Matthew J. Swett  - Pepper Hamilton LLP (Pepper Hamilton LLP is a multi-practice law firm with more than 500 lawyers nationally.)

 

An  subordination, non-disturbance and attornment agreement (SNDA) is a three-party agreement between landlord, tenant and landlord’s lender. In summary, a SNDA provides for: (1) the subordination of the tenant’s leasehold rights to the lien of lender’s mortgage (so that the lender can effectively foreclose its mortgage lien in the event of the landlord’s default under its loan); (2) the agreement of the lender not to disturb the tenant’s rights under the lease in the event the lender does in fact foreclose its mortgage lien following the default of the landlord under its loan (thus ensuring the tenant’s leasehold rights will continue following the foreclosure) and (3) the tenant’s agreement to recognize the lender or the successful purchaser at the foreclosure sale as its landlord.

Generally, without an SNDA the tenant has no protection in the event its landlord’s lender forecloses its mortgage lien. The lender’s mortgage lien on a property that exists at the time the landlord enters into a lease with the tenant generally has priority over the tenant’s leasehold interest. And in many instances, the landlord’s standard form of lease may automatically provide that the tenant’s leasehold interest is subordinate to existing (and sometimes even future) mortgage liens. In either case, if the landlord defaults under its mortgage loan and the mortgage lender forecloses its lien, the lender, or the successful purchaser at the foreclosure sale, (we will call the successful purchaser, whether it be lender or someone else, "successor landlord") will be able to terminate the tenant’s lease if there is not an SNDA executed between the parties.

Some people may argue that it is unlikely that a successor landlord would want to terminate existing leases, but there are instances in which it is a real risk. For example, a lease signed during the recent downturn in the real estate market might be at a rental rate that is significantly lower than the market rate will be in just a few years (we can only hope the economy has improved to such a degree). In that instance, a successor landlord who has the right to terminate a lease upon foreclosure may elect to terminate the lease in order to replace it with one that has a higher rental rate, or use that right of termination to leverage a higher rental rate from the existing tenant who signed its lease during the economic downturn at a bargain rental rate. In either case, the tenant will have virtually no leverage and will likely have to agree to the successor landlord’s demands. It is imperative that the tenant seek to obtain an SNDA from the landlord’s existing mortgage lenders in order to protect its leasehold interest in the event an existing lender forecloses its mortgage.

Of course not all tenants will be able to get SNDAs from existing mortgage lenders in all instances. Many factors will come into play, including the relative bargaining strengths of the parties, the particular lender involved, the creditworthiness of the tenant and the landlord, the relationship between the landlord and the lender and the size and importance of the proposed lease transaction. If a lease does not automatically subordinate the leasehold rights to future mortgage liens, the tenant’s leasehold interest will generally be superior to the lien of a future mortgage. In that event, a lender who seeks to make a mortgage lien in the future will likely require a landlord to obtain an SNDA from all existing tenants, which means that existing tenants will have marginally more leverage with respect to future lenders. In some instances, the landlord may not be able to obtain or be unwilling to obtain a SNDA from its current lender, but will agree that the lien of all future mortgage lenders will not be superior to that of the tenant’s leasehold interests in the absence of an SNDA.

A lender’s standard form SNDA contains far more than the three simple provisions outlined above. For instance, a lender’s form SNDA will also provide that the lender is not obligated to complete any construction obligation of the landlord and is likewise not obligated to fund any improvement allowances not paid by the landlord. A lender’s form SNDA will also provide that the lender is not liable for the defaults of the landlord under the lease and that any rights that the tenant may have against the landlord on account of any landlord default cannot be asserted against the lender. In addition, a lender’s form SNDA will provide that no amendment to the lease can be made without the lender’s prior consent and that any amendment made without the lender’s consent will not be enforceable against the lender. Obviously, these provisions could have drastic implications for a tenant if its landlord were to default under its loan and the lender forecloses on the property.

Consider, for example, the following situation. A tenant signs a lease for a new office space in a multi-story building. The landlord agrees to perform certain building improvements, such as upgrades to the building lobby, and agrees to provide the tenant with a tenant improvement allowance so the tenant can improve its space for its intended use. The lease provides that the tenant will have a 90-day period to construct its improvements, following which the tenant has to commence payment of rent. If landlord defaults on its loan and the lender forecloses on the building before the landlord has paid the allowance to the tenant or completed its work on the lobby, then under a standard SNDA, the lender would not be obligated to pay to the tenant the allowance that the landlord owed to the tenant, nor would the lender be obligated to perform the lobby improvements, or even complete them if they were started but not completed. In addition, under the SNDA the tenant is obligated to recognize the lender as its landlord and continue to perform its lease obligations under the lease, such as the payment of rent. This leaves the tenant in an unenviable position of having to perform its obligations while the successor landlord does not have to perform the obligations that the tenant bargained for when it signed the lease.

Thus, while a lender’s standard form SNDA does provide the basic non-disturbance protection a tenant needs, it provides little additional protection. This is where the tenant’s counsel can provide the tenant with some additional protections to address issues such as ongoing landlord defaults, the obligation to complete construction and to provide tenant improvement allowances. Tenants rarely will be fully satisfied with the terms of an SNDA, but a properly negotiated SNDA will provide a tenant additional protections in the event of a foreclosure.

Lastly, the parties, and in particular the tenant, need to remember that almost every SNDA requires that the parties obtain lender’s approval for any amendment to the lease. It is sometimes possible to negotiate the right for landlord and tenant to enter into a non-material lease amendment without the lender’s prior approval, but where the lender’s consent is required it is imperative that the tenant make sure that the consent is obtained. While the landlord should also want to obtain a needed consent, so as to avoid any allegation that it has defaulted under its loan documents by entering into an amendment without prior approval, the real risk is to the tenant if the consent is not obtained. Pursuant to the typical terms of an SNDA, an amendment to a lease made without the lender’s approval will not be binding on the lender. Of course, the only time that the tenant really cares if the lender is bound to a particular lease term (or amendment to a lease term) is if the lender has foreclosed on the property, when it is particularly important that a successor lender be bound.

For example, during this economic downturn many landlords have sought to "blend and extend" their leases. The concept is that the tenant is given some rent relief (free rent, a lower rent or other concession) in exchange for which the tenant agrees to extend the term of the lease. This gives the landlord some stability for a longer term – an important commodity during tough economic terms. However, if after the amendment there is a foreclosure and the parties had not obtained a required lender consent under an SNDA, then the tenant may not be able to enjoy the benefits of its new bargain and could find itself having to pay the old higher rent for a shorter term. Likewise, the tenant and landlord could have entered into a lease amendment to address the landlord’s inability to fund tenant improvements that it was required to fund under the lease to the tenant. For example, the tenant may be granted a year of free rent in consideration for bearing the cost of the tenant improvements on the landlord’s behalf. If there is a foreclosure (which may be likely in cases in which the landlord was having difficulties in funding the tenant improvement costs in the first place), the tenant will want to be sure that the lender approves the amendment granting it the period of free rent.

While this is not intended to be an all-inclusive discussion of all the issues related to SNDAs and the potential resolutions of those issues, it should be clear that the issues surrounding SNDAs are complex. Unlike the lease between a landlord and tenant, an SNDA involves three parties and the three parties do not have the same interests. In fact, a lender negotiates an SNDA assuming it will succeed to the landlord’s interest. Accordingly, it has and will have different interests and a different risk profile than the original landlord. The tenant’s interest throughout the process is consistent; it only wants to enjoy the benefits of its bargain. The landlord generally does not care what the SNDA says, because the SNDA only comes into play when the landlord is no longer in control of the property.

Five years ago when the real estate market and the economy in general was extremely strong, tenants may not have worried about getting an SNDA. In the vast majority of lease transactions the failure to obtain an SNDA or to fully negotiate an SNDA to protect the tenant’s interests, at least to some degree, did not matter, as loan defaults were infrequent (and any loan defaults were easily cured or refinanced). However, over the last few years and even now, the commercial real estate market is not strong, lenders are very conservative and, in many cases, are aggressively enforcing their rights under their loan documents. It is for these reasons that it is so important that tenants consult the Pepper Hamilton Real Estate Practice Group to negotiate their leases and an SNDA to protect their interests under their lease following a foreclosure of the landlord’s mortgage loan.

Matthew J. Swett