The commercial real estate market has been experiencing the kind of instability that requires due diligence from building owners and tenants alike.
A tenant may believe that, by signing a lease, it is assured its space as long as it upholds all stipulations of that lease. But in the event of a building foreclosure, tenants require additional protections to ensure that their investment in the leased space is not lost.
“Subordination, nondisturbance and attornment — or SNDA — provisions are something tenants should pay attention to in their lease in the event of a default by the landlord that leads to foreclosure,” says Cameron McCausland, partner and director of Transaction Management at Southfield, Michigan-based Plante Moran Cresa. “The tenant could end up with a lender for a landlord, who may not have to uphold agreements within the lease, or even the lease itself, if the tenant is not properly protected.”
If a tenant is relying on its location and on specific features of its space, this kind of interruption can not only be extremely disruptive to a business but could even lead to its demise.
What are SNDA provisions in a lease?
In most commercial leases, SNDA provisions define the responsibilities of property owners, lenders and tenants if the owners should default. Distribution of insurance proceeds in the event of casualty or condemnation is also often included in SNDAs.
Commonly, SNDA provisions are overlooked by tenants when reviewing a commercial lease, as they contain a good amount of legalese. This is one of many reasons that a tenant representative should evaluate any lease before it is signed. If a tenant unknowingly agrees to SNDA provisions that are not favorable, it may end up waiving important rights should a property foreclosure take place.
How can a tenant be affected after a foreclosure?
Tenants need to pay attention to SNDA provisions in their leases to avoid the negative fallout should a lender take over and attempt to implement aggressive tactics. When the lender becomes the landlord, its primary objective will be to preserve or recover as much capital as possible, which can involve raising rent, failing to honor rental abatement periods, revoking tenant improvement allowances and even eviction.
The lender’s actions are often driven by market conditions. If rental rates are high in the current market, tenants are more likely to suddenly experience a rent rate hike, or can be evicted in favor of tenants that are willing to pay more. In a market where rental rates are low and vacancy rates are high, lenders will do whatever they can to preserve cash flow, including the aforementioned above-market rent rates and cancelation of building improvement allowances.
What can tenants do to protect themselves?
In situations where tenants plan to make significant investment in the premises and/or their particular location is crucial to operation, they will want to work directly with the lender on a nondisturbance agreement when a lease is executed. The nondisturbance agreement creates a direct contractual relationship between the tenant and the lender and provides that the lender will not disturb the tenant’s occupation of the leased premises, upholding the tenant’s rights in the lease.
How does the process of negotiating the agreement typically work?
If a tenant is paying below-market rent or is a noncredit tenant with a smaller lease, some resistance from the lender could be expected. Often, lenders will claim that they are under no obligation to enter into any agreements with tenants; landlords will sometimes become involved in the process to move the discussion along.
Tenants can expect to receive a form nondisturbance agreement from the lender, and negotiations will need to take place in order to reach an agreement that more thoroughly protects the tenant’s interests. Tenants should be prepared for a process that can take at least a month or two, or potentially longer. They should also be prepared to walk away from negotiations if favorable terms cannot be reached with the lender, particularly if they fall into the category of tenants who rely heavily on their location and premise specifications to conduct business.
Are there circumstances where a nondisturbance agreement is not necessary?
If a tenant requires flexibility in a lease, for example, if it finds the location is not ideal after some time passes or the rent is above market, or if the tenant needs to downsize, locking itself info an agreement may not be in its best interest. These are a few examples of situations where a tenant may want the freedom to terminate the lease in the event of a foreclosure.
It’s always in a tenant’s best interest to consult with a real estate professional before signing any lease, particularly as it relates to the many complex issues surrounding SNDAs and other binding lease terms.
Cameron McCausland is a partner and director of Transaction Management at Plante Moran Cresa. Reach him at (248) 603-5291 or Cameron.McCausland@plantemoran.com.