Who's on first-protecting the commercial mortgage lender: A lender's overview of subordination, nondisturbance, and attornment agreements

Real Property, Probate and Trust Journal, Fall 2001 by Homburger, Thomas C, Eiben, Lawrence A

Editors' Synopsis: This article examines the benefits that Subordination, Nondisturbance, and Attornment (SNDA) Agreements provide to lenders, landlords, and tenants. The authors discuss provisions that protect lenders and tenants, and review developments in the law related to SNDA agreements.

I. INTRODUCTION

The true value of commercial real estate is determined largely by the capitalization of its net income. The property's rental income, in turn, principally drives the net income. Therefore, when evaluating commercial real estate as suitable security for a mortgage loan, lenders should remember that the property's leases are of crucial importance. Lenders must consider, at a minimum, the obligations and liabilities of the parties under the leases, the right of successors-in-title to the real estate to benefit from the leases, and the extent to which the all-important rental income can be reduced, offset, or interrupted.'

However, even the most favorable leases, standing on their own, do not provide the security that lenders seek. The leases are mutual promises between landlords and tenants that do not form a direct contractual relationship between the producers of the income that have formed such an important part of the lenders' underwriting (the tenants), and the parties secured by the income (the lenders). Absent any contractual agreement between lenders and tenants, both parties are subject to the operation of the applicable law in determining whether they can retain the benefits they anticipated when deciding to proceed with their respective contractual commitments. A foreclosure may expose the lender to the risk of losing relied-upon lease income, and the tenant could lose its leasehold interest in the mortgaged property-a result that, under normal circumstances, would work to the detriment of at least one of the parties.2

A related problem arises for lenders and successors-in-title if the borrower asks the lender to secure the mortgage loan with commercial real estate already subject to potentially unprofitable leases with unfavorable terms. In almost every state in which this situation occurs, absent any agreement to the contrary, lenders will most likely be forced to take the security in a foreclosure, subject to these unfavorable leases with the accompanying diminution of the security's value.'

Courts and scholars have recognized that lenders and tenants can, by contract, eliminate many of the uncertainties described above.' A subordination, nondisturbance, and attornment agreement ("SNDA") provides a set of contractual terms that govern the relationship between a lender and a tenant should the owner-lessor default on its mortgage loan.' Absent an SNDA, the foreclosing lender and the tenant could seek to negotiate a new lease at foreclosure. If the governing law is applied in these circumstances, at least one of the parties will be forced to negotiate in the face of an unfavorable outcome. This forced negotiation will severely diminish that party's negotiating power. In addition, from a practical point of view, a change in market lease rates at the time of foreclosure may cause either the tenant or the lender to refrain from agreeing to a "new" lease under the same terms on which the other party originally relied and on which the other party now seeks to enforce. If the parties are negotiating an SNDA when lenders and tenants are in a more equal position, they are more likely to negotiate mutually satisfying solutions to accommodate the concerns of both parties in the event of a default by the landlord and a subsequent foreclosure.

Considering the particular importance and practical relevance of SNDAs, little case law exists on the subject. Only New York and California seem to have considered the legal issues at any length. In other states, disputes involving SNDAs either have produced little case law or have not made their way to trial at all. On the other hand, commentators have written extensively on the subject. Given the importance of the topic and the common use of SNDAs in mortgage transactions, most disputes involving SNDAs apparently have been resolved by negotiations between the parties involved.

This Article considers the benefits that SNDAs provide to lenders, tenants, landlords, and the tenant-lender relationship; the provisions necessary to protect lenders adequately, and the relatively scant developments in SNDA case law.

II. SUBORDINATION, NONDISTURBANCE & ATTORNMENT-- THE FUSION OF THREE DISTINCT LEGAL DOCTRINES

SNDAs address and shape the consequences of a mortgage loan default that otherwise would be determined as a matter of law by the operation of two distinct legal doctrines-subordination and attornment-and partly through the introduction of a third theory, nondisturbance. A consequence of direct negotiations between the lender and the tenant long before the threat of an impending foreclosure and when the parties have maximum negotiating power, an SNDA combines these three theories to bridge the contractual gap between the tenant and the lender or the foreclosure purchaser (if different from the lender) following foreclosure."