LETTERS OF CREDIT IN THE REAL ESTATE TRANSACTION
By Jeffrey L. Marcus*
November 2004

Deposits and personal guarantees are not the only security available to landlords. An alternative is a letter of credit. In many situations involving payment obligations including leases, a party will prefer not to rely solely on the creditworthiness and financial viability of the other party, but rather on the safety of the tenant's bank. This can be achieved by insisting that the tenant secure a letter of credit as a precondition of the obligation to perform its duties under the lease.

A letter of credit is an undertaking or promise by the party who issues the credit, referred to as the "issuer," (bank) to pay specified sums of money to the "beneficiary" (landlord) for the account of the bank's customer or "applicant" (tenant) on delivery by the landlord to the bank of certain documents specified in the credit. In turn, the bank enters into a reimbursement agreement with the tenant that creates an obligation on the part of the tenant to reimburse the bank for any amounts paid to the landlord under the credit.

A letter of credit essentially protects the landlord from nonperformance under the lease. The steps for issuing a letter of credit are similar to those used for commercial credits. [California Commercial Code governs letters of credit.]

In certain situations, the landlord prefers a letter of credit over other forms of security. First, the bank’s obligation to pay under the letter of credit is independent of the lease and dependent upon the presentation of a certificate or notice of a lease default. A bank is not interested in the dispute between the landlord and tenant and will pay upon presentation of the certificate or notice of default.

Second, because of the independence created by the letter of credit to that of the lease, the letter of credit is not part of a tenant’s estate and it has been argued payment under the letter of credit may be immune from discharge under bankruptcy law. [Caveat, "Letters of credit have yet to find a comfortable place in bankruptcy law."]

A letter of credit requirement should be brought up at the beginning of lease negotiations, since they can take time to line up, and should be explicitly set out in the lease.

*Jeffrey L. Marcus, Esq. provides litigation services and transactional advice to the firm’s clients.  He has more than 14 years’ experience in private and corporate practices involving business transactions and real estate.  Mr. Marcus can be contacted at jeff@marcuslawgroup.com or at the above address/telephone number.