelines is critical to any real-estate specialist. Here are the fundamentals:

A ground lease, in some cases referred to as a "land lease," is a distinct system for the advancement of commercial property, taken pleasure in by those entrusted with developing the Rockefeller Center and the Empire State Building, for example. The plan permits extended lease terms frequently up to 99 years (with the alternative of renewal) for the landowner to retain ownership of the land and gather rent while the designer, in theory, might improve upon the land to its advantage also. Both historically and currently, this irregular relationship in the property space produces ample discussion weighing the structure's pros and cons, which inherently grow more complicated in the face of a ground lessor or ground lessee's insolvency.

According to the majority of courts, consisting of the Second Circuit, the threshold concern in analyzing the aforementioned possibilities concerning a ground lease in insolvency court is whether the ground lease in question is a "true lease" for the purpose of Section 365. Section 365 uses, 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 widely accepted that "the appropriate inquiry for a court in identifying whether § 365 [] governs an arrangement fixing residential or commercial property rights is whether 'the celebrations meant to impose responsibilities and confer rights substantially different from those emerging from the regular landlord/tenant relationship.'" Intl. Trade Ad. v. Rensselaer Polytechnic, 936 F. 2d 744 (2d Cir. 1991). This "intent" is identified 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 economic 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 element 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 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 bought by the lessor particularly for the lessee's usage or entirely to secure tax advantages, or for a purchase price unrelated to the land's worth, it is less likely to be a true lease.

If the ground lease remains in truth identified to be a "real lease" (and subject to court approval), the designated trustee or debtor-in-possession in an insolvency case might then either assume or turn down the lease as it would any other unexpired lease held by the debtor.

However, exceptions use. These greatly count on a debtor's "appropriate guarantees" to the staying parties to the contracts. Section 365 of the Code offers that if there has actually been a default on a debtor's unexpired lease, the DIP may not presume the abovementioned lease unless, at the time of presumption, the DIP: (i) cures or offers "adequate guarantee" that they will in fact "immediately treat [] such default"