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Commercial leases often require tenants to provide a letter of credit in lieu of a cash security deposit. This practice reflects the belief that L/Cs provide owners with greater security than cash deposits in the event of tenant bankruptcy. Until very recently, many of these L/Cs were provided by Signature Bank or, especially for start-ups and tech companies, Silicon Valley banks.
If these banks go bankrupt, the L/Cs issued by them will be temporarily worthless. This is because they are not backed by deposit insurance and merely represent the issuer’s contractual obligations. The federal government quickly resolved the issue. FDIC Declared A “bridge bank,” a temporary bank taking over for a failed bank, honoring all contracts of the failed bank. This includes unpaid L/Cs. Therefore, the owner who accepted the Signing Bank L/C became the owner of the Signing Bridge Bank L/C instead. The FDIC’s announcement also stated that “all obligations of the bridge are supported by the FDIC and the Deposit Insurance Fund.”
Owners may still be concerned that their L/C is not as reliable and comfortable as it should be. In that case, the owner should ask herself if she can request the tenant to exchange that her L/C for a potentially “better” one. It depends on the terms of the lease.
Some leases may also include the right to require tenants to reissue to them L/Cs issued by failing banks, regardless of whether the successor bank or the FDIC has fulfilled the L/C obligations. It contains elaborate clauses such as those given to the owner. In such cases, the owner may simply require that the tenant fulfill its obligations under the lease and provide a new her L/C. However, in more typical cases, the tenant may not be obligated to do anything with her L/C. A tenant who cares about the relationship with the owner, if requested, may arrange for the exchange of her L/C anyway.
Also, Signature Bank or Silicon Valley Bank L/Cs may eventually expire and generally not be renewed within a year. At that point, nearly all leases require the tenant to provide a replacement L/C. Of course the owner wouldn’t want to wait.
If an owner can request a tenant to exchange a Signing Bank or Silicon Valley Bank L/C or wishes to cooperate if a tenant is asked to make such an exchange, what will happen next and how long will it take? Does it cost? In most cases, it is not too difficult for the tenant to respond to the owner’s request and provide a new L/C from an unbroken bank.
Most L/Cs are issued by a bank that provides a revolving credit line (“revolver”) for the tenant. The presence of a revolver means that the tenant’s bank has determined that it is willing to lend the tenant, say, up to $10,000,000 at a time. If a bank issues his L/C with a face value of $1,000,000, it means that the bank may need to prepay $1,000,000 at any time if the L/C is withdrawn. The Bank will treat such advances as if made under revolver. Therefore, as long as the L/C remains unpaid, the bank will limit other borrowings on the revolver to $9,000,000 and the total loan balance will not exceed $10,000,000.
If a tenant maintains multiple revolvers at various banks, the tenant may obtain a loan from another bank, assuming the revolver’s loan balance with the other bank is low enough to cover the issuance of the L/C. You can often get a replacement L/C fairly quickly. If a tenant only has one revolver, i.e. only a signature bank or a Silicon Valley bank, the tenant cannot have the revolving lender issue his L/C in lieu unless the tenant sets up a new revolver. you can’t. That could take time, especially in an environment of tightening credit standards and declining asset values.
In the meantime, tenants may temporarily resort to less sophisticated strategies to obtain alternative L/Cs. That is, the tenant deposits cash with the new L/C issuing bank, and the new bank issues the cash-backed L/C. deposit. Of course, it’s not the best use of cash, nor is it one that every tenant can set up out of the box.
Small businesses that don’t maintain a revolver in the first place often have to back their L/C with cash collateral from day one. If any of these companies deposit cash with a Silicon Valley bank or undersigned bank, the deposit should be treated like any other deposit. If all deposits in the two banks appear to be covered by deposit insurance, tenants should be able to manage their cash fairly quickly. The tenant can use that cash as collateral to have another institution issue her L/C. Faster than setting up a new revolver, but still not immediately.
If a tenant provides a new L/C in lieu of an L/C from a failed bank, the tenant will usually ask the property owner to release the original L/C. This should be done at the same time tenants move cash between banks.
Owners of Silicon Valley Bank or Signature Bank L/Cs must know exactly where their L/Cs are kept. If no one can find it (which happens with some frequency), it can lead to a whole new set of problems. Also, today’s attention to her L/C reminds every property owner that all his L/Cs need to be tracked carefully. Track not only location, but also amount, expiration date, and issuer.
