Commonly Overlooked Lease Issues: Third Party Rights

August 9, 2012 

This article is devoted to highlighting those often neglected lease provisions in San Diego investment real estate and prevailing on our landlord readers to give them a second look when crafting their contracts. Last month, we looked at the benefits of affirmatively addressing the, dare I say, not uncommon occurrence of a landlord default on their lease obligations and potential tenant remedies in such circumstances. Today we look at third party rights.

Third Party Rights: The Lender

Most commonly, when we talk about third party rights under a lease, we are referring to the landlord’s lender’s rights. Lender’s rights frequently arise in one of two situations: the landlord has defaulted on its obligations under the lease, or the landlord has defaulted on its obligations under the loan. Default, default, default. Consider these types of provisions to be rainy day contingencies. 

Of the two situations, it’s more common for a lease to include provisions relevant to the landlord’s default under their loan and the lender’s subsequent foreclosure of San Diego investment real estate. A subordination, non-disturbance and attornment (SNDA) provision provides the first blush of a lender’s rights under the lease agreement. In basic terms, a subordination provision will require a tenant to de-prioritize their interest in the lease to the lender’s interest in the property. To the extent the lender’s interest in the property is lower in priority to the tenant’s interest (usually because the lease predates the loan), the subordination allows the lender to foreclose on the property without involving the tenant in the process and without risk of their award being diminished by a monetary award to the tenant. If the value of the loan is significant, most lenders will require subordination as a condition to issuing the loan. 

Addressing the Lender’s Needs in Advance

Landlords of San Diego investment real estate can address the need for subordination up front by including an SNDA provision in the lease. Absent such provision, the landlord will be at the mercy of their tenant to sign an independent SNDA form when the landlord is looking to refinance, sell to a new landlord, etc. From experience, such circumstances can be a gold mine for a smart tenant – with more than one tenant having held their signature ransom in return for cash payment or some much desired amendment to their lease. 

Coordinating Provisions

As the name implies, the scope of an SNDA provision typically includes more than the base subordination of the lease to the financing documents. Of equal importance to both your lender and your tenant are the “ND” and “A”. 

The non-disturbance portion of the standard SNDA provision in effect enforces the business arrangement that was struck between the landlord and the tenant. Typically, so long as the tenant is not in default under the terms of the lease, their right to continued use of the property in the manner to which they have become accustomed will be upheld. Take into consideration the alternative situation – where the lender has foreclosed on the property without an obligation to uphold the lease and uses the situation as an opportunity to renegotiate the terms of the lease or worse, simply evict the tenant. 

A good non-disturbance provision will accomplish enforcement of the bargain by: 

1. Binding the new lender-landlord to fulfill the landlord’s obligations under the lease. 

2. Limiting the new lender-landlord’s obligations to those arising after the date of its possession. 

3. Fairly allocating certain risks in the case of foreclosure between the lender and the tenant (i.e. the new lender-landlord will not be responsible for returning the security deposit to tenant unless that account was actually received from the prior landlord). 

To protect the lender, the lease should require the tenant to attorn to the new lender-landlord. Attornment requires that the tenant treat the lender as though they were the direct landlord. While this may seem like a minor point, the lender wants to ensure that, for example, rent payments are being directly received by the lender and in their name (rather than the old landlord’s name). or getting notices of default when the original landlord would have been entitled to receive them. 

A sophisticated lender in San Diego investment real estate will almost always require the right to cure a landlord’s default prior to any major tenant remedies kicking in. As the landlord, such provisions provide you with an extra layer of protection, albeit a costly one. Your loan documents may stipulate the specific requirements for lender cure clauses, such as the length of time the lender has to act. Such documents should be consulted when drafting your lease. 

Co-Tenant Rights

Finally, a few points on non-lender, third party rights under a lease agreement. Most commonly, this takes the form of co-tenant rights in a multi-tenant development. Such rights include concepts such as exclusivity provisions, co-tenancy requirements, and relocation and expansion rights. Each of these topics could warrant a blog entry of their owner. But suffice it to say in brief, any landlord operating a multi-tenant development should carefully log the rights granted to each tenant if those rights could impact other tenants in the development. Understanding the interplay of lease rights in San Diego investment real estate can and should impact a landlord’s decisions in terms of how it reacts to requests for termination, default notices, and prospective tenant determinations. 

Source: BiggerPockets Blog

DISCLAIMER: This blog has been curated from an alternate source and is designed for informational purposes to highlight the commercial real estate market. It solely represents the opinion of the specific blogger and does not necessarily represent the opinion of Pacific Coast Commercial.