Recent turmoil in the banking market makes it a good time for landlords to "do some spring cleaning" and review any letters of credit (L/Cs) held as lease security, according to a Washington-based real estate attorney at Holland & Knight.

In an article published by JD Supra, Meg Raker says that L/Cs have generally been the preferred form of security deposit from a tenant to a landlord, but if a bank is placed in receivership by the US Federal Deposit Insurance Corporation (FDIC), the payment of L/Cs issued by the bank may not be guaranteed.

L/Cs and receivership

The main attraction of L/Cs is that they may continue to be available to a landlord even in the event of a tenant bankruptcy, and courts have generally upheld that presentment of an L/C to a third-party issuer does not violate the automatic stay of a tenant party's bankruptcy case, Raker says.

But she suggests landlords may begin to rethink this approach, or at least reconsider the issuers from whom they will accept a L/Cs as lease security.

Unsecured creditors

Although L/Cs are not considered a "deposit" and are therefore not FDIC-insured, landlords may not be totally without recourse in the event of a bank failure. A landlord will be considered one of many among the various unsecured creditors if trying to draw on the L/C.

Raker contemplates leases that have provisions to cover the failure of an issuing bank, but points to circumstances where such provisions may not necessarily guarantee payment. She also looks at issues surrounding the selection of L/C issuers, and possibilities for negotiating stronger draw rights based on an issuer default.

Gold standard wish list

The article concludes with Raker recommending landlords review their L/C arrangements against what she describes as a "gold-standard" wish list that includes a review of the lease terms and L/C terms governing draw requirements.

Landlords should also ensure the L/C is in good standing; keep track of their L/C issuers' creditworthiness and, if circumstances warrant, give immediate notice to tenants demanding replacement L/Cs, she concludes.

The article by Holland & Knight's Meg Raker, Spring Cleaning of Letters of Credit as Lease Security Deposits: Time to Reconsider?, can be found here.

This article represents the views of the author and not necessarily those of the ICC or Coastline Solutions.