By all accounts 2010 and 2011 will be particularly difficult years for commercial property owners and mortgage lenders. As businesses react to the economic downturn by downsizing operations and engaging in cost cutting measures, the demand for commercial rental properties continues to decline. Not surprisingly, the number of commercial foreclosures is also steadily increasing and it is anticipated that this trend will continue for the foreseeable future. The resulting reduction in occupancy levels, commercial rental rates and property values will make it increasingly difficult for many property owners to continue to pay their existing mortgages as well as to arrange for new financing to retire maturing loans. Therefore, many owners are entering into leases with terms and conditions which, just a few years ago, would have been unacceptable. Lenders are contemplating the prospect of becoming the landlord. Tenants who have leased in buildings that are later foreclosed properties are discovering either that their lease will be terminated or that a foreclosing lender has a different agenda then a long term property owner.
Determining the continuing rights of existing tenants in foreclosed commercial properties can be complicated. As a general rule, the first in time has superior rights, i.e., a foreclosing lender takes title to the property subject to the terms of existing leases and a tenant who enters into a lease after the recording of the mortgage is subordinate to the terms of that mortgage. In reality, such matters are not always so simple. For example, if the landlord and tenant under a lease which predates the mortgage on the building sign a lease amendment after the recording of the mortgage, it is possible that some rights of the tenant would be superior to those of the lender while other rights are subordinate.
To address these complexities, lenders will often require owner who is seeking the mortgage to sign leases stating that the rights of the tenant under the lease are subordinate to the interests of the lender and that the lender shall have the option in the event of a foreclosure to either allow the leases to remain in effect or to extinguish the leases and the rights of tenants through the foreclosure process. This option preserves maximum flexibility for the lender as it permits the lender to select those leases which it would like to survive the foreclosure and the ability to extinguish the rights of tenants under leases which are not desirable to the lender, such as leases with unfavorable lease terms or which will impose significant expenditures for tenant improvements. While this simplifies matters for the landlord, this situation leaves a tenant with a great deal of uncertainty in the face of a foreclosure because the tenant may lose its rights as a tenant. As such, many tenants with bargaining power will often resist the landlord’s request that the tenant agree to automatically subordinate the tenant’s lease to the landlord’s mortgage.
To alleviate the concerns of each of the parties involved in these types of transactions, it is often in the interest of the landlord, lender and tenant to enter into a subordination, non-disturbance and attornment agreement, or “SNDA” for short. As its name would suggest, the SNDA performs three basic functions: (i) the tenant agrees to subordinate its interest in the lease to the mortgage of the lender, (ii) the lender agrees, that so long as tenant continues to perform its obligations under the lease, that the lender will not disturb the tenant’s continued occupancy in the event of a foreclosure of the property, and (iii) the tenant will agree to “attorn” to the lender, i.e., to recognize the lender as the new landlord, after foreclosure.
The stability offered by the SNDA can provide each of the parties with substantial benefits:
The SNDA is not a new concept in commercial leases. During the recent real estate boom market taking the time and expense to negotiate the agreement did not interest the parties. Property values and rents were rising, underwriting standards for loans were loosened and finding tenants did not present much challenge to building owners. Now that the market has turned and many building owners, tenants and lenders are contemplating the prospects of foreclosure, the parties’ willingness to invest the time and expense of negotiating the SNDA has changed. While it may not be a worthwhile investment of time and legal fees for every lease, especially leases which are short term or are for a very small amount of space in relation to the entire building, the landlord, lender and tenant would be well advised to at least consider the benefits of the SNDA when entering into leases in today’s market.