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

A properly drafted SNDA utilizes the three legal doctrines described above to accomplish the following: (1) provide the lender with the ability to ensure, if it so elects, that its rights under its mortgage are prior to (or in some cases, subordinate to) any of the tenant's rights in the property, (2) preserve the lease under terms that are satisfactory to both lender and tenant (including the rental income that is so important to the lender); and (3) establish privity of contract between the lender and the tenant so that either party can enforce those agreements that they have determined would be in force following a foreclosure. These three legal concepts-subordination, nondisturbance, and attornment-are defined below.

A. Subordination

A subordination agreement is "an agreement by which one who holds an otherwise senior interest agrees to subordinate that interest to a normally lesser interest."7 Applied to the commercial lease context, a subordination agreement is an agreement whereby the tenant subordinates its leasehold estate to the interest of the lender.

B. Nondisturbance

Black's Law Dictionary defines a disturbance as "an act causing annoyance or disquiet, or interfering with a person's pursuit of a lawful occupation . . . ."8 By inference, a nondisturbance is the landlord's not interfering with a tenant's use and occupancy of the leased premises. However, a nondisturbance agreement usually covers much more than a mere protection of the tenant's occupancy; it is an agreement by the lender to recognize the tenant's rights under the lease that the parties have agreed will apply following a foreclosure.9 Through the attornment portion of an SNDA, discussed below, the parties can enforce the preserved rights.

C. Attornment

Attornment is "a tenant's agreement to hold the land as a tenant of a new landlord"10 with direct privity of contract between the lender and the tenant11 Attornment agreements not only make it the tenant's obligation to recognize the lender as the new landlord under the lease,12 but they also allow the tenant to enforce contractual obligations contained in the lease."

III. LENDER'S CONCERNS IN THE EVENT OF OWNER'S DEFAULT AND FORECLOSURE

The effect of a foreclosure on a lease depends on whether the lease is prior or subordinate to the mortgage. In almost all jurisdictions, if the lease is prior to the mortgage, a foreclosure will not affect the lease.14 The situation varies radically on a state-by-state basis, however, if the mortgage is prior to the lease. In some jurisdictions, such as California and Utah, a foreclosure will automatically terminate the tenant's rights and the lease.15 New York and New Jersey, on the other hand, provide a "pick and choose" rule, permitting a lender to terminate unfavorable leases while keeping others. 16

SNDAs allow lenders and tenants to avoid the often-unwanted consequences, which the applicable state law would mandate, by structuring in advance what the relationship will be between them in a foreclosure. SNDAs also provide a venue where lenders can memorialize terms they negotiate directly with the tenant, because SNDAs are one of the few, if not the only, agreements to incorporate direct agreements between the tenant and the lender. Among the lender's primary concerns that the SNDA can deal with are the following: the priority of the lender's mortgage lien; the preservation of the rental income stream that served as part of the lender's original underwriting of the loan; the continuation of tenant obligations under the lease; the lender's protection from unfavorable lease terms; and the exculpation from, or limitation of, the landlord's liability in certain circumstances. The tenant, on the other hand, can utilize the SNDA to assure the preservation of the tenant's leasehold interest from disturbance caused by the foreclosure.