Tenant Leasing Illustrated – November 2019 – There’s No Crying in Letters of Credit

There’s No Crying in Letters of Credit

The Major League Baseball post-season has arrived and once again my NY Mets sit on the top of the heap.

Wait, what? Oh.

But it is MLB post-season when every pitch is filled with anticipation and tension.

That is, if you are awake.

I admit the action can get somewhat glacial on the seventh pitching change, so for some in the stands there is reading, napping, sunbathing, writing your doctoral thesis, solving quantum physics problems and knitting.

Yes, knitting.

With the average length of an MLB game now taking as long as it took me to finish law school, there is a whole subculture of people who bring their knitting to the ballpark and knit one, pearl two away.

Just kidding. I never went to law school.

The knitters will tell you that knitting does not work at football games because “you might miss something.”

No such danger in baseball. It is like watching a commercial lease negotiation.

Some teams have even hosted “Stich N’Pitch” events to bring fans into the games.

For macho baseball players this can be somewhat hard to take and brings to mind my favorite George Carlin routine about the differences between baseball and football.

Football is played on a gridiron. Baseball is played in a park. In football we tackle, in baseball we tag. You get the idea.

Similar to the differences between tenant and landlord lease drafts.

Landlord first drafts provide that if the tenant timely pays its rent and meets every other obligation under the lease, the landlord, in its sole and absolute discretion, may allow the tenant to visit the premises on occasion at its own risk as long as it indemnifies the landlord.

We mark-up these drafts to provide for optional tenant payments with rights of renewal, first offer, first refusal and first born.

No wonder I spend so much time knitting in the office.

For something almost as slow as a baseball game, think letters of credit.

Most leases require that the tenant post a standby (as opposed to documentary or commercial) letter of credit as security ensuring performance under the lease and meant to be drawn upon only if a default occurs under the lease.

Landlords prefer a letter of credit (or “LC”) over cash because in the event of bankruptcy, an LC is viewed as less likely than cash to be deemed part of the tenant’s estate and, in many states (New York in particular), case law regarding LCs favor the beneficiary (in this case, the landlord).

As we have said in past newsletters, it can take forever to finalize an LC so the parties should start the process as soon as possible and avoid having completed the lease only to have to wait for the LC.

Sometimes a tenant may need to sublease its space and then faster than you can knit me my orange and blue NY Mets birthday sweater the tenant is in the position of requiring an LC for its security deposit from its subtenant.

When put in that position, there are a number of other conditions besides speed that the tenant will want to impose on its subtenant with respect to the LC.

Knock your subtenant LC requirements out of the park by following the following 13 (wow, 13?!) suggestions:

  • Per Yogi, “it gets late early around here.” Same advice to start the process as early as possible since it can take weeks to get your subtenant’s bank to issue an LC in an acceptable form.
    • One cannot downplay the potential delay even if your subtenant feels comfortable with its bank. Banks are more cautious (i.e., slower) than in the past and LCs are usually issued by a separate department in the bank that may be insulated from the leverage your subtenant may think it can exert on its bank.
    • Ask for the form of LC from your subtenant’s bank as soon as possible. Even if your subtenant has yet to submit its application, having the form allows you to start the negotiation process with your subtenant’s bank.
  • Keep it simple. Keep LC draws error free and as simple as possible, with few documents and little or no specific wording required. Ideally, you should only have to indicate to the issuer bank that you are entitled to draw down the sums and are doing so, without any restriction on the use of the funds. Some subtenants will insist that your notice indicate that there has been a default under the sublease, that you have given proper notice etc., but the sublease terms will govern the conditions allowing you to draw down. The draw is intended to work as easily as a cash security deposit and your subtenant should not be allowed to try to prevent the draw by claiming that your statement of default under the lease is incorrect.
  • Specify ISP. Specify that the LC will be governed by the International Standby Practices (ISP98), International Chamber of Commerce, Publication No 590 (the “ISP”) and as to matters not covered by the ISP in accordance with the laws of the state with jurisdiction and U.S. federal law. The ISP is specifically designed for standby LCs and preferable for the beneficiary. Other regimes, such as the Uniform Customs and Practice for Documentary Credits are less user friendly.
  • Do not require original. You should provide that if the original LC is lost, stolen or mutilated, you can still draw down with a copy. Even the ISP permits the issuing bank to insist upon receipt of the original LC unless otherwise provided so you should specifically allow copies. You should note that the bank may require (and is entitled to) an affidavit from you as to the particular circumstances and an indemnity in case the missing letter of credit surfaces.
  • No specific individuals. Do not require draw down or signature by specific individuals (especially third parties). Any party purporting to be an authorized representative of the beneficiary should be entitled to draw down.
  • Allow partial draw downs. You should be able to make multiple partial draws on the LC. All or nothing draws do not work and you may not want to terminate the sublease but instead draw down to cover the amount of the particular default.
  • Automatic renewal. Since most LCs provide for one-year terms, your LC should be “evergreen”, i.e., it should automatically renew until the final expiration date unless the issuing bank provides you with an agreed upon period of notice (e.g., 30, 45, 60 days). If notice of nonrenewal is given for any reason, you should be entitled to draw down on the LC.
  • Ain’t over till it’s over. The expiration date of the LC should be some period (e.g., 60, 90 days) later than the expiration date under your sublease. This gives you time to determine and calculate damages to the premises. And remember to extend the outside date of the LC in the event of any renewal or extension of the sublease term.
  • Shorten time to honor. The issuing bank has a reasonable period of time to honor your draw of the LC under the ISP. You may want to shorten this to a stated period (e.g. three or four business days) giving your subtenant less time to contest the draw.
  • No away games. Many LC forms require presentment at particular offices of the issuing bank and often those offices are nowhere near the property. You should allow for presentment by facsimile or other electronic means or by overnight delivery service.
  • Allow for relief pitcher. The LC should indicate by its terms that it is transferable with the form of required transfer notice attached as an exhibit. Any fees associated with the transfer should be on the account of your subtenant (and you should indicate that any failure by your subtenant to pay such charge will not affect the transfer).
  • Require minimum creditworthiness. You should require that the issuing bank have a minimum financial standing (e.g., based on total assets or a rating agency) and deterioration of such standing should allow you to require a substitute issuer and/or to draw down on the LC.
  • Advise/confirm on foreign banks. If a foreign or out of state bank is the issuer, you may require for convenience of presentment and jurisdiction to require confirmation of the issuing bank’s LC; in effect, a payment guaranty from a second local bank. For lesser protection, you can have the LC be “advised” through a local bank to check on the authenticity of the LC and its status and obtain assistance when drawing down..

Per that great commercial leasing attorney, George Carlin, in baseball, we make sacrifices. In commercial leasing, we require security deposits. In baseball, the object is to go home. In commercial leasing, the object is to sublease your space as an effective exit strategy. But baseball players, knitters and tenants can all agree that following the 13 suggestions above will make your sublease security deposit provision a home run.