COMPLETION GUARANTEES IN GROUND LEASES: WHAT ARE THEY GOOD FOR? by Dena Cohen, Partner, Herrick, Feinstein LLP There is no shortage of discussion among lawyers about the
under a ground lease does not timely complete the new
utility of completion guarantees. In a typical development
building, the landlord’s remedy against the guarantor is
ground lease, the landlord selects a developer to construct
generally to sue for the cost of completing construction. A
new or substantially refurbish property and then operate
lawsuit against a completion guarantor is hardly an ideal
that property for the production of income. Once completed
remedy and probably not what the landlord envisioned
and rented, the newly constructed building becomes
when it demanded the guarantee.
collateral for the tenant’s long-term rental obligation (usually 99 years). Given the importance to the landlord of the new building, the landlord will want to be very careful in its selection of a developer to lease the land and will only consider experienced developers who are prepared to commit to build the new structure within a reasonable time period and to stand behind that commitment with ″skin in the game.″ One way a developer may demonstrate commitment is by delivering to the landlord a completion guarantee; i.e., a guarantee from the sponsor of the project or a credit worthy equity partner, that the new building will be completed and operating when promised.
What does all of this mean for the landlord? Since the tenant is likely a limited liability entity without substantial assets, has the landlord essentially given the tenant an option between the time it signs the lease and the time it closes on a construction loan? The answer is – sort of. But the option need not be free and can be structured to deliver enough compensation to the landlord to make the risk worthwhile and impose enough stress on the tenant to make sure the lease obligations are taken seriously. Instead of demanding a completion guarantee before the developer is prepared to deliver one, the landlord could approach the problem by looking at its end game. Since
When a completion guarantee is used, there is usually
the purpose of the completion guarantee is to provide
some tension between the landlord and the tenant about
security for the tenant’s long-term rental obligation under
the timing of its delivery. In most cases, the tenant will
the lease, the landlord might require substantial upfront
be obtaining a construction loan and expects to deliver a
rental payments and/or staggered prepaid rental until the
completion guaranty to the lender at the closing of the loan
completion guarantee is delivered. The prepaid rent could
at which time it would also provide a similar guaranty to the
be applied after completion of the new building providing
landlord (the interplay between the guaranty delivered to
built in security. If the project does not succeed, it probably
the lender and the guaranty delivered to the landlord is a
won’t pay for the cost of completion, but it may provide the
separate discussion beyond the scope of this article). The
landlord with a comfortable financial cushion while it seeks
closing of the construction loan almost always occurs after
a new tenant.
the ground lease is signed. The guarantor will not want to make an unconditional commitment to the landlord to construct a new building costing tens of millions of dollars before a construction loan has been secured and all of the equity is in place. Given this reality, how can a landlord ensure that it will get the building it bargained for? It’s worth mentioning that as a practical matter, a completion
DENA COHEN Partner
guarantee does not actually translate into completion by the tenant of a new building, let alone on time. If the tenant
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