LEASE AGREEMENT REFERENCE GUIDE 390: SUBORDINATION IN COMMERCIAL LEASES $24.95
Subordination - A Review of the Basics
This LARG looks at issues related to subordination clauses and nondisturbance agreements. The first portion of this LARG reviews the basics of subordination, and the Lease Clause Critique analyses a pro-landlord subordination clause. The article entitled "A Tenant's Subordination Checklist" reviews subordination issues from the perspective of the tenant.
The mission of the subordination clause in the lease is a simple one--it ensures that the lien of occupancy leases for real estate projects are and will remain subordinate to the project's financing. However, that simple objective usually precipitates a clash between the interests of the tenant, the landlord, and the landlord's lender during lease negotiations. The tenant must be extremely concerned with the details in the subordination clause, since without a nondisturbance agreement from the lender, his subordinate lease will be terminated in the event of a foreclosure. As a result, almost every alert tenant will condition the subordination of his lease upon his receipt of a nondisturbance agreement executed by the project's lender; that agreement provides that the tenant's possession will not be disturbed in the event of foreclosure unless the tenant is in default.
The landlord looks for maximum flexibility in the subordination language contained in the lease in order to minimize financing difficulties for the project. The landlord wants language that will just about give the project's lender anything it wants regarding subordination of space leases. The landlord's wish list on subordination goes considerably beyond the tenant's bare promise to subordinate his lease to project financing; it obligates the tenant to attorn to a foreclosing lender or its successor, requires the tenant to amend the lease with "nonsubstantive modifications" if the lender so desires, and contains a promise by the tenant to enter into an entirely new lease on the same terms and conditions as the original lease for the balance of the lease term in the event of a foreclosure if the lender is concerned about financing and lease priority issues.
The Lender Perspective
The lender looks at the language contained in the subordination clause in the lease with great care. If it has to foreclose on the project, it wants to satisfy itself that the property can be disposed of to a purchaser without financing and lease lien difficulties. If certain leases contain provisions objectionable to the lender, he wants the opportunity to have them changed before he forecloses and takes possession.
Examples of items objectionable to the lender include tenant rights to withhold or deduct money from rental payments due under the lease, unusual landlord duties to restore the project in the event of condemnation or casualty, and unusual tenant remedies for landlord defaults, especially those relating to landlord obligations for maintenance of the project. While most tenants probably would properly regard such items as substantive parts of the lease, many "modifications" clauses provide for arbitration of disputes between the lender and the tenant about what's substantive. The tenant would be wise to take a close look at the mechanics of the arbitration process set out in the lease--usually if he loses the arbitration, he must agree to the modifications or face the termination of his lease.
Although the subordination clause appearing in the body of the lease contains the basic agreement between the landlord and the tenant concerning subordination, much of the negotiation regarding subordination issues arises when the nondisturbance agreement (also sometimes called a recognition agreement) is executed between the lender, the landlord and the tenant. Since an informed tenant will invariably condition his agreement to subordinate his lease upon the receipt of a nondisturbance agreement executed by the lender, this document is usually part of the lease negotiations; frequently it pops up at the very end of the deal.
The nondisturbance agreement is a financing document with a scope that has been expanded over the years. While initially it merely contained the lender's promise that it would not terminate subordinate tenant leases in the event of a foreclosure if the tenant was not in default under the terms of the lease, it grew to cover many issues in which the lender had an interest. For example, nondisturbance agreements frequently contain language covering the following points: