Burndown (“Reduction”) of a Cash Security Deposit or Letter of Credit (“LOC”)

Given that a landlord will be spending approximately $1,000,000 during the first 6 to 12 months of a 10 year, 10,000 square foot office lease renting at $50 PSF with terms such as (a) a 6 month free rent concession, (b) a $50 PSF tenant improvement allowance and (c) brokerage commissions payable to both the landlord’s and tenant’s brokers, from a landlord’s perspective, even if it “only” required a 6 month security deposit (i.e., $250,000) from its tenant, to a tenant that very well may be significantly greater than what they had anticipated or can afford to lock up for the full 10 year lease term.

As we try to be equal opportunity for the eclectic musical tastes of our audience, please know that, with some love initially from Jerry Garcia of the Grateful Dead, there is a bit of “Help on the Way” for those tenants faced with what they may consider, as Mick Jagger might say, a “Beast of Burden” in the form of an excessive amount of security being required of them by their landlord. For both those disco fans out there from the 1970’s as well as tenant advocates, a happy-sad compromise to this conundrum can be found by channeling the classic song by The Trammps, namely that of “(burn baby burn) Disco Inferno.” In order to do so, those negotiating on behalf of tenants must convince the landlord – preferably at the letter of intent stage – that after a period of two (2) to four (4) years from the lease or rent commencement date, that the “excessive” security deposit will be burned down (a/k/a reduced) on a yearly basis in one (1) or two (2) month increments to that of 3 or 4 months of the then base rent.

As to the amount of the security deposit, after a thorough review of the tenant’s and its principal’s financial statements, historical track record, business plan and other factors such as the aforementioned $1,000,000 first year costs to be incurred by the landlord, the amount of security deposit ultimately will be based upon just how much risk the landlord feels it should have given its due diligence and financial outlay incurred in entering into the lease.

Simply stated, the shorter the lease term, the greater the tenant concessions and the greater the risks uncovered during a landlord’s due diligence, the greater the amount of security deposit a landlord should demand.

A “burndown” clause essentially states that, so long as tenant in not in default of the lease at a particular point in time during the lease term, then tenant’s security deposit will be reduced (either by way of a return of such reduction or by way of a rent credit).

For a letter of credit, upon the occurrence of the burndown date, tenant must provide landlord with the instruments and authorizations required by the issuer of the letter of credit to have the amount thereof reduced as previously agreed.

Tenant Advocates: Ensure that the clause is applicable so long as tenant is not in default “beyond any applicable notice and cure period,” and furthermore, if the landlord’s attorney was shrewd enough to have inserted language into its burn down provision that all rent payments during the course of the lease must have been paid in a timely fashion, please take your finely sharpened surgical machete to that language and delete it!

Tenant Advocates: Negotiate for language stating that, upon receipt of the instruments and authorization from the issuing bank, landlord must promptly execute and deliver an amendment to the letter of credit reflecting the reduced security deposit amount.

Pro-Landlord Language:

“Notwithstanding anything to the contrary contained in this Lease, and provided that (1) this Lease is in full force and effect, (2) Tenant shall have fully and timely paid all installments of Fixed Rent and Additional Rent, and (3) Tenant shall not then (nor have been during the prior twenty four (24) month period) be in default of this Lease, then Tenant may provide to Landlord (and Landlord shall promptly thereafter execute and deliver to Tenant, if necessary) such instruments and authorizations, as may be reasonably required by the issuer of the Letter of Credit to reduce the face amount thereof by $80,000.00 to $240,000.00 as of the first (1^st) day subsequent to the fifth (5^th) anniversary of the Lease Commencement Date.”

Pro-Tenant Language:

“Notwithstanding anything to the contrary contained in this Lease, and provided that this Lease is in full force and effect and Tenant shall not then be in monetary or material nonmonetary default of this Lease (beyond the expiration of any applicable notice and cure period), then Tenant may provide to Landlord (and Landlord shall promptly thereafter execute and deliver to Tenant, if necessary) such instruments and authorizations, as may be reasonably required by the issuer of the Letter of Credit to reduce the face amount thereof by $80,000.00 to $240,000.00 as of the first (1^st) day subsequent to the third (3^rd) anniversary of the Rent Commencement Date.”

In closing, when it comes to negotiating the proper amount of a tenant’s initial security deposit – and regardless of whether or not you are a fan of the songs “Burning Up” by Madonna,“ “Burnin’ For You” by Blue Oyster Cult, “Burn It Up” by Jessie James or “Burn It Down” by Linkin Park – the takeaway for landlord and tenant advocates is still the same.

Landlords need to have as much security deposit from a tenant as possible so as to partially mitigate against its short and long term risks. Conversely, tenants need to be cognizant of the fact that:

1. if its financial statements and business track record do not give its landlord the financial warm and fuzzies; and/or
2. if it is requesting of its landlord a tenant concession cocktail full of free rent, a tenant improvement allowance, landlord’s work and/or the payment of the brokers’ commission, a large security will in most cases be part of the equation.

The game to be played thereafter by tenant advocates is one of persuasion, charm and – as the song by Bruce Springsteen goes – giving enough financial comfort to a landlord so that it has a “Reason to Believe” that granting a security deposit burn down provision to its tenant is warranted!