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Tenants Beware! Lenders Rewrite Leases Through SNDA Agreements

You have just spent quite some time battling with the landlord to negotiate a lease. Now you are finishing up the last details to finalize the deal. One of those details is a review of a subordination non-disturbance and attornment agreement (SNDA) that has been sent to you by the landlord’s lender. Your main concern, especially if you are representing a tenant who is putting in expensive tenant improvements or expect to build a great deal of “locational good will,” is to preserve the lease in the event the landlord defaults on its loan. You do not want the lender to foreclose on the lease and kick the tenant out of the space.

This article focuses on how the SNDA can have other impacts that are at least as important as a tenant’s concern not to be disturbed in its possession of the premises. This commentary is not intended to be an exhaustive discussion on everything that a tenant should look at when reviewing an SNDA. It offers only a review of some important issues that frequently arise when analyzing a typical SNDA prepared by a lender.

Practitioners, when they request non-disturbance rights from a lender, must be careful to consider the entire document when they review a proposed SNDA. As with any “form” document, you must be prepared for the SNDA to be a one-sided agreement that is heavily in the lender’s favor whenever and wherever possible.

One of the traps is that an SNDA can undo what you have so carefully negotiated with the landlord. Just because the SNDA states that the lender [or any purchaser, as successor landlord] will not terminate the lease or disturb a tenant’s possession of the leased premises, it does not mean that the SNDA will not change the deal you made with the landlord even moments ago. Typically, a lender form of SNDA will attempt to change your agreement with the landlord from the very first paragraph in the SNDA and it will continue to endeavor to do so throughout the document.

What follows is a listing of selected clauses from a typical SNDA and suggested tenant responses with respect to each provision. A practitioner’s likelihood of successfully prevailing on any of these issues—a tenant’s “bargaining power”—will depend on many factors such as: (a) whether the loan is an existing loan or a new one; (b) the size of the lease; (c) whether it is a tenants’ or owners’ market; (d) the desirability of the tenant; and (e) the negotiating experience and level of preparation of each of the parties involved in the transaction.

Subordination


Boilerplate
The Lease now is and at all times shall continue to be subject and subordinate in each and every respect to the Mortgage and to the lien of the Mortgage and to any and all increases, renewals, modifications, amendments, supplements, extensions, substitutions, and replacements of the Mortgage, including, without limitation, amendments which increase the amount of the indebtedness secured thereby.

Comment
The Lease is not, and should not be, subject to terms, covenants, and provisions of security instrument itself, only to the lien of the Mortgage and any subsequent renewals, assignments, etc. Tenant should not be contesting that the lien is superior to the lease. However, it usually does not, however, have copies of the security agreement and its extensions (all the documents typically within the definition of “security instrument” in an SNDA). Tenant does not know what is contained in those documents. The security instrument, for instance, could state that the lease is modified in certain ways; tenants cannot be bound by such provisions. The lease, being subject to the lien of the security instrument, without more, protects the lender as it is an express statement by tenant that the lease is subordinate to the lien created by the mortgage.

Nondisturbance


Boilerplate
So long as no default exists under the Lease or this Agreement beyond any applicable grace or cure period, the Lease shall not be terminated, nor shall Tenant’s possession of the premises demised under the Lease or other rights and options thereunder be disturbed in any foreclosure action or proceeding instituted under or in connection with the Mortgage unless such right would have existed if the Mortgage had not been made.

Comment
A lender should only be able to terminate a lease in the manner set forth in the lease. The lease’s default provisions may have been carefully crafted to balance the interests of the landlord and the tenant and this SNDA provision just eliminates whatever had been negotiated Accordingly, the words, “so long as not in default beyond applicable notice and cure periods” should not be acceptable. If the tenant’s default is the kind that would support eviction, the lender, or landlord, will not be stuck with the tenant as it can still evict. A lender, however, should not be given an additional, alternate route to terminate the lease beyond what is in the lease. Usually a landlord can evict a tenant after a tenant is in default beyond applicable cure periods. The lease provides the sole remedies with respect to the possessory rights of the tenant. Whatever is stated in the lease should govern how all the parties view this issue. The same is true for renewal options and options to expand.

Attornment


Boilerplate
If the interest of Landlord under the Lease shall be transferred to (a) Lender or its nominee or designee, (b) any assignee or transferee from Lender or its nominee or designee, or (c) any other person or entity as may become the owner of Landlord’s interest by purchase at foreclosure or by deed in lieu of foreclosure or otherwise (any such party described in clause (a), (b) or (c) above, the “Successor Landlord”), Tenant shall be bound to Successor Landlord under all of the terms, covenants and conditions of the Lease for the balance of the term thereof remaining and any extensions or renewals thereof which may be effected in accordance with any option therefor in the Lease, with the same force and effect as if Successor Landlord were the landlord under the Lease, provided that the provisions of the Mortgage shall govern with respect to the disposition of any casualty insurance proceeds or condemnation awards.

Comment
You are so excited that the landlord has given your client non-disturbance protection that you have failed to notice that in the very next paragraph the lender has rewritten your lease with respect to casualty and condemnation insurance. This can be devastating to your client’s interests. If, in the case of a casualty, the proceeds are utilized to pay down the mortgage instead of rebuilding the building the tenant’s business operations will cease. On the other hand, if the proceeds do not go to the lender, the lender still has its asset as collateral and the money will be applied to: (a) fixing the damaged collateral; and (b) allowing the tenant [whose rent payments give the landlord the ability to pay down its loan to the bank] to stay in business and pay rent to the landlord. And remember; it is the tenant who is paying for the cost of the insurance in the first place! It is not doing so for the purpose of paying down any existing loans, but to make sure there are funds available to rebuild the building so its business can operate without interruption.

With respect to condemnation awards, if the tenant has invested in the building and put in expensive tenant improvements, it has most likely worked hard to make sure that the lease protects those interests. One little proviso in an SNDA, however, can negate all that the tenant has worked so diligently to safeguard. Under the boilerplate provision reproduced above, the mortgage would govern the disposition of the casualty proceeds or condemnation awards. This gives the lender far too much leverage: (a) in the case of a casualty, to shut down the operations of a tenant; or (b) in the case of condemnation, to prevent tenant from recouping the money it invested in the lease.

Boilerplate
No Successor Landlord shall be liable for any act or omission of any prior landlord.

Comment
This one is a tough one to argue with the lender. Most lenders are not very keen about paying money damages to a tenant under any situation. Nevertheless, it is fair to insist that a lender, or successor landlord cure any breach or default that exists or continues to exist beyond the date it obtains possession, if the lease requires it to do so. The lender has the ability to know of such obligation before it decides to succeed to the interest of the landlord. If the succeeding landlord desires to receive the rents and other benefits arising out of ownership, it must also accept the obligations of ownership as well.

Boilerplate
No Successor Landlord shall be subject to any offset, or counterclaims which Tenant might have against any prior landlord, except that Successor Landlord shall be subject to counterclaims, or offsets accruing in and applicable to the period after Successor Landlord obtains possession of the Leased portion of the Property.

Comment
Tenant has some strong arguments to prevail in its quest to revise many of the lender friendly provisions in this section. With respect to the tenant’s right to offset rent, tenant is not asking the successor landlord to take anything out of its pocket to remedy a default. For landlord obligations, other than actions to recover for services that the original landlord has failed to render, the test should be: “Would the successor landlord be responsible for paying the cost to remedy the obligation if the item had not previously been taken care of by the tenant?” If yes, it should be a valid offset item. If no, it should not be a valid offset item. Only allowing offset for capital improvements/repair items is generally not sufficient for a tenant. The concern is to make sure the successor landlord is not let off the hook for any of the obligations that it would have to comply with once it obtains possession of the premises. From a tenant’s perspective, these items, whether it be the payment of its landlord’s taxes or the undertaking of repairs that the lease requires the landlord to take care of, are things that: (a) the tenant has already paid once when it has paid rent; and (b) could seriously disrupt the continuous operation of its business if they are not corrected in a timely manner. If the tenant cures the defect before the lender takes possession, it is preventing damage to the lender’s collateral. If the tenant pays to remedy a situation and it cannot offset such costs against the rent, the lender is receiving a windfall from the tenant. Since tenants are in the business of making money for themselves and not to make gifts to lenders, a lender’s insistence on the inclusion of this clause is unreasonable. Further, a lender’s claim that a negotiated right of offset is not available if the tenant has not asserted the right at “its first opportunity” or “within a reasonable time” is without merit. Tenant is under no obligation to pay for the cure, in the first place, and the lender should be grateful that it has received an “interest free loan” from the tenant since the tenant is only permitted to offset such costs against the next succeeding rent payments due. Tenant is not asking for a “thank you” from the lender for taking care of its obligations, it is asking only to offset such costs. Remember also that if an offset is not permitted under the lease, Tenant has no right to offset. Therefore, if a landlord agrees to insert language giving a tenant the right to offset, the lender’s inclusion of a provision stating that it is not subject to such a condition is an attempt to eliminate a negotiated right under the lease.

As to valid counterclaims, tenants should be able to assert them against old claims that a successor landlord revives. Otherwise, it would be the same as asking the tenant to defend itself with two hands tied behind its back. Old counterclaims not brought by the successor landlord should not be the new landlord’s problem. Tenant should be able to take those issues up with the prior landlord. Even with legitimate counterclaims and offsets, a tenant can agree to give notice to lender so that it is aware of what it is getting into before it forecloses on the property. In any event, if the lender knew or should have known of the underlying claim, that should be sufficient notice.

Boilerplate
No Successor Landlord shall be bound by any amendment, modification or cancellation of the Lease or surrender of the premises demised under the Lease made without Lender’s prior written consent.

Comment
Changes resulting in: (a) a reduction of rent or other sums payable under the lease; (b) reducing or extending the term of the lease; (c) modifying the permitted uses; or (d) reducing a tenant’s obligations to comply with laws, are common examples of clauses where it would be proper to trigger a consent requirement. The main point to discuss with the lender with respect to this provision is whether it desires to get involved with every change in the lease’s operational obligations no matter how insignificant, i.e. sweeping sidewalks. If the lender inserts a long laundry list of the different types of modifications that can be made to an agreement, it increases the risk that some of the items listed relate to day to day matters [such as the location of the garbage drop off point] too mundane to involve the lender. The general concept is the lender does not need to have approval authority over any operational matters other than possibly requiring a tenant to continuously operate its business within the premises. A lender should only have a right to consent if an item materially impacts upon the tenant’s non-operational leasehold obligations, as illustrated by the examples above. Attempting to make distinctions between material operating obligations and non-material operating obligations will not work. What one person thinks is a material operating obligation today may not be seen as such by another person who looks at the SNDA two weeks later. As for non-operational revisions, if the change increases landlord obligations or decreases tenant obligations the modification will usually be thought of as material and lenders usually want to be notified first before the change is effective as to them.

Boilerplate
No Successor Landlord shall be obligated to complete any construction work required to be done by any prior landlord or to reimburse Tenant for the cost of any construction work done by Tenant, except for construction prior to Tenant’s occupancy of the portion of the Property Leased.

Comment
Beware of clauses absolving lender for construction or reimbursement obligations of prior owner. Be careful with respect to tenant allowances especially where the allowance is built into the rent. These are big ticket items and could cost the tenant dearly if its landlord becomes insolvent.

Limited Liability of Lender


Boilerplate
The partners, shareholders, directors, officers and principals, direct and indirect, of Lender as a Successor Landlord (collectively the “Exculpated Parties”) shall not be liable for the performance of such Successor Landlord’s obligations under this Agreement and the Lease. The liability of Lender as a Successor Landlord for its obligations under this Agreement and the Lease shall be limited to its interest in the Property and Tenant shall not look to any of their other property or assets or the property or assets of any of the Exculpated Parties in seeking either to enforce Lender as Successor Landlord’s obligations or to satisfy a judgment for its failure to perform such obligations.

Comment
Lender should acknowledge that the property could be stripped of its value under certain circumstances and should not force the tenant to look to the interest in the property which would have no value under those conditions. In the event that any liability of lender does arise pursuant to the SNDA or the Lease, such liability should be limited and restricted to its interest in the property or any portion thereof, including: (w) the rents and profits thereof; (x) the proceeds of any insurance policy payable or received by lender; (y) eminent domain awards payable to or collected by lender; and (z) sales, financing, or similar proceeds payable to or received by lender, and shall in no event exceed such interest. This section should not limit any right that tenant may otherwise have to obtain injunctive relief against lender. Except as set forth herein, the lender should be protected in the same manner as the landlord under the lease. If the successor purchaser is not the lender or an affiliate of the lender, the exculpation provision in the Lease should prevail.

Direct Payments to Lender


Boilerplate
Tenant agrees that after Lender gives notice to Tenant stating that a default has occurred under the Mortgage or under the loan documents delivered in connection with the Mortgage and that rent under the Lease should be paid to Lender, Tenant will pay to Lender, or in accordance with the directions of Lender, as and when due, all rent, additional rent and other monies due and to become due to Landlord under the Lease.

Comment
Some organizations are very small and not much notice is needed to make sure that the tenant’s payments are sent to the right party. On the other hand, large tenants may not even have their accounting departments in the same location as their legal or real estate departments. In those instances, a practitioner may seek to give his client some time to react to the notice from the lender. Tenant is not asking that it skirt its obligation to pay rent in accordance with the provisions of the lease. Tenant, however, should ask for at least 20 days notice as a fair request of a lender before it is obligated to send rent payments to a lender acting as a successor landlord.

Notice to Lender and Right to Cure


Boilerplate
Tenant shall notify Lender of any default by Landlord under the Lease and agrees that, notwithstanding any provisions of the Lease to the contrary, no notice of cancellation thereof or of an abatement shall be effective unless Lender shall have received notice of default giving rise to such cancellation or abatement. After Lender receives a default notice, Lender shall have the following periods of time to cure Landlord’s default and avoid a termination or abatement, as the case may be: (a) to the extent of a default by Landlord that can be cured by the payment of money, Lender shall have ten (10) days from the date of Tenant’s notice to make such payment; and (b) to the extent that a default by Landlord is otherwise curable, Lender shall commence such cure within thirty (30) days after the date of Tenant’s notice to commence such cure and if Lender thereafter diligently prosecutes such cure and such cure was not reasonably capable of being cured with thirty (30) days after the date of Tenant’s notice, Lender shall complete its cure as soon thereafter as reasonably possible, and, Tenant shall not otherwise be required to forebear from executing its remedies for a period of sixty (60) days after the date of Tenant’s notice.

Comment
Here, the goal is achieving a fair balance. It is important to make sure that the lender does not have an unlimited amount of time to effectuate a cure. Understanding that it may take time before a lender is able to obtain possession and weighing that against tenant’s need to have effective use and occupancy of the premises is the analysis that a practitioner must make. Usually, a tenant’s possession is not completely lost by a landlord default. Nevertheless, a tenant’s business activities are being adversely affected by such conduct. Examples of such defaults are leaking roofs; potholes; non-functioning lights; and entrances that are blocked. The economic reality is that a tenant is frequently willing to stay because it cannot replace the location sooner. If it could, it would move. Although the tenant is entitled to the benefit of its bargain, it can be in a tenant’s best interests to work together with the lender to get the property working again. There is a point where there their interests diverge. Agreeing to a ninety day outside date for the cure to be completed should be a fair allocation of the risks involved as a tenant cannot be out of business nor have its business hindered for an indefinite period of time.

CONCLUSION

Lenders must remember that a tenant is a vital part of the lending relationship in a commercial lease. They are as important as a third leg of a three legged stool. Without the tenant, the economics of the loan do not make sense. The landlord would be left with space that is not providing income to pay off the loan. The payment of rent thus gives the landlord the means to pay the lender without diminishing its other assets. An underwriter will consider whether the space is leased when it determines the amount of the loan and also when it determines whether it will offer the loan at all. Therefore, a tenant’s concerns deserve to be respected, not only because a tenant has the right to rely on what it bargained for in its lease but also because it brings value to the property and that value is the lender’s collateral for the loan. Having an experienced and savvy attorney on your side to champion a tenant’s cause when negotiating an SNDA can make all the difference between having a leasing transaction that is “almost” done right and one that fully protects a tenant’s interests.

This article is reprinted with permission from the December 2008 and January 2009 issue of Commercial Leasing Law & Strategy. © 2008-9 ALM Properties Inc. Further duplication without permission is prohibited.


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