Leasehold Mortgages and Lender Protection

The Mortgage Instructions Toolkit provides practical guidance for lawyers responding to lender requests in residential real estate transactions. This page addresses leasehold mortgages and lender protection.

The situation

Instead of owning the land on which a house is located, the owner of the house may have a long-term lease on the land owned by a ground lease landlord. The ground lease landlord may be the government (municipal, provincial, or federal), Crown corporation, First Nation,  corporation or other person.

The owner or purchaser of the house (the ground lease tenant), may be able to obtain a mortgage loan secured by the tenant’s leasehold estate. For the ground lease tenant’s leasehold estate to receive financing, the balance of the ground lease term must meet the lender’s underwriting criteria.

The financial institution will have specific instructions for the lawyer handling the leasehold mortgage loan being made to the ground lease tenant borrower. However, in some cases, these instructions are insufficient to adequately protect the lender.

As legal counsel handling the leasehold mortgage transaction for the financial institution, you must consider going beyond the specific lender instructions. Otherwise, you risk liability for failing to perform your legal duties to your lender client to the required standard.

Sample lender instructions

If this is a leasehold mortgage on non-First Nations land, obtain a copy and review the lease to confirm that the remaining term of the lease exceeds the amortization period of the Mortgage by a minimum of five years. You must also advise the Mortgagee of the amount of the rental payments. Obtain all necessary consents of the landlord, including signature of the Landlord in the lender’s form of agreement in which they accept to notify the Mortgagee of any default under the lease and acknowledge that the lease is in good standing.

Practice guidance

In addition to a search of title to confirm that the Landlord is the owner of the property and what the ground lease may be subject to, here are provisions to consider addressing in a recorded/registered agreement between the mortgage lender and the ground lease landlord (the landlord):

  1. At the same time as the landlord gives a notice to the borrower, the landlord must give a copy of the notice to the lender. No notice to the borrower is effective until the landlord gives the notice to the lender.
  2. The landlord will not:
    1. terminate the lease
    2. recover possession of the property, or
    3. exercise any other right or remedy arising out of any breach of the lease
    unless the landlord gives notice to the lender and provides the lender with a period of time, which ends after any cure period afforded the borrower, for the lender to cure the breach. This does not apply to any breach of the lease which only the borrower may cure (e.g. insolvency), which the ground landlord must agree to waive.
  3. The lender must consent to any modification or consensual termination of the lease or the acceptance of any surrender.
  4. If the lease is terminated by the landlord, tenant, or any insolvency or bankruptcy trustee, the landlord must give notice to the lender and provide a  period of time for the lender to exercise a right to enter into a replacement lease on the same terms and conditions as the terminated lease for a term equal to the balance of the term of the original lease.
  5. The landlord must accept the cure of any breach of the lease by the lender and any exercise of any tenant rights under the lease, including the lender giving any notice and exercising any extension or renewal term or pre-emptive right to purchase (e.g. right of first refusal) in the lease.
  6. The lender’s exercise of any rights under the agreement with the landlord or under the loan documents will not subject the lender to liability under the lease unless the lender acquires the leasehold estate and physically occupies the leased premises or expressly assumes the lease.
  7. The Lender may freely assign the lease and may freely enter the leased premises without assuming the lease.
  8. When the lender acquires the leasehold estate, the lender will not be liable for any occurrence or breach following the lender’s assignment of the lease. Lender’s liability in all circumstances is limited to its interest in the leasehold estate.
  9. The lease and lender’s leasehold mortgage must not be subject or subordinate to any mortgage or other security instrument encumbering the landlord’s fee simple estate; and any mortgage or other security instrument granted by landlord must expressly provide so.
  10. The landlord must legally acknowledge (attorn to) the lender when the lender acquires the tenant’s leasehold estate.
  11. The lender is entitled to be named as an insured mortgagee, and first loss payee under any property insurance policy and be entitled to participate in any insurance or expropriation settlement or proceeding.
  12. The lender has the right, at any time, to make direct payments of rent to the landlord.
  13. The merger of leasehold and fee simple estates is prohibited.
  14. Specifics on giving notice and other typical boiler plate provisions must be included.