Your Landlord Financially Challenged? How to Protect Tenants, Subtenants and Brokers
The scene: Midtown office of a midsize ad agency.
The dramatis personae: Company’s VP for operations, attorney and broker.
The discussions to this point: On the table is a draft term sheet for a 15,000 rsf lease at a rent which is 20 percent lower than tenant is currently paying; also a $42 per rsf TI (tenant improvement) allowance.
(We now listen in on the conversation …)
Tenant: You know that $48 rsf rent is great, gonna save us a [boat]load of money over the next 10 years, but I’ve been reading the trades and understand that [insert name of latest high-profile financially challenged landlord] is way deep underwater on a number of mortgages, and we’re concerned about getting our TI money–hey, $600,000 ain’t chicken feed–and, for a our corporate image, his ability to provide Class A building services–the lobby, office cleaning, etc. That’s essential.
Lawyer: Well, let’s make getting an SNDA a must here, and also we’ll look for an L/C on that TI work or an escrow. Maybe rent set-offs and self-help too. …
Broker [gazing off into the distance, momentarily caught up in his own thoughts about the subject]: (to himself) Hmmm. I better figure out how I’m gonna make sure my six-figure commission gets paid … especially as half is due six months after signing. Gotta find that memo on this to all brokers from the company’s new international HQ office in Saigon on this. Try for an escrow? Commission in lieu of rent? Nah, that will never fly. Broker’s Entitlement Affidavit? (Does that apply to commercial leases?) Well, there’s always a lien action … but who’s gonna pay for the litigation?”
I DON’T THINK the above scenario is too far from reality in today’s troubled real estate market. But what does it all mean?
Protecting Tenants, Subtenants and Brokers From Landlord Defaults
Here’s a topic that was not on the radar screen 25 years ago but would have been considered almost laughable if presented as part of a Continuing Ed program or as suitable for a leasing law column. But here we are. It’s 2010, and the market today is still in the crapper; pockmarked with overextended landlords who paid hyperinflated prices for properties with borrowed money, all having been predicated on ever increasing dollars per rsf.
Well, then came Lehman Brothers and the worldwide financial debacle. Now with debt service often far outstripping income, many landlords are in trouble. Most talking real estate heads predict continuing stormy seas for property owners who may be upside down in their current loans. This gloomy POV is supported by recent numbers indicating that almost $46 billion in defaulted CMBS loans are outstanding.
To be a bit Talmudic here (’tis the season, after all) we ask–rhetorically–what is the meaning of all this for that advertising company in our drama and others similarly situated? This means landlords and tenants can expect to see some significant turnover in ownership of commercial properties in the coming years, particularly through commercial foreclosure actions. Now, we all have gone through market cycles of different dimensions. That–by definition–is a market (anyone remember “Stay Alive ’til 95?”), but nothing as negatively charged as today’s climate.
So what can (should) the tenant-side players in the leasing community do to safeguard the status of their leases and, as to their brokers, make sure they get paid the commissions they’ve worked so hard to earn? We’ll start this investigation by looking from the tenant’s perspective.
Protection From What and of What
First, from what:
1. Foreclosure: lease termination by reason of lenders canceling out the subordinate interest that the lease represents.
2. Money defaults: for example, how to protect commitments to pay for TI allowances.
3. Performance default: for example, landlord’s work and building services (everything from HVAC to keeping the passenger cab brass shiny and fresh flowers in the lobby).
4. Overall, landlord bankruptcy, and the adverse consequences to the commercial tenant.
Second, with what (to the tune of “Here Comes the Sun”–not exactly, but don’t lose hope; all is not lost):
1. SNDA: Subordination, Non-Disturbance and Attornment Agreement: The Lender agrees that if it forecloses on its mortgage lien, the lease will not be “disturbed”; tenant’s rights are (with various caveats) protected (especially important if tenant is investing significant money in its initial installations).
2. Letter of credit, attorney escrow account: to secure landlord’s financial obligations to tenant, or as another alternative …
3. Rights of set-off (set-off against fixed rent and other payments coming due under the lease).
4. Self-help: Hire someone to perform the work required, at the landlord’s expense.
5. Rights of recourse: A landlord in financial distress may reduce building services, maintenance or capital improvements to the property in order to save money. (Off-topic tenant-leasing tip: lease language–provide a very specific level of service).
Tenant then looks at:
6. Legal action (including claim of constructive eviction) for a wide range of relief, such as damages, rescission, or specific performance. (Practical problem: It’s time-consuming and may not give sufficient protection.)
(Pssstt–really practical pointer: Go with a quality landlord–one with a good reputation and no mortgages in default etc. That, dear reader, is 99 percent of the battle.)
Space limitations mean we can’t go into a detailed discussion of each point, but let’s do a Richard Dawson-style “number one answer”:
SNDA: Subordination, Non-Disturbance and Attornment Agreement.
Subordination: The tenant agrees that the lien or priority of its lease is expressly subordinate to the lien of the mortgage.
Non-Disturbance: The lender agrees that if it forecloses against the landlord’s interest, terminates same, it will leave the tenant alone; it will not disturb (disrupt) the tenant, not terminate the lease; and
Attornment: The tenant agrees that if through foreclosure the lender or some other party succeeds to the landlord’s interest, then the tenant will recognize (attorn) (turn) to the new party as its landlord for all purposes under the lease.
O.K. So we’ve all agreed, the latest chapter in our real estate saga is aptly titled “Dark Clouds on the Horizon” (a little spooky, no?). But let’s say you’ve requested and have the clout to get an SNDA from the landlord’s lender. What does the SNDA look like? Fair and balanced? Not at all. It is a totally lender-oriented form. So what’s the downside for the tenant in the seven pages of single-space verbiage? Isn’t it enough to say, “Hey, I got my SNDA?”
No, it is not. We read carefully and we see, for example that if the lender becomes your new landlord, it is not bound by any prior landlord lease defaults and no right of offset survives. So from the get-go, kiss goodbye that unfunded, unsecured $600,000 in TI money and the carefully crafted rights of set-off against rent your street-smart attorney negotiated. Free-rent periods in the third and sixth lease years? Nope, those get jettisoned. Also, you’ll likely see specialized insurance provisions to the effect that the lender can glom all casualty proceeds, thus effectively emasculating important lease provisions regarding the landlord’s restoration obligations; and it’s also been pointed out that certain hard-fought-for special protections in the event of a claimed default may be also be sacrificed.
Bottom line is that the SNDA is more than a mere lease-housekeeping checklist item. The SNDA can be a two-edged lease-altering sword with–per the above examples–some very unpleasant repercussions for the overly trusting or altogether too casual tenant team.
Jeffrey Margolis is founding principal of the Margolis Law Firm in New York City where he specializes in “dirt law”–buying, selling and leasing. He writes monthly for The Commercial Observer on legal issues. This discussion as to protecting tenants, subtenants and their brokers from landlords in distress will continue next month.