Off-balance-sheet financing: Synthetic leases

Real Property, Probate and Trust Journal, Summer 1997 by Murray, John C

Documents for a synthetic lease transaction may also include a loan agreement, a mortgage, and a trust agreement. A loan agreement between the trustee/owner/lessor and the lenders (which may consist of entities representing separate tranches) is used to specify the conditions under which the trustee/owner/lessor will use the proceeds of the loans to fund construction advances to the lessee pursuant to the participation agreement. A mortgage between the trustee/owner/lessor, as mortgagor, and the lenders (or a specific tranche of lenders), as mortgagee, will secure payments advanced under the loan agreement and other operative documents. A trust agreement between the lead or agent bank and the co-agents, or owner participants, authorizes and directs the lead bank, as trustee/owner/lessor, to execute the participation agreement, lease, or lease with open-end mortgage, and all other operative documents to which it is a party in connection with the transaction.32

A guarantee containing strong financial covenants, executed by the lessee/corporate user, secures any negotiated payment due as a result of termination of the lease, and a return payment to the lessor of the initial acquisition costs of the real estate advanced by the trustee/owner/lessee (not to exceed 89.9% of the property's fair market value at the inception of the lease) if the lessee/corporate user exercises its option to return the property to the lessor for resale to a third party upon expiration of the lease term. The lease may also contain a remarketing option, enabling the lessee/corporate user to market the property for sale on behalf of the lessor. Upon a subsequent sale of the property, the lessee/corporate user will be entitled to any proceeds over the amount necessary to retire the debt and equity advances used to fund the transaction. The lessee/corporate user retains the appreciation in the property's value resulting from the lessee's fixed-rate purchase option and the requirement that excess sales proceeds be distributed to the lessee/corporate user if the option is not exercised. If the lessee/corporate user does not purchase the property or arrange a third-party purchase at the end of the lease term, the lessee/corporate user will be obligated to the lessor for the lessor's acquisition costs (or a specified portion thereof). The parent corporation may also be required to guarantee the payment and performance obligations of its corporate subsidiary, if the subsidiary enters into a construction agency agreement.

Lastly, a construction agency agreement between the trustee/owner/lessor and the lessee/corporate user (or its subsidiary or designee), may be used to provide for construction of the improvements on the property. In some synthetic leasing transactions the lessee/corporate user will enter into an initial construction mortgage with a third-party lender. In such a case the trustee/owner/lessor will usually be required to execute the mortgage as the fee owner of the property.