Please picture this scenario –

Company A owns a large piece of land and it leases it to Company B in order for Company B to build a factory thereon, and to run its business therefrom. Companies A and B enter into a 30-year lease agreement in terms of which Company A allows Company B to develop the piece of land to suit its business needs. The parties agree to register the lease in the Deeds Office and it gets duly registered. In order for Company B to develop the piece of land, it requires finance from a financial institution to do so. Company B approaches a financial institution which is prepared to provide finance provided that Company B  passes a mortgage bond over its leasehold right registered over the piece of land belonging to Company A, in its favour. Is this allowed in law?

Put differently – Can a lessee put up its rights, title and interest in and to a lease as security for its indebtedness to a financial institution?

Yes, it can. This is so because :-

1. The Deeds Registries Act 47 of 1937 defines immovable property to include “any registered lease of land which, when entered into, was for a period of not less than 10 (ten) years or for the natural life of the lessee or any other person mentioned in the lease, or which is renewable from time to time at the will of the lessee indefinitely or for periods which together with the first period amount in all to not less than ten years”.
2. Mortgage bond means a bond attested by the registrar specially hypothecating immovable property. Effectively, and in essence therefore, a long-term registered lease becomes immovable property when it is registered in the Deeds Office. This makes it possible to register a mortgage bond over the leasehold rights. Please note that it is not Company A’s piece of land over which the mortgage bond is registered but rather the leasehold rights held by Company B registered over the piece of land owned by Company A.

In order for the financial institutions to protect their rights and security after granting loans where the leasehold rights are put up as security, the financial institutions insist on the conclusion of tripartite agreements between themselves, the lessors (owners of the land) and the lessees (tenants / borrowers).

The broad terms of such tripartite agreements are :-

1. The lease cannot be cancelled without the financial institution’s written consent, and that before the lease is cancelled, the financial institution must be notified of the default by the tenant.
2. In the event of the lease  being cancelled, that it (the financial institution) be given an option to lease the property and have the right to cede the option to lease rights to third parties.
3. The lessor agrees to consent to the cession of the lease to a third party should it (the financial institution) be forced to either sequestrate the tenant or foreclose on the bond.
4. The leased area cannot be sold without its (the financial institution’s) consent to the sale.

What are the lessons learnt?

1. Leasehold rights can be bonded. This is good for our economy in that those tenants who want to develop leased land can do so on borrowed finance. Naturally, the lease period must be 10 years or more, and such a lease must be registered in the Deeds Office.
2. For a bond to be registered, this requires the co-operation of three parties, namely, the financial institution, the lessor and the lessee.

Should you require property law related advice, please contact me, Sifiso Msomi on 031 575 7113 / msomi@wylie.co.za.