Commercial Leasing: Should You have a Non Disturbance Agreement?
The tenant who is entering into a new commercial lease typically focuses on the basic business terms of the lease: amount of rent, cost of utilities, and length of term. However, there are a number of additional important issues that often get overlooked by the tenant in negotiating the lease. This article focuses on one of those issues: Should the lease require the landlord to provide a non disturbance agreement from its lender? A non disturbance agreement is a document whereby the landlord’s mortgage lender agrees that the tenant may remain in possession of the premises if the lender takes the property back in foreclosure. Without a non disturbance agreement, the lender may be able to foreclose on the property and require the tenant to vacate the premises. Consider the following situation:
A tenant wishes to lease 4000 square feet of space in an office building for use as a medical practice. The tenant intends to spend about $75,000 at the inception of the lease to make the space ready for occupancy. The landlord and tenant execute a five year lease at below market value—the rental rate is low because the landlord recognizes the value that is added by the tenant’s renovations. The tenant remodels the premises by adding patient exam rooms, carpeting, interior partitions, cabinets, and countertops, and then enjoys the first lease year without problem. In the second lease year the landlord suffers economic distress and fails to make mortgage payments to the lender who holds a mortgage on the office building. The lender files a foreclosure action and names the tenant as a defendant, seeking to take possession of the property free from the tenant’s lease. The lender successfully forecloses on the property and the tenant is removed from the premises. This situation results in an unhappy tenant who has spent $75,000 improving space that it no longer occupies, and who has lost the benefit of having low rent payments. What can a tenant do to protect itself from this happening?
As part of the lease negotiations between a landlord and tenant, the tenant may ask the landlord to provide a non disturbance agreement from its lender. If the landlord is willing to accommodate this request, the landlord will provide a copy of the proposed lease to the lender and request a non disturbance agreement. Usually the document provided by the lender will be in the form of a Subordination, Non Disturbance and Attornment Agreement sometimes referred to as an “SNDA.” A commercial lender typically has its own SNDA form that includes three components: 1. subordination, 2. non disturbance, and 3. attornment. The subordination part of the document normally will have the tenant acknowledging that the lender’s mortgage is superior and the tenant’s lease is inferior in priority. The non disturbance part of the document will include a provision whereby the landlord agrees that if the tenant is not in default, the lender will not disturb the tenant’s possession provided the tenant honors its obligations under the lease. Attornment is the tenant’s agreement to acknowledge the lender’s rights, accept the lender as the landlord, and to pay rent to the lender.
Although many lenders will agree to a non disturbance provision whereby the tenant remains in possession, most lenders will limit their affirmative obligations under the lease and will not accept responsibility for actions other than allowing continued possession. For example, if a lease states that in the third lease year the landlord will remodel the restroom at landlord’s cost, the lender will likely not be willing to honor this affirmative burden. Therefore, the tenant may end up with the ability to stay in the premises but will not be entitled to have the premises remodeled. The SNDA from the lender often will provide:
a) the lender is not liable for any act or default on the part of the original landlord under the lease;
b) the lender is not responsible for the commencement or completion of any construction or any contribution toward construction or installation of any improvements upon the demised premises;
c) the lender is not responsible to honor any prepayment of rent or deposit for more than one month in advance, rental security or any other sums deposited with the original or any prior landlord under the lease and not delivered to lender; and
d) the lender shall not honor any right or option to purchase the property or any part thereof.
A tenant should give thought as to whether his particular situation merits the time, energy and expense that will be used in efforts to obtain a non disturbance agreement. If the lease is a short term lease, the parties will rarely seek a non disturbance agreement because foreclosure actions may take months to complete. A non disturbance agreement is more important if a tenant will sustain significant expense and damage if forced to relocate or if the tenant is contributing a significant amount of its own money for renovations and improvements. Under most loan documents the lender is not obligated to execute an SNDA. However, many lenders will cooperate in granting some form of non disturbance agreement in order to help their borrowers find acceptable tenants, thereby increasing cash flow. The lender will consider the financial terms of the lease in determining whether to grant an SNDA. In the factual case presented above, it is likely that the lender will refuse to issue a non disturbance agreement because the monthly payments under the lease were established at a low rate.
If the landlord or lender is unwilling to provide a non disturbance agreement the tenant should take this into consideration when negotiating the terms of the lease. The tenant should assess the risk of whether the landlord is likely to default on its mortgage loan and consider the impact that a forced removal from the premises will have on the tenant’s business. The tenant may want to restructure the lease transaction. For example, it may be better to have the landlord make the initial leasehold improvements at landlord’s expense in exchange for tenant paying a higher monthly rent. In this event, the tenant will not lose the funds spent on renovation if it loses possession through foreclosure. A tenant who has considered the consequences of foreclosure can help protect itself from negative consequences.
If you would like additional information regarding this article, please contact Terri Costa a firstname.lastname@example.org or (941) 329-6617.