When negotiating a lease, it is easy to skim the subordination clause and assume the boilerplate language is sufficient. A future lender, however, is likely to scrutinize that provision during loan due diligence. Landlords and tenants alike may not fully appreciate the level of analysis a lender undertakes when evaluating the leases affecting a property that will serve as collateral for a proposed loan. This article highlights the issues lenders consider when determining whether to require a separate subordination agreement—typically a Subordination, Non-Disturbance and Attornment Agreement (an “SNDA”)—and the key considerations that arise when negotiating an SNDA with a tenant.

When the Subordination Provision Is Not Enough

One of the first due diligence steps a lender takes in connection with financing a commercial property is determining whether the leases affecting the property are acceptable. In addition to reviewing the economics of a lease—such as the rent schedule and the length of the remaining term—a lender must be comfortable that the lease will not have priority over the proposed mortgage. If a lease will be superior to the mortgage, the lender must determine whether it grants the tenant rights that could hinder the lender’s ability to foreclose on or sell the property.

To that end, lenders carefully review the lease’s subordination provisions. If a lease is self-subordinating—meaning it expressly provides that the lease is unconditionally subordinate and subject to all existing and future mortgages—a separate SNDA is often unnecessary. Even in those circumstances, however, lenders may still request an SNDA for significant tenants or to address matters such as notice-and-cure rights and successor-liability provisions, as discussed below.

Where a lease conditions subordination on the lender’s agreement not to disturb the tenant’s rights following a foreclosure, a lender may still conclude that a separate SNDA is unnecessary if the lease contains no provisions that are problematic from the lender’s perspective or if the tenant is small enough that the lender is willing to accept the risk of losing the tenancy.

More commonly, however, lenders require an SNDA for leases that:

• Are silent as to subordination;
• Grant rights such as purchase options, below-market renewal rights, landlord indemnification obligations, or similar protections; or
• Expressly require delivery of an SNDA as a condition to subordination.

In addition, regardless of whether a lease is expressly subordinate to existing or future mortgages, lenders typically require an SNDA for any “major” lease—that is, a lease covering a specified percentage of the property’s square footage or generating rental income above a certain threshold. In these situations, an SNDA creates certainty for both parties. For the lender, it helps ensure that the critical rental stream associated with the lease will continue following a foreclosure. For the tenant, it provides assurance that lease terms that may have been heavily negotiated will remain in place despite a change in ownership.

Drafting and Negotiating an SNDA

Once a lender identifies the tenants from whom SNDAs will be required, it typically prepares the initial draft. If the lease includes an SNDA form as an exhibit, the lender will often begin with that form, making only those revisions necessary to reflect transaction-specific terms.
Certain tenants, however, may insist on using their own forms. Tenants with a national or global presence frequently reject lender forms, regardless of the size of the lease at issue, and instead require the use of a standardized tenant form. This is particularly common among national retail tenants that operate hundreds of locations and seek to avoid the administrative burden and inconsistency that would result if each location were subject to a different form of SNDA. In most instances, though, the lender’s form serves as the starting point for negotiations.

Although SNDAs commonly involve only the lender and the tenant, the landlord/borrower may also be included when necessary. One common example is when the landlord/borrower agrees that, following notice from the lender, rent may be paid directly to the lender. Regardless of the parties involved, the core provisions of a typical SNDA establish three fundamental concepts:

• The lease is subordinate to the mortgage;
• The lender agrees not to disturb the tenant’s possession if it succeeds to ownership; and
• The tenant agrees to recognize the lender as its new landlord upon the lender’s succession to title.

In addition to these core provisions, SNDAs frequently include notice-and-cure rights in favor of the lender, as well as limitations on the lender’s liability following a succession in title.

These liability limitations are often broad, providing that the lender will not be liable for or bound by, among other things:

• Any defaults of the existing landlord;
• Any payment obligations for tenant improvement allowances or leasing commissions that became due before the lender acquired title;
• Any lease amendment entered into without notice to the lender (and, where applicable, the lender’s consent);
• Rental payments made more than one month in advance;
• Obligations relating to security deposits or letters of credit, except to the extent such amounts are transferred to the lender; and
• Offsets or defenses that did not arise after the lender’s succession to title unless the lender received notice and an opportunity to cure.

Because lenders and tenants often have competing interests on these issues, the lender-liability provisions are frequently the most heavily negotiated sections of an SNDA. Lenders seek to minimize the obligations they may inherit if they take title to the property, while tenants seek to preserve the rights and protections for which they originally negotiated. Not surprisingly, larger and more significant tenants often have greater leverage in negotiating these provisions.

Landlords and lenders should also anticipate that tenants of all sizes will require time to review, process, and negotiate SNDAs. Accordingly, preparation and delivery of initial SNDA drafts should be prioritized early in the financing process to accommodate review cycles, avoid unnecessary delays, and help keep the transaction on schedule.

Both lenders and tenants share a common goal in a post-foreclosure scenario: certainty and predictability regarding the continued treatment of the lease. At the same time, their objectives are inherently in tension.

A lender seeks to minimize future liability under a lease, while a tenant seeks to preserve the rights and protections it negotiated with the original landlord.

A Subordination, Non-Disturbance and Attornment Agreement helps bridge that gap by establishing a workable middle ground between those competing interests and facilitating a smoother transition if the lender ultimately steps into the landlord’s shoes.

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