This past Friday, March 10, 2023, the Federal Deposit Insurance Corp. (FDIC) announced its takeover of the failed Silicon Valley Bank (“SVB”) after a run on the bank late last week caused the largest-scale U.S. bank failure since Washington Mutual in the 2008 financial crisis. Two days later, New York regulators shuttered Signature Bank (“Signature”). The federal government has made it clear that, while FDIC will guaranty all deposits, including uninsured ones, bailouts of these banks will not occur. The failures of SVB and Signature are likely to have widespread ramifications across many industry sectors, including commercial leasing.
How will the bank failures impact landlords in the commercial leasing sector?
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SVB was a very common issuer of tenant letter of credit security deposits. A letter of credit security deposit is the issuing bank’s contractual obligation to pay the landlord beneficiary the amount that such landlord’s tenant is in default.
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Landlords holding tenant letters of credit issued by SVB or Signature as security deposits will be directly impacted by the bank failures. Any undrawn standby letters of credit issued by SVB, Signature or any other bank under FDIC receivership may be repudiated by the FDIC, making any such letter of credit worthless. Any affected landlord will want to act promptly to provide proper protection of their interests under any applicable lease.
How can landlords protect their interests under such leases?
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Any landlord holding a letter of credit security deposit should identify the issuing bank.
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In any lease where the security deposit is a letter of credit issued by SVB or Signature, the landlord should carefully review the terms of the lease regarding the security deposit and the landlord’s approval rights over the issuing bank, but in any event require the tenant to provide it with a letter of credit issued by a different financial institution.
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All landlords should review the terms their lease agreements relating to landlord approval rights over issuing banks, draw procedures and requirements and the process for replacing a letter of credit.
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In the event the lease agreement in question does not provide landlord with adequate approval rights over the issuing bank, clear draw procedures and stringent replacement requirements, the landlord should consider amending the lease agreement to so require.
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