Your Landlord Is In Foreclosure-As A Tenant, Should You Be Worried?

Several years ago during the bustling real estate market you found the perfect space to lease in a brand new building or shopping center. You spent time negotiating the basic terms of the lease, such as the lease term, Base Rent, CAM (and its components) and tenant improvement costs, but you likely glossed over the "boilerplate" provisions before you signed the lease. Then the economy, and the real estate market in particular, took a turn for the worse, and you've discovered that your landlord's lender is preparing to foreclose on your landlord's property. Now you're thinking: What's going to happen to us and our lease; can we stay or will we need to find new space; will our lease continue after foreclosure, under the same or different terms? Where do you look to seek answers to these questions? Remember those "boilerplate" provisions you glossed over when your lease was signed? That's the place to start.

The first and most important question you need to ask is whether your lease is subordinate to the landlord's mortgage, or whether the mortgage is subordinate to your lease. In other words, does your lease or the landlord's mortgage have priority? This is important because if a lease by its terms is subordinate to a landlord's mortgage, a so-call "junior lease", the lease can be terminated by a lender as part of a lender's foreclosure action, even if you, as a tenant, want to remain in possession of the space and are willing to continue paying rent and abide by all of the other terms of the lease.

Absent a written understanding with a landlord and its lender provided in the lease or by separate agreement, the question of whether the lease or the mortgage has priority over the other usually hinges on the general rule of "first-in-time, first-in-right", or even more basically, whichever happened first has priority. Of course, there are exceptions to the general rule based on the unique facts of each case, and it should be noted that states vary in their treatment of how a particular set of facts may affect priority.

The general rule cited above does not apply in the case where the lease specifies a tenant's rights vis-a-vis the landlord's lender. Leases often contain a provision stating that the lease is automatically subordinate to all existing and future mortgages on the property. For instance, a lease may provide as follows:

"This Lease, and Tenant's rights hereunder shall be subject and subordinate to the lien of any mortgages or deeds of trust or other similar instruments that may now exist or may hereafter be placed on the premises and all renewals, replacements, and extensions thereof without further notice or action on the part of Landlord or Tenant."

This provision makes it clear that the lease is subordinate to mortgages which exist on the property before or after the lease becomes effective. In this instance, it doesn't matter

whether the landlord's mortgage became effective before or after the lease, because the tenant has agreed that any mortgagee of the landlord has priority over the tenant's lease rights.

In the event a tenant is confronted with a lease containing the subordination provisions described above, it could seek to protect itself by insisting that the landlord include a "non-disturbance" provision in the lease, such as:

"With respect to any mortgages entered into by Landlord after the execution of this Lease, the subordination of this Lease shall be subject to and conditioned upon Landlord's mortgagee agreeing that Tenant's possession of the premises will not be disturbed so long as Tenant is not in default hereunder and attorns to the record owner of Landlord's property."

This non-disturbance language will not apply to prior mortgages on the landlord's property because one could not alter the mortgagee's natural priority (first in time, first in right) without the mortgage holder's consent or agreement. But it would provide a tenant with the benefit of knowing that future mortgagees of the landlord would respect the tenant's leasehold rights.

Even though a lease may contain subordination language, as described above, for lenders, it's usually not enough. Lenders, as a condition to making a loan to a landlord, often require the landlord's tenants to directly enter into a separate written agreement with the lender to establish and/or confirm that the lender's mortgage has priority over a tenant's lease. These separate written agreements take the form of a Subordination, Non-Disturbance and Attornment Agreement or "SNDA" for short. As the name of the document indicates, an SNDA is three different agreements rolled-up into a single document. A landlord's lender's form of SNDA generally covers the following main legal concepts:

  1. Subordination: The tenant agrees that its rights under the lease are subordinate to the lien of the mortgage of the lender.
  2. Non-Disturbance: The lender agrees that so long as the tenant is not in default under the lease, the lender will not terminate the lease if it forecloses on the property.
  3. Attornment: The tenant agrees that it will accept the lender or other purchaser at the foreclosure sale as its new landlord.

The SNDA gives the landlord's lender assurance that the tenant's rights under its lease are expressly subordinate to the lender's mortgage lien. The good news is that SNDAs are a two-way street. Even though an SNDA may place some restrictions on the landlord's ability to modify an existing lease without the lender's approval, the tenant has the comfort of knowing that the lender and its successors will honor the tenant's right under the lease assuming the tenant remains in compliance with the lease terms. In addition, a tenant, especially one that will occupy a significant portion of the landlord's property, may insist that the landlord obtain an SNDA from the landlord's existing (and future) lender to the effect that the tenant's right to continue under its lease will not be disturbed by the lender so long as the tenant is not in default under the terms of its lease. This is the ultimate form of protection for a tenant, because both the landlord and the landlord's mortgagee have agreed not to interfere with the tenant's rights under the lease, and the general rules regarding priority will not apply in a foreclosure proceeding brought by the landlord's mortgage holder.

If you have any questions concerning commercial leases or other real estate matters, please feel free to contact Jay Healy for further information: (630) 655-6000.

Categories: Firm News, Publications