Priority of Lenders’ Lien

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PRIORITY OF LENDER’S LIEN

  1. Priority Issues. If a tenant is in possession of its premises under a lease which predates the lender’s deed of trust or if a memorandum of lease is recorded prior to the lender’s deed of trust, the lease will be senior in priority to the lender’s deed of trust. If a lender forecloses the lender’s deed of trust, the deed of trust will automatically terminate all leases which are subordinate to the deed of trust. Conversely, where the lender forecloses a deed of trust which is subordinate to a lease, the lender will take title to the project subject to the senior leases. Whether a lender desires its deed of trust to be senior or junior to the existing leases depends, to some degree, on the rent payable under the existing leases. However, as a general rule, a lender will always want all existing leases to be subordinate to the lien of the lender’s loan documents to be sure that the lender has priority with respect to the distribution of insurance proceeds in the event of a casualty, and condemnation proceeds in the event of a condemnation.
  2. Subordination Provision. A subordination provision subordinates a lease to the lender’s deed of trust. Some leases contain “automatic” subordination provisions and some leases contain provisions which allow the lender the unilateral right to elect at any time to treat the lease as subordinate to the lender’s deed of trust or to treat the lender’s deed of trust as subordinate to the lease.
  3. Attornment Agreement. An attornment agreement is an agreement by the tenant to recognize the lender (or the successful bidder at a foreclosure sale) as the new landlord under the lease if the lender obtains the landlord’s interest, whether by deed in lieu of foreclosure or by foreclosure. A tenant who executes an attornment agreement is obligated to perform under the lease for the benefit of lender upon the lender obtaining the landlord’s interest in the project.
  4. Non-Disturbance Agreement. A non-disturbance agreement is an agreement by a lender not to disturb a tenant after foreclosure so long as the tenant is not in default under the lease and the tenant is in physical possession of the premises. Frequently, a tenant will extract a non-disturbance agreement from a lender in exchange for the tenant’s agreement to subordinate the tenant’s leasehold interest to the lender’s loan documents.
  5. Subordination, Non-Disturbance and Attornment Agreements
  6. Tenant’s Perspective. The subordination, non-disturbance and attornment agreement (the “SNDA”) is the agreement which sets forth the respective rights of the landlord, tenant and lender if the project is foreclosed or if the lender takes back the project by way of a deed in lieu of foreclosure. From the tenant’s perspective, the SNDA should contain a non-disturbance agreement and, to the greatest extent possible, the SNDA should require the lender to perform all of the landlord’s obligations under the lease after foreclosure. The tenant will also want to be sure that if the lender forecloses and another entity or person takes title to the property, such entity or person will recognize the tenant’s rights under the lease.

A tenant which enters into a lease for space in a project already encumbered by a deed of trust may require, as a condition of the tenant’s obligations under the lease, that the landlord provide the tenant with a non-disturbance agreement. Because the tenant’s lease is junior to any pre-existing deed of trust, the tenant bears the risk that its lease will be terminated if the lender forecloses on its deed of trust unless the tenant obtains a non-disturbance agreement. The larger the tenant and the greater the tenant’s investment in the premises, the more important it is to the tenant to obtain a non-disturbance agreement from pre-existing lenders.

  1. Lender’s Perspective. From the lender’s perspective, the SNDA should contain satisfactory subordination and attornment clauses. A lender should draft the subordination provision broadly to subordinate the lease to any and all amendments and modifications of the loan documents and the extension or renewal of the debt evidenced by the loan documents to ensure the continued priority of the loan documents ahead of the leases irrespective of any subsequent adjustments to the terms and provisions of the loan documents.

The lender will also want to be released from certain lease terms if the lender acquires the landlord’s interest, including, among other things: (i) liability for breaches which occur prior to lender obtaining title to the project, (ii) obligations to complete or undertake capital or tenant improvements, (iii) amendments or modifications to the lease made without the lender’s consent, (iv) rent paid more than one month in advance, (v) accrued tenant offsets, claims, counterclaims or defenses, (v) obligations to return security deposits which are not received by the lender, (vi) liabilities in excess of the lender’s equity in the project, and (vii) liabilities for indirect or consequential damages, including, among other things, loss of profits, subrents or damage to good will or reputation.

The SNDA is also an opportunity for the lender to require that the tenant obtain the lender’s prior written consent to certain types of alterations and provide the lender with all notices the tenant sends to the landlord under the lease, including, without limitation, default notices. Finally, the SNDA provides the lender an opportunity to amend those terms and provisions of the tenant’s lease which the lender finds objectionable (for example, early termination rights, exclusive covenants or agreements to assume the tenant’s obligations under a prior tenancy agreement), and to provide the lender with the right, but not the obligation, to cure the defaults of the landlord upon notice to the lender before the tenant is entitled to assert any remedies under the lease.