A Letter of Credit (“LOC”) is simply an agreement from a bank guaranteeing that Party A’s payment to Party B will be received on time and for the correct amount. LOC’s are used primarily in sizeable international trade transactions, i.e., a supplier in one country and a customer in another. LOC’s, however, can also be useful, and are regularly employed, in long-term commercial lease situations. For a tenant, an LOC may help it secure a particular lease it might otherwise have been unable to secure. An LOC could also free up cash the tenant can use to run its business, instead of parking it in the landlord’s account as a security deposit. LOC’s are attractive to landlords, because they allow a landlord to get its money notwithstanding the tenant’s insolvency or that it might dispute the landlord’s claim of default. Not even a bankruptcy filing by the tenant will prevent the landlord from drawing on a properly drafted LOC (although this may reduce the tenant-debtor’s obligations to the landlord under the Bankruptcy Code – more about that in a later post).
The beleaguered commercial real estate market has negatively impacted not only tenants, but landlords, as well. For example, tenants whose leases require the landlord to construct or fund tenant improvements could find themselves out of luck if their landlord were to file for bankruptcy protection. As a protective measure, a tenant could require the landlord to post an LOC naming the prime tenant as a beneficiary to ensure the availability of funds to cover the completion of the build-out in the event the landlord is unable to do so.