Utilizing Letters of Credit to Protect Landlords in Long-term Leases

February 18, 2013

Long-term commercial leases may involve a great deal at stake financially. As a result, landlords may seek added layers of protection against the possibility of a tenant default. One such added assurance is a letter of credit. These letters can help not only minimize the landlord’s risk of exposure, they may also benefit potential tenants by helping to induce a landlord to agree to rent a property to that tenant.

In the context of a rental property, a letter of credit is a promise from a bank or other lending institution to a landlord guaranteeing that the landlord will receive payment fully and timely each month. These letters may benefit a potential tenant by serving as an added inducement that helps persuade a landlord to rent a space to that tenant, or allow a tenant to negotiate a smaller security deposit that the landlord would otherwise require without the letter. The letters help landlords, as they protect them against a wide variety of financial misfortunes that might befall the tenant, including insolvency or bankruptcy. The law considers a landlord’s claim for payment on a letter of credit from a third-party financial institution as a claim against the bank, not an attempt to obtain property from the bankrupt tenant.

Most letters of credit will also survive any contingency. So long as the landlord presents the required documents, as expressed under the terms of the letter of credit, to the financial institution before the letter expires, and assuming the claim did not involve fraud, the institution must pay the landlord.

Furthermore, even if the relationship between the tenant and landlord descends into dispute, the landlord generally may still receive payment under the letter. Whether the tenant disputes the landlord’s claim of default, or the amount of landlord’s damages, the institution must still pay the landlord in accordance with the letter’s terms. A tenant’s decision to litigate its claims against its landlord would occur independently of the landlord’s right to receive payment under the terms of the letter.

From a landlord’s perspective, a letter that imposes the fewest requirements on a qualifying demand for payment would be preferable. Ideally, a landlord should seek a letter that requires him or her to make a draft or demand, with no supporting documents. This standard has the lowest risk of becoming entangled in court-ordered injunctive relief or the automatic stay in bankruptcy. The tenant, meanwhile, will likely want to negotiate for certain notices and disclosures before the landlord may draw on the letter of credit. An example of a middle ground solution might involve requiring a landlord to issue a summary document stating the tenant’s default, and the landlord’s right, under the lease terms, to draw upon the letter as a result of the default.

Negotiating the terms of a long-term commercial lease often involves a wide spectrum of language meant to protect landlord and tenant, given the large economic investment each party has at stake. To obtain detailed, personalized advice and counsel regarding your next commercial lease, consult the real estate attorneys at Samuel C. Berger, P.C. Our New Jersey real estate attorneys can help your business make certain that your long-term commercial lease agreements adequately meet your business objectives and protect your rights and fiscal security, as well. Contact us online or call (201) 587-1500 or (212) 380-8117.

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