*Please see the downloadable forms attached at the end of this article (Exhibits A – E)
Retailers are often creative, entrepreneurial types who focus on the big picture items at which they excel; namely, how to successfully locate, open and operate profitable retail businesses. Far too often, the admittedly somewhat mundane issues relating to title and ownership of a property get overlooked in the initial rush to get the lease signed and the business up and running. However, ignoring those issues can have grave consequences, as illustrated in the following scenarios:
Scenario One
You expend a significant amount of time and money locating the perfect site for your retail business, only to discover that the owner of the site has entered into an agreement to sell the property to a third party. Since you are eager to secure what you believe is your ideal space, you decide to contact the third-party purchaser and spend several months negotiating the terms of a lease, rather than waiting until the acquisition by the purchaser is concluded. Once the lease is signed, you proceed to draw your store and begin the permitting process. You then receive a call from the prospective purchaser, informing you that its negotiations with the owner have fallen apart and that it will not be acquiring the property after all.
Scenario Two
In your search for retail space you find a location that is currently leased to another tenant which no longer needs the space because of its financial situation or current needs, but which it is offering for sublease at a very attractive rate. You jump at the opportunity, enter into a sublease, build out the space, open for business, and the store performs beyond your wildest expectations. Shortly thereafter, you receive a letter from the owner of the property, informing you that your sublandlord’s lease has been terminated because it is seriously delinquent in rent, and that you will therefore need to immediately vacate your space.
Scenario Three
You have concluded that there is no existing space in a certain market that meet your needs so you decide to enter into a 30-year ground lease with the owner of property located in a good location and spend hundreds of thousands of dollars building a store tailored to your requirements. Shortly after you open you are notified that you built your store directly on top of a utility line that serves adjoining properties, as set forth in a recorded utility easement of which you were unaware, that the county is foreclosing its tax lien on the property as a result of the owner’s failure to pay real property taxes for the last 10 years, and that the county plans to sell the property at auction in connection therewith.
Scenario Four
You have been operating at a location for several years in which, through your hard work, you have built a loyal customer base and, as a result, have one of the best-performing stores in your chain. You suddenly receive notice that your new landlord is XYZ Bank, which has acquired the property in a foreclosure as a result of your original landlord’s default on its loan with the bank. Shortly thereafter, you receive a notice informing you that the bank is terminating your lease and that you are to vacate your premises within 30 days.
In each of the above scenarios, you will be at risk of losing hundreds of thousands, if not millions, of dollars in site selection, lease negotiation, legal, architectural, engineering, permitting, construction, and relocation costs and expenses, as well as lost profits and loss of good will. What can you as a savvy retailer do to protect yourself from such occurrences?
Scenario One—The method by which a retailer can protect itself in this scenario is simple and straight forward yet often overlooked. First of all, in any leasing transaction you should, at a minimum, request that the landlord provide you with reasonably-satisfactory evidence that the landlord owns the property you are interested in leasing. This can take the form of an existing title report, an existing tax bill, and/or a copy of the recorded deed conveying the property to the landlord. In addition, in those instances in which, as depicted in this scenario, you elect for business reasons to deal with a prospective purchaser of the property prior to its acquisition of title, you should include in the lease an express title contingency provision that conditions your obligations under the lease on the purchaser delivering to you reasonably-satisfactory evidence that is has acquired title by a specific date. If the purchaser fails to do so, you should have the right to terminate the lease at any time before the date on which it provides such evidence to you. In addition, if you do, in fact, exercise your termination right, the purchaser should be obligated to reimburse you for all of your expenses incurred in connection with the lease and return to you any prepaid rent, security deposits, etc. that have been paid pursuant to the terms of the lease. A form of such a title contingency provision is attached to this article as Exhibit A.
Scenario Two—Any retailer that enters into a sublease as set forth in this scenario has the right to feel insecure. Since a sublease does not establish a legally-binding relationship between you and the landlord, you must not only abide by the terms of your sublease with your sublandlord, but you must also be concerned that your sublandlord will somehow lose its underlying lease (the “Prime Lease”) with the landlord. Since a subtenant’s rights derive solely from the Prime Lease, you lose your right to possession of the premises if and when the Prime Lease is terminated, absent some sort of direct agreement with the landlord.
You can protect yourself to a certain extent by making sure your sublease gives you certain rights with respect to the sublandlord. For example, the sublandlord should be prohibited from voluntarily terminating the sublease, and the sublease should obligate the sublandlord to provide you with any notices of default from the landlord, together with the right to cure the same if the sublandlord does not. However, this will do you no good if the sublandlord violates those obligations and the Prime Lease is terminated as a result. Moreover, there are limits to this approach, such as when a sublandlord files bankruptcy.
To avoid being evicted in the event the Prime Lease is terminated, you should expressly condition your sublease obligations on the landlord recognizing you subtenancy by executing and delivering to you what is commonly referred to as a “recognition agreement” prior to your execution of the sublease or within a short time thereafter. A form of prime landlord consent contingency provision is attached as Exhibit B. A recognition agreement, a basic form of which is attached hereto as Exhibit C, ideally should provide that, if the Prime Lease ever terminates, the landlord will recognize you as a direct tenant on the terms and conditions set forth in the sublease. As a fallback, in order to obtain the agreement, you may sometimes be forced to agree to live with the terms of the Prime Lease (rather than the sublease) as equitably applied to the subleased space, even though this obviously is not the preferred approach for subtenants.
Whether or not a landlord will agree to sign a recognition agreement is another matter. In soft markets or to secure a strong credit tenant, the answer is probably yes. In healthier markets or for smaller tenants, an owner will most likely look at a number of economic considerations before it agrees to a recognition agreement, including (i) whether it thinks the market will decline or improve during the sublease term, (ii) how the rent it will get from you as a subtenant compares to the costs the landlord will incur in reletting the space, such as brokers’ commissions, remodeling costs and lease concessions, and (iii) whether the owner is likely to find a larger tenant to take both the sublandlord’s space and any adjacent space that is available.
Scenario Three—In situations in which you are ground-leasing property and constructing a store on that property, or in store leases in which you are investing significant amounts of your own money in leasehold improvement, you should definitely obtain leasehold title insurance coverage to avoid the doomsday consequences depicted in this scenario. Unfortunately, even though title insurance is commonly used in purchase and loan transactions, it is still not regularly used by tenants to protect themselves when they enter into leases.
Part of the reason for this is undoubtedly that, for many years, leasehold title insurance was truly of little value. From 1975 through 2001, the American Land Title Association (“ALTA”) utilized a leasehold policy that (i) was designed for space leases rather than for ground leases or leases of entire buildings, (ii) made it very difficult to determine the appropriate amount of insurance, and (iii) provided remedies of very limited use.
However, all of that has changed. Since October 13, 2001, all of the leasehold policies have been withdrawn by the ALTA and leasehold coverage is now provided solely through a leasehold endorsement attached to a standard owner’s policy of title insurance (ALTA Endorsement 13). That endorsement, the form of which is attached as Exhibit D, provides coverage for both loss of possession and loss of right to use the premises for a particular use. It compensates the tenant for loss of its leasehold improvements, loss of the remaining lease term, and incidental damages, including relocation costs. Therefore, it should be used whenever you are spending a significant amount in tenant leasehold improvements, much as it would if you were actually acquiring title to the real estate.
Scenario Four—There are very few retail projects today that are owned outright by landlords. The vast majorities of projects are or, during the course of any particular retail lease, will be encumbered by financing and loan documents securing that financing. For this reason, you need to be cognizant of the inherent risk associated with such financing, which is that your lease could be terminated by the lender’s foreclosure action, and you should address that risk upfront in the lease in order to avoid the termination notice received by the tenant in this scenario.
The way you should address the risk is to require that the landlord’s lender provide you with a subordination, non-disturbance and attornment agreement (“SNDA”). An SNDA sets forth certain agreements between you and the lender, relating primarily to what happens if your landlord defaults on its loan and the lender forecloses its security interest in the property and suddenly becomes your landlord under the lease. The landlord also often signs the agreement or at least consents to it.
To accomplish its goals, an SNDA typically includes the following elements:
- A subordination provision, pursuant to which you agree that your lease is subordinate to the lender’s financing documents.
- A non-disturbance provision, pursuant to which the lender agrees that, if it completes a foreclosure or similar action against your landlord, the lender will not disturb your right of possession of your premises.
- An attornment provision, pursuant to which you agree to attorn to, or recognize, the successor landlord as your new landlord if the lender ever completes a foreclosure, and the lender agrees that the successor landlord will perform the landlord’s contractual obligations to you under the lease.
- A successor landlord’s protection provision, pursuant to which the successor landlord, after foreclosure, is protected against certain problems that might have arisen under the lease before foreclosure.
The lease should therefore obligate the landlord to provide you with an SNDA from all future lenders. A tenant-friendly form of SNDA is attached hereto as Exhibit E. The obvious question that remains is what to do with respect to a lender who already has a lien on the landlord’s property when you enter into your lease. An existing lender has no obligation to grant non-disturbance protection to a subsequent tenant and does not have very much to gain from doing so since the lease is already subject to the lender’s recorded financing documents. In such cases, the best you can do is to simply ask for an SNDA, unless you wish to make your receipt of one a condition of the deal. Nevertheless, many existing lenders often will agree to grant non-disturbance protection to a subsequent tenant because they want the security of knowing that, upon foreclosure, they will have rent-paying tenants ready to attorn to them, thereby maintaining the property’s income stream.
Therefore, in order to protect your significant investment in the leasing process and tenant improvements, preserve the profits you hope to generate, and avoid the costs of unexpectedly losing your lease, you should pay close attention to title and ownership issues and negotiate into the lease document those protective devices discussed in this article that apply to your specific circumstances. Your failure to do so could truly be disastrous.
