Once a tenant has signed a commercial office lease it’s generally expected that it will remain in place for the duration of its term. Retail tenants in particular may spend large sums of money to upgrade their leased premises in reliance upon the negotiated terms and the expectation that a unique location will help drive strong revenue.
“These expectations, however, can go horribly wrong if their landlord experiences financial reversals and defaults on its loan obligations,” says Robert Chavez, founder and CEO of Guardian Commercial Realty.
Given the increase in commercial property foreclosures, Smart Business spoke to Chavez about SNDAs and how they pertain to a tenant’s rights in the event of a building foreclosure.
What is SNDA?
SNDA is the acronym for subordination, nondisturbance and attornment. Subordination and attornment provisions are included in most commercial offices leases as they define the responsibilities between a landlord, its lender and its tenants in the event of a default by the landlord and foreclosure by the lender. These provisions can also impact the distribution of insurance proceeds in the event of a casualty or condemnation. Subordination and attornment may be one of the most boring sections in a commercial office lease and is often ignored by tenants because it is so bland and legalese. Just because it is boring, however, does not mean it is not important. Subordination and attornment provisions buried in a lease can cause a tenant to waive very important rights in the event of a foreclosure.
What could happen to a tenant in a foreclosure?
In the event of a foreclosure, the tenant will have a new landlord — the lender. Subject to myriad underlying documents, the lender can either terminate or enforce existing leases within the foreclosed property. The lender may also be excused from funding tenant improvement allowances, as well as honoring rental abatement periods, self help provisions and other concessions that remain unfulfilled due to the landlord’s default. The lender’s objective will be to preserve and/or maximize the cash flow of its property to recover its loan principal and interest. Market conditions will play a large role in the lender’s actions. During strong economic periods with rising rental rates and low vacancies, lenders may elect to terminate existing leases and find new tenants willing to pay higher rents. The lender could also institute eviction proceedings immediately following foreclosure, making it impossible for the tenant to adequately plan for relocation. Aggressive lenders may also use these tactics as leverage to increase the tenant’s rent irrespective of the rent set forth in the lease. During recessionary periods with low rents and high vacancy, lenders will want to keep any above-market rents in place and do whatever else they can to preserve cash flow.
What should a tenant do to protect itself?
In situations where a tenant will make a significant investment in the leased premises, expect to benefit from a premium location, or is confident that its rent will be below market for the term, the tenant should insist upon a nondisturbance agreement. The nondisturbance agreement, executed by the tenant and lender, must be carefully drafted to ensure that the lender will honor all of the tenant’s rights under the lease after foreclosure. Tenants should expect resistance from lenders when seeking a nondisturbance agreement; this is especially true for non-credit tenants with smaller leases.
The scenario typically plays out in stages. First, the lender refuses to execute a nondisturbance agreement as it is under no obligation to do so. Next, if the tenant is persistent and the landlord is persuasive, the lender agrees to execute its ‘form’ nondisturbance agreement, but without any changes. Finally, after much negotiation, the lender and tenant agree to reasonable changes to achieve a mutually acceptable nondisturbance agreement. This process can take four to six weeks, and there is no guarantee that the lender will cooperate.
Sophisticated tenants have walked away from transactions at the 11th hour when the lender has refused to cooperate reasonably.
Should tenants always seek a nondisturbance agreement?
There may be circumstances under which a nondisturbance agreement may not be in a tenant’s best interests. Over time, a property may have become unattractive to the tenant because the rent is above market or the building’s condition is deteriorating. The tenant may also need to downsize or relocate. If so, then the tenant may want flexibility, and the nondisturbance agreement may lock the tenant into the lease, eliminating its ability to terminate in the event of a foreclosure.
It is important to note that this commentary is only the tip of the iceberg as it relates to SNDAs and their related issues. A tenant is well advised to seek the advice of an experienced real estate attorney before executing a lease.
ROBERT CHAVEZ is the founder and CEO of Guardian Commercial Realty. Reach him at Robert.Chavez@guardianusa.net or (310) 882-2060.