Beware Amending a Lease Where There Is an Existing SNDA

Most commercial real estate leases are located on property encumbered by a deed of trust. The rental stream from these leases is a major factor in the lender’s valuation of the real property as its security and its underwriting of the loan. The rental stream is also the borrower’s source of funds to make its monthly loan payments to the lender.  Before making the loan, the lender will review the existing leases to determine if those leases are acceptable to it and support the loan. The lender will also decide if it wants any of the existing tenants to subordinate their leases to the new loan and if it is willing to provide the tenant with a subordination, non-disturbance and attornment agreement (“SNDA”).

An SNDA is a three-party agreement between the landlord, tenant and landlord’s lender (and any successor to the lender). Generally speaking, a SNDA provides for: (1) the subordination of the tenant’s leasehold rights to the lien of the lender’s deed of trust; (2) the lender’s agreement not to disturb the tenant’s lease rights if the lender forecloses its lien following landlord default under its loan, and (3) the tenant’s agreement to recognize the lender or the successful purchaser at the foreclosure sale as its landlord. The typical SNDA states that the lease is subordinate (or junior) to the deed of trust, but if the deed of trust is foreclosed, the new owner after foreclosure will not disturb the tenant’s possession under its lease so long as the tenant is not in default under the lease and the tenant recognizes the new owner as its landlord – this is known as attornment. Attornment requires a tenant to honor the lender (or new owner upon foreclosure) as the tenant’s new landlord instead of the landlord/borrower.

While laws vary from state to state, the general rule is that foreclosure of a deed of trust terminates any encumbrance on the property that is junior to that deed of trust. Absent an SNDA, the party acquiring the property at the foreclosure sale will be bound by any lease executed before the deed of trust but foreclosure terminates any lease executed after the deed of trust. The purpose of the SNDA is to spell out in advance what will happen to a lease and the rights of the parties in the event of a foreclosure, such that neither the new owner nor the tenant will suffer undesirable consequences.

The lender typically drafts the SNDA and that agreement includes a number of protections in favor of the new owner after a foreclosure. A common provision in an SNDA provides that no amendment to the lease can be made without the lender’s prior written consent and that any amendment made without the lender’s consent will not be enforceable against the lender.  It is sometimes possible to negotiate with the lender that the landlord and tenant may enter into certain “non-material” lease amendments without lender approval. Where this provision does not exist in the SNDA or when the lease amendment does not fall within the definition of “non-material” in the SNDA, it is imperative that the parties make sure that lender consent is obtained.

A common mistake made when amending a lease is forgetting if there is a previously executed SNDA and, if so, whether lender consent is required for any lease amendment. Common examples include (a) a right by the tenant to exercise an option to extend the term of the lease, (b) the right of the tenant to exercise a right of early termination, (c) a right to expand or contract the size of the lease premises, or (d) a right to terminate the lease after the occurrence of certain circumstances. A tenant is well advised to negotiate a provision in the SNDA to provide that lender’s consent is not required for any lease amendment to document the exercise of an existing right in the lease (previously approved by the lender).

When an existing SNDA provision is in place, a landlord and tenant will commonly and mistakenly modify the lease and forget to request the lender’s consent. This could have adverse consequences as the modification may not be effective against the lender, causing significant damage to the tenant benefitting from the modification.

There are numerous examples of the ways in which this oversight may be detrimental to the tenant. For example, in a down market,  a landlord may provide a tenant with some rent relief (whether in the form of free rent, lower rent or some other concession) in exchange for an extension of the lease.  This gives the landlord more stability with respect to its cash flow and provides the tenant with a better chance to weather an economic downturn. If the landlord and tenant do not secure the lender’s consent to this type of amendment, and the parties have already signed an SNDA with the lender in connection with the initial lease signing, if there is a foreclosure, the new landlord may not be obligated to honor the rent concession given to the tenant.  The tenant may find itself paying a higher rent for a shortened lease term.

Some tenants argue that it is unlikely that a successor landlord would want to terminate an existing lease upon foreclosure, but there are instances in which it is a real risk. For example, a lease signed during a downturn in the real estate market might be at a rental rate that is significantly lower than the market rate at the time of a foreclosure. In that instance, a successor landlord who has the right to terminate a lease upon foreclosure may elect to terminate the lease in order to replace it with one that has a higher rental rate, or use that right of termination to leverage a higher rental rate from the existing tenant who signed its lease during the economic downturn. In either case, the tenant will have virtually no leverage and will likely have to agree to the successor landlord’s demands. Thus, it is imperative that the tenant seek to obtain an SNDA from the landlord’s existing lender(s) in order to protect its leasehold interest.

What issues have you encountered in connection with an SNDA provision and related lease amendments?

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