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Commercial Real Estate Leases: Demystifying Subordination Agreements

October 13, 2020

By
Shawn M. Spalding
Attorney, Stoll Keenon Ogden PLLC
(502) 568-5457
shawn.spalding@skofirm.com

You trudged your way through a new lease draft and are nearing the often esoteric “boilerplate” when you reach the subordination and attornment terms. What are the practical and legal considerations that go into the subordination provisions,; what is the purpose of a Subordination, Non-Disturbance and Attornment Agreement;, and why should you be sure to read this lease section carefully?

To learn more about lease subordination and the implications of subordination agreements for tenants and lenders, click “Read More” below.

Lease and Mortgage Subordination
A lease agreement provides the right to access and use the leased premises and is therefore viewed similarly to a mortgage or other encumbrance — each is an instrument representing a third-party claim against all or a portion of the underlying real property. The lease and the tenant’s interest in the leasehold estate is therefore subject to many of the same legal rights and obligations as other lien holders, including the order of lien priority in a foreclosure.

Priority
Priority among these competing interests is typically determined on a first in time, first in right basis. The general rule in many jurisdictions is that a subordinate lien is wiped out upon a foreclosure, whereas a senior lien remains. In practice, this means a lease that arises after a mortgage is recorded would be terminated upon a foreclosure of such mortgage. Early termination of the lease in this scenario runs contrary to the original intentions of the lease parties and may generate undesirable consequences. For example, the purchaser in a foreclosure would have the right to alter the existing lease arrangements (e.g. terminate certain services or lease space to a competitive tenant), leaving the tenant in an unfortunate position. Without the written lease agreement in place, the tenant’s occupancy becomes a tenancy at will, which would give both landlord and tenant the right to terminate possession of the leased premises upon notice. Conversely, if a lease pre-dates a recorded mortgage, the lease will be senior to such mortgage and is therefore not at risk of termination barring a separate agreement to the contrary.

The Subordination Non-Disturbance and Attornment Agreement
To avoid unintended consequences occasioned solely by the priority of the mortgage or lease on the real property, parties often enter into a subordination, non-disturbance and attornment agreement (“SNDA”). In an SNDA, the tenant agrees to subordinate the claim of its leasehold estate in the premises to the lien of the mortgage, and in exchange, the mortgagee agrees that it will not disturb the tenant’s use and possession of the premises upon a foreclosure. The tenant additionally agrees that it will recognize (i.e. attorn to) the mortgagee or mortgagee’s successor as the landlord under the applicable lease following any such foreclosure. In this way, the tenant protects its interest in the lease and leasehold estate, and the mortgagee ensures its lien is senior to the tenant’s leasehold interest and establishes a direct agreement with the tenant.

Addressing Subordination in the Lease
Modern leases often provide that the lease is automatically subordinate to all present and future mortgages. Careful attention should be paid to this provision by all interested parties. A tenant may object to such a blanket subordination and prefer, instead, that a conditional subordination be provided, whereby the tenant agrees to subordinate its lease interest to any mortgage, provided the applicable mortgagee executes and delivers an SNDA. This modification effectively maintains the status quo at the property and is often accepted as a reasonable compromise among interested parties. Lease subordination provisions may also address a range of additional rights and obligations, such as timing requirements to execute an SNDA and giving the mortgagee the option of subordinating its mortgage to the lease.

Lease subordination is informed by a number of variables that are often unique to each party and property. Care is therefore recommended by all parties in pursuing, drafting, and accepting any subordination agreement.

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Our firm’s Real Estate practice group provides legal assistance to a variety of clients in nearly all aspects of real estate planning. Please contact them to discuss subordination agreements and commercial real estate leases.

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