Commercial Lease Letter of Credit vs Cash Security Deposit: Complete Tenant Guide

Q: What is the difference between a letter of credit and a cash security deposit in a commercial lease?

A cash security deposit is money the tenant pays directly to the landlord (or a designated escrow account) that the landlord holds — and can access — during the lease term. The tenant loses the use of that capital for the entire deposit period, earning no return on it unless the lease specifies an interest-bearing escrow. A letter of credit (LC) is a bank instrument — the tenant's bank issues an unconditional guarantee to pay the landlord a specified amount on demand, but the tenant's actual cash remains under the tenant's control (either as collateral in a restricted account or as part of the tenant's general operating capital if the LC is unsecured). The key practical differences: cash deposits are immediately accessible to the landlord; LC draws require a formal demand to the issuing bank; and cash deposits have a significant opportunity cost that LCs can eliminate or reduce.

Q: What is a standby letter of credit (ILOC) in a commercial lease?

A standby letter of credit (also called an ILOC — Irrevocable Letter of Credit) is a bank instrument in which the issuing bank unconditionally agrees to pay the named beneficiary (the landlord) a specified dollar amount upon presentation of a conforming draw demand — typically a sight draft accompanied by a landlord certification that the tenant is in default. 'Standby' refers to the fact that the LC is not the primary payment mechanism (rent is the primary mechanism) — it stands by to be drawn upon only if the tenant defaults. 'Irrevocable' means the bank cannot cancel or modify the LC without the beneficiary's (landlord's) consent. Once issued, the bank is unconditionally obligated to honor conforming draw demands regardless of any dispute between the landlord and tenant.

Q: What is a burn-down schedule for a letter of credit in a commercial lease?

A burn-down schedule is a lease provision that automatically reduces the required LC amount at defined intervals — typically annually — as the tenant demonstrates satisfactory lease performance (no defaults, timely rent payments). A $150,000 LC on a 5-year lease might burn down to $120,000 after year 1 (no defaults), to $90,000 after year 2, to $60,000 after year 3, and to $30,000 after year 4 — providing progressively less security as the landlord's risk decreases over the lease term. Burn-down schedules are the most important deposit-related negotiating point for tenants: they reduce ongoing LC fee costs, free up bank credit capacity, and align the deposit amount with the landlord's actual remaining credit risk.

Q: Can a landlord draw on a letter of credit without giving the tenant notice?

This depends entirely on how the LC draw conditions are structured. A no-cure draw right allows the landlord to draw on the LC at any time after a default occurs, without giving the tenant an opportunity to cure — sometimes even without providing notice of the draw beforehand. A cure-conditioned draw right requires the landlord to provide the tenant with notice of the default and allow the standard lease cure period to expire before making an LC draw. No-cure draw rights are common in LC-based deposits because the LC is a separate instrument from the lease — the bank has no obligation to adjudicate lease disputes and must simply pay conforming draws. Tenants should negotiate for a cure notice requirement as a condition of any LC draw, separate from the bank's independent LC draw obligation.

Q: What happens to a letter of credit when a commercial lease is assigned?

What happens to an LC on assignment depends on the LC structure and the assignment terms. Most LCs are issued to a named beneficiary (the original landlord); if the building is sold or the landlord assigns its interest, the LC must be formally transferred (assigned) to the new landlord — which requires the issuing bank's consent and may require a new LC application or amendment. Similarly, if the tenant assigns the lease (sublease or full assignment), the assignee must typically provide a replacement LC or credit enhancement acceptable to the landlord. Common assignment pitfall: the original LC remains outstanding in the name of the original landlord after a building sale, with no automatic transfer mechanism. The tenant should negotiate a clear LC transfer protocol that covers both landlord and tenant assignment scenarios.

Q: What is an evergreen letter of credit in a commercial lease?

An evergreen LC is one that automatically renews for successive one-year periods unless the issuing bank provides notice of non-renewal (typically 30–90 days before expiration). Evergreen provisions are standard in commercial lease LCs because the lease term typically spans multiple years — the LC needs to remain valid throughout the lease term without the tenant needing to manually renew it each year. The alternative is a non-evergreen LC, which expires on a specified date and must be actively renewed by the tenant. Non-evergreen LCs create default risk: if the tenant fails to renew before expiration (even through administrative oversight), the landlord may have the right to draw the full LC amount as a 'failure to maintain security deposit.' Most leases give the landlord the right to draw the LC amount immediately if the tenant fails to renew an expiring non-evergreen LC within a defined deadline (often 30 days before expiration).

Cash Security Deposit vs. Letter of Credit: The Core Difference

How Cash Security Deposits Work

A cash security deposit is exactly what it sounds like: the tenant writes a check to the landlord at lease execution, and the landlord holds that cash — either in their operating account or in a separate escrow — for the duration of the lease. At the end of the lease, the landlord either returns the deposit (less any legitimate deductions for unpaid rent, cleaning, or repairs beyond normal wear and tear) or applies it against amounts the tenant owes.

From a tenant's perspective, cash deposits have one overwhelming disadvantage: you lose the use of that capital for the entire deposit term. A $150,000 cash deposit means $150,000 that isn't generating revenue in your business, isn't invested in growth, and isn't earning a market return. That opportunity cost is real and compounding.

Cash deposits also create a credit risk problem in the opposite direction from what most tenants think about: if the landlord gets into financial trouble, holds the cash deposit in their operating account (not a segregated escrow), and then files for bankruptcy, the tenant may be an unsecured creditor trying to recover their deposit from a landlord who has no assets. The tenant's cash is gone.

How Letters of Credit Work

A standby letter of credit (LC) is a bank instrument — not a cash payment. Here's how it works:

The tenant applies for an LC from their bank (or another financial institution)
The bank issues the LC in favor of the landlord (the "beneficiary")
The LC states that if the landlord presents a conforming draw demand (typically: a sight draft + certification that the tenant is in default), the bank will pay the face amount to the landlord unconditionally
The landlord receives the LC document, which is the equivalent of a bank guarantee
The tenant pays the bank an annual LC fee (typically 0.75%–2% of the face amount) but retains their cash

The critical distinction: the bank — not the tenant — is on the hook to pay the landlord. The tenant's obligation is to maintain the LC in good standing (by paying the annual fee and renewing before expiration). The landlord gets effectively the same security as cash — a guaranteed payment source — but the tenant keeps their capital working.

The Real Math: Opportunity Cost of Cash vs. LC Fees

Cash Deposit vs. Letter of Credit: 5-Year Cost Comparison on $150,000

SCENARIO: $150,000 security deposit, 5-year lease

OPTION A: CASH SECURITY DEPOSIT
Cash paid to landlord at signing: $150,000
Cash returned at lease expiration: $150,000
Nominal cost to tenant: $0

But: opportunity cost of $150K for 5 years
Conservative yield (S&P 500 index, 7%/yr): $150K × [(1.07^5 - 1)] = $60,765
Moderate yield (business investment, 5%/yr): $150K × [(1.05^5 - 1)] = $41,442
Risk-free yield (T-bills ~5% 2026): $150K × 5% × 5yr = $37,500

Real cost of cash deposit (risk-free basis): $37,500 over 5 years
Real cost of cash deposit (invested basis): $41,442 – $60,765 over 5 years

OPTION B: STANDBY LETTER OF CREDIT
Annual LC fee (1% of $150K): $1,500/year
5-year total LC fees: $7,500

Annual LC fee (2% of $150K — riskier credits): $3,000/year
5-year total LC fees (2%): $15,000

Cash retained (earning 5%/yr T-bill): $150K → $191,442 after 5yr
Net return on retained cash (minus LC fees): $41,442 – $7,500 = $33,942 gain
Net return (2% LC fees): $41,442 – $15,000 = $26,442 gain

BREAK-EVEN ANALYSIS:
LC is cheaper than cash deposit when:
Annual LC fee < Opportunity cost of deposited capital
1% LC on $150K = $1,500/yr vs. $8,288/yr opportunity cost at 5.5%

WINNER: Letter of Credit — by $22,000–$30,000 over 5 years
(assuming tenant can deploy cash at 5%+ return)

When Cash Deposits Make Sense

Cash deposits are appropriate when:

The deposit amount is small enough that LC fees are proportionally expensive (generally under $25,000)
The tenant lacks a banking relationship to obtain an LC
The lease requires interest to be paid on the cash deposit (rare, but makes cash more competitive)
The landlord holds the cash in a segregated, FDIC-insured escrow that protects the tenant against landlord insolvency
The tenant's business would earn less than 2% on their cash (in which case LC fees may exceed the opportunity cost)

Standby LC Mechanics: What Every Tenant Needs to Know

LC Issuer Requirements

Landlords don't accept LCs from just any bank. Most commercial leases specify minimum issuer requirements for the tenant's LC:

Requirement Type	Typical Market Standard	What It Means for Tenants
Minimum credit rating	A- (S&P) or A3 (Moody's) or better	Community banks, credit unions often excluded — must use a major bank
Minimum assets	$1B+ in total assets (common)	Regional bank may qualify; small local bank may not
FDIC membership	Usually required	Standard for US banks; US branch of foreign bank may require additional approval
Approved bank list	Landlord provides list of approved issuers	Tenant may need to establish relationship with an approved bank
ISP98 or UCP600	ISP98 (standby) or UCP600 (documentary)	LC must specify governing rules — ISP98 is standard for standby LCs

Practical implication: if you currently bank with a small community bank or credit union, you may need to open a relationship with a major money center bank (JPMorgan Chase, Bank of America, Wells Fargo, Citibank) or a large regional bank to obtain an acceptable LC for a major commercial landlord.

LC Draw Mechanics: Cure vs. No-Cure Draw Rights

The most contested provision in any LC-based security deposit is the landlord's draw right — specifically, whether the landlord must give the tenant notice and an opportunity to cure before drawing on the LC.

There are two structures:

✓ Cure-Conditioned Draw Right (Tenant-Favorable)

The landlord must: (1) provide the tenant with written notice of the alleged default; (2) allow the applicable cure period specified in the lease to expire; and (3) only then present a draw demand to the bank. This structure gives the tenant the opportunity to cure the default before losing the LC proceeds and protects against wrongful draws on disputed defaults. The landlord is separately constrained by the lease cure mechanism even though the bank itself has no obligation to check.

No-Cure Draw Right (Landlord-Favorable / Common): The landlord can draw on the LC at any time after an alleged default, without first giving the tenant notice or an opportunity to cure. The bank must honor the draw if the paperwork conforms — regardless of any dispute between landlord and tenant about whether a default actually occurred. Tenants have no practical recourse against the bank draw itself; their only remedy is a lawsuit against the landlord for wrongful draw (which they must litigate after the money is already gone).

The critical insight: because the LC is a separate instrument from the lease, the bank's obligation is purely documentary — does the draw demand conform to the LC's specified requirements? The bank does not and cannot adjudicate whether a default actually occurred. Even if the landlord's default allegation is factually wrong, the bank will honor a properly formatted draw demand. This is why cure-conditioned draw rights in the lease (even though they don't bind the bank) are still important: they give the tenant a contractual breach claim against the landlord for any draw made before the cure period expires.

Evergreen vs. Non-Evergreen Letters of Credit

Commercial lease LCs must remain valid for the entire lease term plus a return period. This creates a durational challenge: banks typically issue LCs with one-year terms. Two structures address this:

Evergreen LC: Automatically renews for successive one-year periods unless the bank provides non-renewal notice (typically 60–90 days before expiration). The tenant doesn't need to actively renew — it rolls over automatically. If the bank decides to non-renew (a rare event, typically triggered by the tenant's deteriorating creditworthiness), the LC beneficiary (landlord) receives advance notice and has the right to draw the full LC amount before expiration if the tenant doesn't substitute a replacement LC within a specified period.
Non-Evergreen LC: Expires on a specific date. The tenant must actively apply for and deliver a replacement LC before each expiration. Failure to renew — even through administrative oversight — typically gives the landlord the immediate right to draw the full LC amount as a "failure to maintain security deposit." Non-evergreen LCs create default exposure that has nothing to do with rent payment or lease compliance.

Always use evergreen LCs for commercial leases. If the landlord's form documents specify non-evergreen, negotiate to add evergreen language — it's a standard LC structure and any bank can accommodate it.

Burn-Down Schedule: $150,000 LC on 5-Year Lease (No Defaults)

Year 1: $150,000 — full deposit (high landlord risk period)
Year 2: $120,000 — 20% reduction after 12 months no default
Year 3: $90,000 — additional 20% reduction
Year 4: $60,000 — additional 20% reduction
Year 5: $30,000 — reduced to 1 month's equivalent

LC FEE SAVINGS FROM BURN-DOWN (at 1% annual fee):
Without burn-down: $1,500/yr × 5yr = $7,500 total fees
With burn-down:
Year 1: $150K × 1% = $1,500
Year 2: $120K × 1% = $1,200
Year 3: $90K × 1% = $ 900
Year 4: $60K × 1% = $ 600
Year 5: $30K × 1% = $ 300
Total with burn-down: $4,500

SAVINGS FROM BURN-DOWN: $3,000 over 5 years
Plus: reduced bank collateral requirement
Plus: improved business credit availability

CONDITIONS FOR BURN-DOWN (typical):
- No event of default at the reduction date
- Tenant not in bankruptcy proceedings
- All rent paid on time for preceding 12 months
- Reduction is automatic — no landlord approval needed

Burn-Down Schedule Negotiation Strategy

Structuring the Burn-Down

Burn-down schedules are the most tenant-favorable deposit negotiating point and are widely accepted by sophisticated landlords — particularly in markets with strong tenant demand. Key negotiating parameters:

First reduction date: When does the first burn-down occur? The sooner the better for tenants. Aim for annual reductions starting at the end of year 1
Reduction amount: How much does the deposit decrease at each reduction event? 20–25% annual reductions on an initial 5-year deposit are common and reasonable
Conditions for reduction: What does the tenant need to demonstrate to trigger the reduction? Typically: no uncured material default during the preceding 12 months and all base rent paid by the due date (without late fees). Avoid conditions that require landlord affirmative approval — automatic reductions are better than discretionary ones
Floor amount: What is the minimum deposit that cannot be further burned down? Some landlords require a minimum floor (e.g., one month's base rent) that is never reduced. Negotiate the floor as low as possible (ideally zero at lease expiration)
Reinstatement on default: If a default occurs after a reduction has been triggered, does the deposit reinstate to the original amount? Most landlords require reinstatement — which means the tenant must replenish the LC to the original (pre-reduction) level after any default is cured. Negotiate to limit reinstatement to the default amount actually drawn, not a full reinstatement to the original LC amount

What Happens to the LC on Assignment

LC assignment mechanics are frequently overlooked but critically important:

When the building is sold (landlord assignment): The original LC names the original landlord as beneficiary. When the landlord sells the building, the new owner needs to be substituted as beneficiary — otherwise they cannot draw the LC if the tenant defaults. Most leases require the tenant to cooperate in transferring the LC to a new landlord, but the mechanics must be spelled out: who bears the bank transfer fee? What happens if the bank won't consent to transfer? The lease should provide a clear protocol: (1) landlord provides notice of impending sale, (2) tenant obtains an amendment from the bank substituting the new owner as beneficiary, (3) original LC is cancelled upon confirmation of the amended LC, with no gap in security.

When the tenant assigns the lease: The assignee must provide a replacement LC (or cash deposit) acceptable to the landlord as a condition of assignment consent. The original tenant's LC is typically returned only after the assignee's replacement security has been delivered and confirmed. Tenants negotiating their original lease should confirm that LC transfer mechanics don't create an unreasonable barrier to permitted assignments.

6 Red Flags in Security Deposit and LC Provisions

🛑 Red Flag 1: No Burn-Down Schedule — Full Deposit Required for Entire Term

A lease that requires the full initial deposit amount (whether cash or LC) to be maintained throughout the entire lease term with no reduction — regardless of the tenant's perfect payment history — is economically punitive for long-term tenants. The landlord's credit risk is highest in year 1 when the tenant is unproven; by year 4 of a 5-year lease with a perfect payment record, the landlord's credit risk has been substantially reduced. A no-burn-down requirement forces the tenant to subsidize the landlord's risk position indefinitely. Always push for annual burn-down tied to no-default performance.

🛑 Red Flag 2: No-Cure Draw Right with Broad Default Definition

When a no-cure draw right is combined with a broad default definition (including technical defaults, non-monetary defaults, or breaches that have occurred but are still within the cure period), the landlord can draw the LC based on a disputed or curable default without giving the tenant any opportunity to fix the problem. The tenant's money is gone before they even know it's under threat. If the landlord insists on a no-cure draw right, negotiate at minimum to require the landlord to provide simultaneous written notice to the tenant at the time the draw demand is presented to the bank — so the tenant knows immediately and can seek emergency injunctive relief if the draw is improper.

🛑 Red Flag 3: Non-Evergreen LC With Short Renewal Window

A non-evergreen LC with a 30-day pre-expiration renewal deadline means the tenant must successfully deliver a new LC to the landlord within 30 days before each annual expiration — or the landlord can draw the full amount as a "failure to maintain security." Bank LC renewal processing times can take 2–3 weeks; mailing delays, address errors, or administrative oversights can push a renewal past the deadline. Any lease that requires non-evergreen LCs should at minimum provide a 10-business-day cure period after landlord notice of non-renewal before the landlord can draw — allowing the tenant to substitute a replacement LC without losing the deposit over an administrative delay.

🛑 Red Flag 4: Cash Deposit Held in Landlord's Operating Account (Not Segregated Escrow)

When a landlord holds a cash security deposit in their operating account — not a separately designated, FDIC-insured escrow account — the tenant's deposit is commingled with the landlord's other funds. If the landlord files for bankruptcy, the deposit may be part of the bankruptcy estate, with the tenant as an unsecured creditor with little hope of recovery. Many commercial leases don't require segregated escrow as a matter of default. If you're paying a large cash deposit, require the lease to specify that the deposit is held in a federally insured, interest-bearing segregated account in the tenant's name, and that the tenant's interest in the deposit is acknowledged and protected against the landlord's creditors.

🛑 Red Flag 5: Full Reinstatement Requirement After Any Default

Some leases require that if a default occurs and any portion of the LC is drawn, the tenant must reinstate the LC to its full original amount (not the pre-default, post-burn-down amount) within 30 days. If a tenant had burned down a $150,000 LC to $60,000 over three years of perfect performance and then experienced a single default resulting in a $10,000 draw, a full reinstatement requirement could force the tenant to restore the LC to $150,000 — effectively eliminating all the burn-down benefit for a single incident. Negotiate reinstatement to the drawn amount only: if $10,000 was drawn, restore $10,000, not the original $150,000.

🛑 Red Flag 6: No LC Transfer Mechanism on Building Sale

A lease that requires the tenant to cooperate in LC transfer on building sale but doesn't specify a timeline, cost allocation, or protocol for the transfer creates execution risk. If the landlord sells the building and the tenant's LC still names the original (now former) landlord as beneficiary, the new owner cannot draw the LC if the tenant defaults — and the landlord may have breached their obligation to the new owner by failing to transfer the security. More practically: if the tenant has an obligation to cooperate in the LC transfer but no defined timeline or consequence for failure, the mechanics can get complicated. Negotiate a specific 30-day LC transfer protocol with clear cost allocation (bank transfer fees typically $500–$1,500 should be landlord's cost on a building sale).

✅ 12-Item Security Deposit and LC Negotiation Checklist

Negotiate letter of credit instead of cash deposit for any deposit over $50,000: The annual LC fee (0.75%–2%) almost always costs less than the opportunity cost of tying up capital — especially for tenants who can deploy cash productively in their business
Negotiate a burn-down schedule with annual reductions tied to no-default performance: Aim for 20–25% annual reductions starting at month 12, with the deposit fully eliminated or reduced to a nominal floor by the final year of the lease
Specify an evergreen LC structure: The LC should automatically renew annually unless the bank provides 60–90 day non-renewal notice — eliminating manual renewal risk and administrative default exposure
Negotiate a cure-conditioned draw right or at minimum a simultaneous-notice requirement: The landlord should be required to give notice of default and allow the cure period to expire before drawing on the LC — preventing draws on curable or disputed defaults
Confirm acceptable LC issuer requirements match your banking relationships: Know before lease negotiation whether your bank qualifies — if not, identify an acceptable bank and establish the relationship before lease execution so you're not scrambling at signing
Require the LC to be governed by ISP98 (standby LC rules): This ensures the LC is subject to internationally recognized standby letter of credit practices that protect against ambiguous draw demand requirements
Negotiate reinstatement to drawn amount only (not full original amount): If the LC is drawn due to a default, the tenant should be required to restore only the drawn amount — not reinstate the LC to its original pre-burn-down level
Include a clear LC transfer protocol for building sales: Define the timeline (30 days), cost allocation (landlord bears bank transfer fees on building sale), and the substitution mechanics so LC transfer is not a barrier to building transactions
For cash deposits, require segregated FDIC-insured escrow: If the landlord insists on cash, require a separately designated, FDIC-insured escrow account in the tenant's name — not the landlord's operating account
Require LC to remain valid through a defined return period after lease expiration: The LC should remain valid for 60–90 days after the lease expiration date to cover the landlord's deduction calculation period — after which it must be returned or allowed to expire
Address what happens to the LC on permitted sublease or assignment: Clarify whether the original LC continues, is transferred to the assignee, or must be replaced — and define the timeline for any required replacement
Confirm the burn-down reduction is automatic — not subject to landlord approval: Burn-down provisions that require affirmative landlord approval are weaker than automatic reductions because the landlord can condition or delay the reduction; automatic reductions triggered by the passage of time plus the absence of default are more reliable

LC vs. Cash Security Deposit: At-a-Glance Comparison

Feature	Cash Security Deposit	Letter of Credit
Tenant capital required	Full amount, upfront	Collateral (may be none if unsecured LC)
Opportunity cost	High ($37.5K+ on $150K over 5yr)	Low (1–2% annual fee)
Landlord access speed	Immediate (already held)	1–5 business days (bank draw)
Landlord insolvency risk	Tenant at risk if not in escrow	Tenant protected (bank holds)
Interest earned by tenant	Only if lease requires escrow	Tenant keeps the cash + earnings
Burn-down availability	Yes (proportional cash return)	Yes (LC face amount reduction)
Complexity	Low	Higher (bank relationship required)
Better for tenants when	Small deposit (<$25K); no bank relationship	Any deposit >$50K; good banking relationship

Frequently Asked Questions

What is the difference between a letter of credit and a cash security deposit in a commercial lease?

A cash security deposit is money the tenant pays to the landlord at lease signing — the landlord holds the cash and can access it if the tenant defaults. A letter of credit is a bank instrument where the bank (not the tenant) guarantees payment to the landlord on demand. The key financial difference: with a cash deposit, the tenant loses the use of their capital for the entire lease term, incurring real opportunity costs. A $150,000 cash deposit at a 5% opportunity cost loses $37,500 over 5 years. The same deposit via standby LC costs roughly $1,500–$3,000/year in bank fees — typically $7,500–$15,000 total — while the tenant's cash remains working in their business.

What is a standby letter of credit (ILOC) in a commercial lease?

A standby (irrevocable) letter of credit is a bank instrument in which the issuing bank unconditionally promises to pay the landlord (the beneficiary) a specified face amount upon presentation of a conforming draw demand — typically a sight draft plus a certification that the tenant is in default. The bank's obligation is purely documentary: if the paperwork conforms, the bank pays. The bank does not adjudicate whether a default actually occurred or investigate the landlord-tenant dispute. This unconditional nature is why landlords accept LCs as cash-equivalent security — the payment is guaranteed, not contingent on winning a dispute with the tenant. "Irrevocable" means the bank cannot cancel or modify the LC without the landlord's consent.

What is a burn-down schedule for a letter of credit in a commercial lease?

A burn-down schedule automatically reduces the required LC face amount at defined intervals as the tenant demonstrates satisfactory performance. A typical burn-down on a $150,000 LC over 5 years: $120,000 after year 1 (no defaults), $90,000 after year 2, $60,000 after year 3, $30,000 after year 4. Conditions for each reduction typically include: no uncured material default during the preceding 12 months, all base rent paid on time. Burn-down saves on annual LC fees (from $7,500 to $4,500 over 5 years on a 1% fee structure) and reduces the bank collateral requirement and credit capacity consumed by the LC. It's the most valuable deposit negotiating point for tenants with strong payment performance.

Can a landlord draw on a letter of credit without giving the tenant notice?

It depends on how the draw conditions are written in the lease. A no-cure draw right allows the landlord to draw on the LC immediately after a default occurs, without providing notice or allowing a cure period. The bank must honor conforming draw demands regardless of any landlord-tenant dispute. A cure-conditioned draw right in the lease requires the landlord to provide the tenant with default notice and wait for the cure period to expire before drawing. Even with cure-conditioned draw rights in the lease, the bank itself has no obligation to enforce lease terms — it will honor any conforming demand. The cure condition binds the landlord contractually and creates a wrongful draw claim if violated, but doesn't physically prevent the bank from paying a conforming demand.

What happens to a letter of credit when a commercial lease is assigned?

When a tenant assigns their lease to an assignee, the original LC must typically be replaced by the assignee's LC (or cash) as a condition of assignment consent. The original tenant's LC is returned when the replacement security is confirmed. When the building is sold (landlord assignment), the LC must be transferred to the new owner — which requires a formal bank amendment substituting the new owner as beneficiary. Without a clear transfer protocol in the lease, LC transfers can create gaps in security coverage that complicate building sales. Negotiate a specific 30-day LC transfer procedure with cost allocation (transfer fees on building sale should be landlord's cost) and mechanics for substitution to avoid ambiguity.

What is an evergreen letter of credit in a commercial lease?

An evergreen LC automatically renews for successive one-year periods unless the issuing bank provides advance non-renewal notice (typically 60–90 days before expiration). It's the standard structure for commercial lease LCs because the lease term spans multiple years — and the LC must remain valid throughout. The alternative, a non-evergreen LC, expires on a specific date and must be actively renewed each year. Non-evergreen LCs create administrative default risk: if the tenant fails to renew before expiration (even through oversight), the landlord typically has the right to draw the full LC amount as a "failure to maintain security deposit." Always use evergreen LCs in commercial leases, and confirm the non-renewal notice period (typically 60–90 days) gives adequate time to obtain a substitute LC before the current one expires.

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Commercial Lease Letter of Credit vs Cash Security Deposit: Complete Tenant Guide 2026