Anyone who has taken piano lessons will remember a right-hand melody with the left hand playing chords that harmonize the melody. This subordinate harmony method has dominated classical music since the 17th century when the Baroque period began. It comprises most of what music theory students learn.
However, earlier music was constructed differently. For instance, madrigals typically were comprised of several equally important horizontal voice parts, which, sung separately, sound like complete songs. However, when sung together, the parts blend with each other. These polyphonic compositions contain what academics call coordinate harmony.
Many legal contracts operate like coordinate harmony. The parties have different roles, but each is equally important to the transaction. Differences in bargaining power may allow one party to have the upper hand, but both parties must cooperate to some point, and if one party is too heavy-handed, the other party may walk away.
Sometimes, commercial real estate tenants or creditors are asked to sign agreements subordinating their rights to another party’s rights. Subordination agreements are common in the commercial real estate business where mortgage lenders want to assure that their interest in the real estate is primary and that they can take over the property smoothly if there is a mortgage foreclosure.
Frequently, accompanied by non-disturbance agreements and attornment agreements, which also give rights to mortgage lenders. This article is part of a series discussing commercial real estate lease provisions and discusses Subordination, Non-Disturbance, and Attornment Agreements (SNDA) and how tenants should respond if presented with on.
What is an SNDA?
Commercial tenants may be perplexed when months or years after signing their leases, they are asked to sign an SNDA, particularly if they signed one previously. Not wanting to disclose their business, landlords may just inform tenants that they “need the SNDA for the mortgage lender.”
Frequently, SNDAs signal a change in the landlord’s mortgage situation. The landlord may have refinanced its mortgage or obtained a second mortgage. Or the landlord may be working with its mortgage lender to prevent foreclosure after a mortgage default. Other times a new property owner may require an SNDA from tenants.
A tenant’s lease may require it to sign an SNDA on request, and the SNDA form may be attached to the lease. Or, the lender may tell tenants that the SNDA is nonnegotiable. Other times, a tenant may be told it must sign a particular SNDA form because it’s “just like the last one they signed.”
Sometimes, the tenant’s lease may include SNDA language that applies to current and future mortgage lenders. When the lease includes this language, the tenant may have only limited ability to negotiate those lease provisions.
Residential tenants aren’t likely to encounter an SNDA. However, many office, industrial, retail, or other business tenants must sign an SNDA. Sometimes, they can negotiate the SNDA. Regardless, tenants should understand the SNDA and how it affects their leases before they sign. For starters, tenants should understand that an SNDA is actually three types of agreements, each with a distinct purpose.
What is Subordination?
Subordination is putting something in a lower position or rank. Therefore, a subordination agreement puts the lease below the mortgage loan in priority. Mortgage lenders want the leases to be subordinate to the mortgage. That way, the mortgage loan is paid first if there is a foreclosure.
Mortgage lenders are concerned about subordination agreements when a lease is, or could be, recorded in the county records. Real estate liens follow the rule “first in time, first in right.” That means that with county real estate records, the early bird gets the worm (or the real estate rights).
If a lease has been recorded in the real estate records, then the tenant’s rights will be superior to a later recorded mortgage. That means that the mortgage lender wouldn’t be able to take ownership of the property in foreclosure without buying out or otherwise satisfying the lease obligations.
Mortgage lenders don’t want the hassle of dealing with leases in a foreclosure. Therefore, most lenders won’t agree to loan money unless they get first priority, so they will require tenants to sign subordination agreements. Frequently, lenders will ask all tenants, including those whose leases haven’t been recorded, to sign subordination agreements.
Although technically, subordinated leases could be terminated in foreclosure or bankruptcy, from a practical matter, subordination agreements rarely hurt tenants. Even if the property goes through a foreclosure or bankruptcy, the new owner usually wants to keep the tenants rather than find new ones. However, the subordination can be used to force a tenant with below-market lease terms to renegotiate its lease.
What is a Non-Disturbance Agreement?
Non-disturbance agreements assure that the leases will continue if the property is involved in a foreclosure. In a non-disturbance agreement, the lender agrees that it will let the tenant stay at the property. In exchange, the tenant will continue to perform under its lease and pay rent to the lender if it becomes the property owner.
Frequently, tenants won’t notice a change if a property becomes involved in a foreclosure or bankruptcy. It is important to the lender that the property continue to operate smoothly, so most lenders won’t let a foreclosure or bankruptcy disrupt property operations.
However, it’s not unusual for tenants to notice a change in operations before the property goes into foreclosure or bankruptcy. A landlord having financial troubles may cut back on services or defer building maintenance. The building may begin to look shabby, and repairs may take longer–if they are completed at all. Elevators may break down more frequently due to lack of regular maintenance. Landlord’s failures might even breach lease terms.
Due to these breaches, tenants may be seeking a way to get out of their leases before the lender forecloses. If a tenant’s lease has priority over the mortgage, it will have significant bargaining power in a foreclosure. However, a non-disturbance agreement usually will prevent the tenant from cancelling its lease in a foreclosure.
Tenants who want to leave a declining building should act promptly. They should attempt to renegotiate lease terms or with their landlord or declare a landlord default and terminate their leases before things get so bad that the property is involved in a foreclosure or bankruptcy.
What is an Attornment Agreement?
The concept of attornment dates to the English feudal system. Under English common law, attornment was the tenant’s acknowledgment and acceptance of a new lord.
The term’s meaning in an SNDA is similar. The tenant agrees that it will recognize the mortgage lender as its new landlord if the property goes through foreclosure. Frequently, attornment clauses will go further and require tenants to accept any new property owner as their landlord.
The words “attorney” and “attornment” look similar because they both come from the term “attorn,” which means to “assign or turn to.” In a power of attorney, people give someone authority to act on their behalf as an “attorney-in-fact.” Attorneys-at-law are people authorized by law to act on behalf of others in court.
Many tenants ignore SNDA language when negotiating their commercial leases. But that is the best time for the tenants to negotiate the SNDA–when the landlord is financially healthy, and the tenant has the most bargaining power because the landlord wants them to sign the lease.
SNDAs primarily benefit the landlord and mortgage lender by allowing for a smooth transition if there is a foreclosure. But tenants should ensure that the SNDA is not overly one-sided. Ideally, the lease will have an SNDA form attached. If a lender offers a more comprehensive SNDA, the tenant will have a basis on which to object.
Tenants should focus on the scope of the subordination and attornment. Does it apply only to the current mortgage lender? Or, will it apply to new mortgage loans or other financial liens, also? Landlords and lenders will want the scope as broad as possible. For tenants, a narrower scope is better.
Tenants should make sure that the non-disturbance language is mutual. The lender can evict a tenant that doesn’t pay rent, so tenants shouldn’t be required to stay at the property if the landlord or lender has breached the lease.
Most commercial leases have SNDA language. However, by negotiating these terms up-front, tenants can prevent a nasty surprise should the landlord have financial difficulties.
This series draws from Elizabeth Whitman’s background in and passion for classical music to illustrate creative solutions for legal challenges experienced by businesses and real estate investors.