Subordination, non-disturbance and attornment agreements (“SNDAs”) are used to adjust the priorities between commercial tenants and lenders of the property they are leasing.  In the absence of an SNDA, the priorities between tenants and lenders are governed by state recording acts and related common law principles.  For the purpose of establishing the priority of competing liens against real estate, leases are viewed as liens.  A lease that is entered into after a mortgage has been executed and recorded is generally automatically subordinate to the mortgage because the tenant, as a result of the recording acts, is deemed to have constructive notice of the mortgage and therefore assumes the risk that its lease will be wiped out if its landlord defaults on its mortgage and the lender forecloses.  On the other hand, a lender that places a mortgage on a piece of property after an executed lease will normally be deemed to have constructive or actual notice of the lease if the lease is recorded or if the tenant has taken possession of the premises.

Since most lenders require that the lien of their mortgage be superior to all other liens against the secured property, either as a matter of preference or because compliance with statutory limitations on their lending powers requires that the lien of their mortgage be a “first lien”, a landlord that wants its property to be financeable needs to insure that its leases contain subordination clauses that either provide for automatic subordination or require tenants to execute SNDAs are essential.

In many states leases are not automatically extinguished by a foreclosure.  A foreclosing lender can preserve desirable subordinate leases at its election and avoid the automatic termination of such leases by not joining the tenants of such leases as parties to the foreclosure action or, in the event of a non-judicial foreclosure, by not giving such tenants notices of default and sale.  This opportunity on the lender’s part to “pick and choose” which leases are foreclosed puts the tenant at even more risk since it could suffer the worst of both worlds – no opportunity to get out of the lease if it is unfavorable (above market rent or an unprofitable location, for example), while the lender can terminate the lease if it is favorable to the tenant (such as when it contains below market rent).

However, subordination alone does not address all of a lender’s concerns.  In the absence of an agreement otherwise, in about half of the states, including Oregon, a subordinate lease is extinguished by completion of a foreclosure action, whether or not the tenant is joined as a party (See ORS 86.770).  The lender’s remedy for this circumstance is attornment.  Attornment is the tenant’s agreement to recognize the lender as a permissible successor landlord to the lease.  Therefore, attornment binds the tenant to the lease by creating privity of estate between the lender and the tenant.  The tenant agrees that the lease continues after foreclosure and that the tenant will recognize the lender as landlord.  Attornment is critical for lenders in states such as Oregon where foreclosure automatically terminates the lease.  In “pick and choose jurisdictions”, on the other hand, the lender does not necessarily need attornment because, as noted above, it can unilaterally control whether the lease survives foreclosure.

From a tenant’s perspective, the tenant should demand that its obligation to subordinate and attorn to a mortgagee be expressly conditioned upon receiving written assurance of non-disturbance protection from the lender should the landlord default under its mortgage.  It should be noted that, while many leases contain a provision that “this Lease shall continue notwithstanding a foreclosure of the mortgage”, such language does not protect a tenant.  The reason is because, even though the lender, as a third party beneficiary of the lease, enjoys the benefit of a tenant’s lease covenant to subordinate,  the landlord’s statement that the lease will continue notwithstanding foreclosure has no binding effect on the lender.  Unless the tenant’s obligation to subordinate and attorn to the lender is directly and expressly conditioned upon getting a non-disturbance agreement from the lender, the tenant is not really protected.

While lenders often agree to provide non-disturbance protection, most will not assume all of the landlord’s obligations under the lease. Accordingly, most SNDAs provide that the lender will not be (i) liable for any act or omission of any prior landlord, (ii) subject to any offsets or defences that the tenant might have against any prior landlord, (iii) bound by any rent that tenant might have paid to any prior landlord more than thirty days in advance of its due date, or (iv) bound by any amendment or modification of the lease made without the lender’s consent.

With respect to a lender who already has a lien when the tenant enters into its lease, the situation is quite different.  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 mortgage.  In such cases, the best a tenant can do is to simply ask for an SNDA, unless the tenant wishes to make its receipt of one a condition of the deal.  Nevertheless, many existing lenders 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.

Because of the benefits provided to both commercial tenants and lenders, SNDAs are a valuable tool that should not be overlooked in leasing and financing transactions.