Bar News - November 17, 2006
Business Law: What You Need to Know about Commercial Lease Transaction Agreements
By: Julia A. Schappals
What is “SNDA”? It actually consists of three separate agreements commonly used in commercial lease transactions: the subordination agreement, the non-disturbance agreement, and the attornment agreement. Although there is no legal compulsion to use these agreements, all three are commonly attached to the lease and typically referred to in the singular by the SNDA acronym.
A commercial lender (mortgagee) usually requires the SNDA as a condition to providing a loan to a landlord-mortgagor secured by the leased property. SNDAs protect the interests of such a mortgagee if the landlord-mortgagor defaults on its loan payments and the mortgagee (or its assignee, e.g. a third party purchaser of the property at a foreclosure sale) takes over the property. In this regard, the SNDA protects the commercial value of the property and facilitates the landlord-mortgagor’s ability to obtain additional loan funds using the same property as collateral.
Under the traditional priority rules a recorded mortgage has priority over a subsequent recorded lease, unless the parties otherwise agree. Foreclosure of that mortgage would terminate the lease thus allowing a tenant to vacate before the lease expiration date and leaving the premises without a rent revenue stream. Because the value of commercial property is frequently dependent on this rental income stream, a mortgagee wants to assure that if a foreclosure ensues, the paying tenant’s lease remains in effect, thus making the property attractive to foreclosure buyers. On the other hand, a mortgagee does not want to be stuck with a problem tenant who defaults in its lease obligations.
The mortgagee has no privity with the tenant under a lease and therefore can’t prevent a tenant from leaving if a lease terminates upon foreclosure. Most commercial mortgagees therefore condition loans to a landlord-mortgagor upon the tenant executing agreements assuring that if foreclosure occurs and the tenant is not in default of its lease, (a) the priorities of the mortgage and lease are changed so the lease has priority over the mortgage and thus is not terminated (subordination) and (b) the tenant will recognize the mortgagee or third party purchaser of the property as the new landlord (attornment). The attornment agreement has been held to be a third party beneficiary agreement enforceable by a subsequent purchaser at a foreclosure sale.
In return for the subordination and attornment agreements, the savvy tenant requires the mortgagee to agree that so long as the tenant is not in default of the lease, the mortgagee (or its assigns) will not disturb or evict (non-disturbance agreement). The non-disturbance agreement is frequently the tenant’s best protection against a new landlord seeking to evict the tenant in order to re-let the property at higher rents.
Negotiating the SNDA
SNDA’s tend to be mortgagee-drafted boilerplate, heavily biased in the mortgagee’s favor. Frequently, the provisions attempt to modify the terms of the original lease in order to make the property attractive to a purchaser at a foreclosure sale. Obviously, property is most attractive if the rent stream from the tenant is preserved and the new landlord has the fewest obligations, risks or expenditures possible. The mortgagee achieves this objective in the SNDA by shifting back to the tenant many of the risks and obligations of the original landlord.
Many tenants simply execute the SNDA documents without much discussion or requests for changes. If the tenant makes substantial improvements to the property or if moving from the premises could create significant problems for the tenant, careful negotiation of the SNDA should occur to protect the tenant’s interest. Despite the mortgagee’s resistance to modifying its standard form, there are several commonly accepted revisions.
Below is a roadmap to a few of the most frequently negotiated issues concerning the SNDA:
- • Subordination Condition: The tenant is usually required to subordinate the lease to present and future mortgages. The tenant should condition the subordination upon the landlord’s obligation to secure a non-disturbance agreement from existing and future mortgagees. The “quiet enjoyment” provision of the lease is not an acceptable substitute. Ideally, in the case of existing mortgages, the tenant should have the right to cancel the lease (or delay the commencement date) without cost if the landlord fails to provide the non-disturbance agreement within a specified period.
- • Landlord’s Cure Period: The SNDA often contains a provision which requires the tenant to notify the mortgagee of any landlord default under the lease and provides an additional cure period for the mortgagee. This additional cure period runs sequentially to that of the landlord and is often open-ended, thus preventing or unduly delaying a tenant from terminating a lease for the landlord’s default. The tenant should insist on a provision stating that the tenant will provide written notice of landlord default to the landlord and mortgagee simultaneously but that only the single cure period stated in the lease will apply.
- • Payments Made Directly To Mortgagee: This provision requires the tenant to commence making rent payment directly to the mortgagee upon receipt of mortgagee’s notice that the landlord-mortgagor has defaulted in its loan payment. This raises the obvious problem that the tenant will be in the middle of a fight between the landlord and the mortgagee for the rent payment or become embroiled in problems resulting from a landlord-mortgagor’s bankruptcy. To mitigate this risk, the SNDA may contain the following:
- • (a) a statement to the effect that if the tenant receives such a notice of default, the landlord-mortgagor releases the tenant from any claim arising out of the tenant’s payment directly to the mortgagee. To ensure that the tenant can enforce the release, there should also be a statement that the landlord-mortgagor is a party and signatory to the SNDA. This statement should be in each agreement comprising the SNDA, and;
- • (b) a provision exempting the tenant from tendering payment directly to the mortgagee in the event of landlord-mortgagor bankruptcy.
- • Mortgagee Consent to Lease Termination : Mortgagees often seek a power to veto any voluntary lease termination by the tenant. Although this is frequently the subject of intense negotiation, most mortgagees will eventually agree that the tenant’s termination will be governed by the terms of the tenant’s lease. An acceptable compromise can be reached by the tenant agreeing to provide notice to the mortgagee of the tenant’s election to terminate the lease.
- • Insurance Proceeds/Condemnation Awards: If the tenant has made improvements to the property at the tenant’s expense, subordinating the lease to a mortgage may adversely affect the tenant’s recovery of insurance proceeds and condemnation awards. The tenant should insist that the lease terms govern in these situations.
- · “Cleaning Up The Lease”: This term refers to provisions in the SNDA which attempt to alter the original lease terms to make the property more attractive to a buyer (who thus becomes the new landlord) in the event of a foreclosure sale. The tenant usually has an obligation to cooperate with the landlord in executing the SNDA and cannot simply refuse to consider these changes thus considerable negotiation may occur. Typically, these provisions state that the new landlord:
- (a) “is not subject to any offsets or defenses the tenant may have against the prior landlord.” Mortgagees usually refuse to delete this onerous clause but most will eventually agree to exclude continuing or material defaults, and/or inclusion of the qualification “except as specified in the lease.”
- (b) “is not required to refund any security deposit.” Obviously, the tenant should not have to endure a forfeiture thus an exclusion should be drafted for any deposit (funds given as security for performance or funds from which a landlord may draw in the event of a tenant default) amounts actually remitted prior to executing the SNDA, or any such payments which are “required under the lease”.
- (c) “will not be liable for any prior landlord’s act or omission.” This should be changed to exclude a prior landlord’s continuing or material defaults.
- (d) “is not bound by any advance rent or other payments the tenant paid to any prior landlord.” Most mortgagees will agree to insert the qualifying phrase “except as required under the lease”.
- (e) “is not bound by any prior landlord’s warranty or representation.” It is particularly important to modify this clause if the lease contains landlord warranties concerning compliance with laws and regulations. This can be done by inserting the phrase “except as set forth in the lease” or by carving out particular landlord warranties.
Although the SNDA terms and negotiation may heavily favor the mortgagee’s interests at the expense of the tenant, the system actually works to everyone’s benefit. The tenant who is in compliance with lease obligations doesn’t face eviction risk if the landlord defaults in mortgage payments while the landlord can increase the value of the real estate by using it as collateral for additional financing. The mortgagee can provide funding without risking loss of a revenue stream if the landlord defaults on repayment.
Julia A. Schappals, a solo practitioner of Bedford, was the general counsel of QLogic Corporation and the assistant general counsel of AST Computer. She is an active member of the California and New Hampshire Bars. She can be reached at firstname.lastname@example.org or 603-714-4349.