Letters of Credit and the Game of Thrones
My sixteen year old son Noah is a distracting (but fun) influence. He is always luring me into watching the Knicks or Mets (showing how easily I am distracted) or a classic “guy’s movie” when I should be doing something more constructive.
Recently, Noah hooked most of our family on Game of Thrones, the HBO medieval fantasy series.
Game of Thrones is filled with intrigue, violence, treachery, nudity, sword fighting and dragons. Everything you would expect in a lease negotiation (okay, not all of our lease negotiations involve sword fighting).
In one episode, the Queen remarks to a rival that “in the game of thrones, you either win or you die”. All kidding aside, that sounds like the way many issues are viewed in a lease negotiation.
Part of the reason stems from the fact that although both landlord and tenant should benefit from entering into a lease, most individual lease issues involve a zero sum game. One participant’s gain (or loss) is counter balanced by the loss (or gain) of the other participant.
I can think of very few areas in which the interests of the landlord and tenant somewhat align, but one area is in quickly obtaining a letter of credit for use as the lease security deposit.
Most leases today require that the tenant post a letter of credit as security ensuring full and punctual performance under the lease. Landlords prefer a letter of credit over cash because in the event of bankruptcy, a letter of credit is viewed as less likely than cash to be deemed part of the tenant’s bankruptcy estate and, in many states (New York in particular), case law regarding letters of credit favor the beneficiary (i.e., the landlord).
So far, so good.
The landlord is entitled to have the letter of credit operate not much differently than cash. Although the security deposit provisions are certainly subject to negotiation, and there are some points to negotiate with the landlord regarding the form of letter of credit, for the most part the landlord and tenant each have an interest in getting the letter of credit issued as quickly as possible.
Yet, I cannot tell you how many times we have completed the negotiation of a lease only to have the lease execution delayed while the parties wait for the tenant’s bank to issue the letter of credit. For a tenant under time pressure, perhaps to commence a build out and/or move out of its current space, any delay can potentially be disastrous.
To avoid getting caught in letter of credit delay purgatory, make sure to address the following:
- Start the process right away. It will often take two or three weeks to get your bank to issue a letter of credit in a form acceptable to your landlord. Send your bank the form of letter of credit required by your landlord (usually included as an exhibit to the lease) as soon as you receive the first draft of the lease.Tenants often downplay the urgency of the letter of credit process because they feel comfortable with their relationship with their bank. But in today’s economy, banks are more cautious (i.e., slower) and letters of credit are usually issued by a separate department in the bank that may be insulated from the leverage you may think you can exert on your bank.
- Be proactive in bringing your bank and your landlord together. Get in touch directly with the bank officer responsible for issuing the letter of credit and have the bank send a draft letter of credit for the landlord’s review before issuing the final version. You will need to perform a subtle dance to navigate the distance between your bank and your landlord, both of whom are used to getting their way. Each will be most comfortable starting with its own form and using its customary language, and they will not likely ever speak directly to resolve open issues. You will need to explain to each of them the other party’s positions and concerns to get to a final agreement.
- Notwithstanding the relative alignment of interests, you should still be prepared to negotiate some points with your landlord. Your landlord is entitled to a standard letter of credit from a creditworthy bank that is “evergreen”, transferable and capable of being drawn down in a straightforward manner. But that does not mean that you have to agree to everything in the landlord’s form.
- If your landlord gets too “creative” in an effort to protect itself, the bank will not likely agree and this will only delay the process. We recently worked with a landlord that would only agree to have the person signing its draw request warrant that he or she “purportedly” represented the landlord, a qualification that few banks would accept.
- Letters of credit typically do not expire upon lease expiration in order to cover tenant’s post-lease expiration obligations, such as timely move-out without causing damage. That being said, there should be some outside date (30 or 60 days) after lease expiration and a procedure for return of the letter of credit.
- Landlord should only be entitled to draw on the letter of credit after a lease default and expiration of applicable cure periods.
- You should try to avoid responsibility for any additional fees associated with landlord’s transfer of the property.
- Negotiate an interim option so that the process does not interfere with critical dates. Grant yourself the right to post the security deposit in cash if the letter of credit is not ready upon the execution of the lease, with a 60 or 90 day period to deliver the final letter of credit.
Although we are all tempted to go medieval and unsheathe our swords when dealing with a bank, it would probably be better to utilize these four approaches to speed up delivery of your letter of credit security deposits. Of course, if you happen to be handy with a sword, we could use you at our next lease negotiation.