Collateral securing a commercial mortgage loan commonly consists of the real property and all other assets owned by the borrower, including all cash and revenue derived from the operation of the property. In most cases, such revenue will consist of rental payments, which may include proceeds of security deposits. Particularly with larger tenants, a security deposit may be delivered in the form of a letter of credit issued to the borrower, as landlord of the mortgaged property. Such a letter of credit may represent a material sum to which the borrower has access and over which the lender would wish to exercise a substantial measure of control beyond typical lockbox measures. In light of the work necessary to perfect a security interest in a letter of credit, lenders will generally only undertake the effort if the amount of the letter of credit is significant in relation to the amount of the loan.
The borrower’s (and, consequently, the lender’s) right to draw on a letter of credit and apply its proceeds, however, are constrained by the terms of the applicable leases and, in many jurisdictions, the rights of tenants under local law. Certain states have statutes governing the use and deposit of security deposits. This article will discuss the various approaches by which a lender can secure an interest in a letter of credit held by a borrower on account of a tenant security deposit.
