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

In Principal Mutual Life Insurance Company v. Vars, Pave, McCord & Freedman," the court discussed both Dover and Miscione and, in effect, followed Miscione without adopting the Miscione court's blanket pronouncement that an attornment clause alters the priorities between a lease and a mortgage." "Instead, it appears to us the parties simply contracted that the lease would not be extinguished by the foreclosure."76 Furthermore, the Principal court distinguished the attornment clause under consideration from the one discussed in Miscione, finding that the clause in Principal required the tenant to enter into a new lease with the same terms if the lender requested the tenant to do so." "By operation of law, therefore, the lease would be extinguished in the event of foreclosure."78 The court then dealt with the conundrum that if the foreclosure extinguished the subordinate lease, the automatic termination would not render the lender's request to the tenant to enter into a new lease meaningless because the foreclosure extinguished the lease. After the foreclosure, the purchaser would have no legal right to demand that the tenant enter into a new lease. The court solved this problem by applying the law of third party beneficiaries, concluding that the foreclosure sale purchaser (the third party beneficiary) could request the tenant to enter into a new lease on the same terms as the old lease-the practical equivalent of an attornment despite automatic termination of the lease." Although the foreclosure extinguished the lease as a matter of law, the lender's request was intended to take effect upon, or simultaneously with, the extinguishment of the lease so that the third party beneficiary could enforce the lease at the time of extinguishment.80 Any contrary holding would, in the court's judgment, render the attornment clause meaningless."

in the most recent California decision, Vallely Investments, L.P. v. Bancamerica Commercial Corporation,82 the court looked to the holding of Principal for an analogy to support its holding, thus implicitly ratifying the Principal theory.83 In Vallely Investments, the tenant-leasehold mortgagor and its leasehold mortgagee agreed, following a default under the leasehold mortgage and in exchange for the release of the tenant's personal liability under the leasehold mortgage, that the leasehold estate would be assigned to an affiliate of the leasehold mortgagee.84 The leasehold mortgagee subsequently foreclosed the leasehold mortgage through a friendly foreclosure to eliminate any subordinate interests.85 In the lease assignment in lieu of foreclosure, the mortgagee's affiliate agreed that it would assume and perform all of the assigning tenant's obligations under the underlying lease. After the friendly foreclosure, a subsequent purchaser of the leasehold estate failed to make its annual rent payment to the landlord.8' The landlord sued the mortgagee's affiliate on the theory that the affiliate had assumed responsibility for the tenant's obligations under the lease and that such obligations were not extinguished by the friendly foreclosure." The Principal decision, in which the landlord was able to enforce an attornment agreement as a third party beneficiary even though a foreclosure proceeding terminated the lease, supported the court's decision in favor of the landlord.89 Similarly, in Vallely Investments, the friendly foreclosure of the leasehold mortgage terminated the leasehold rights of the mortgagee's affiliate that it had realized through the assignment in lieu of foreclosure. However, it did not terminate the third party beneficiary rights that the landlord possessed through the assumption by the mortgage's affiliate of the tenant's obligations under the lease.