Who’s on Top? Tenants, Subordination and Foreclosure

It is a standard provision in nearly every lease that the lease will be “subordinate” to the lien of any mortgage on the leased property.  While there are variations on exactly what the lease might say and exactly what problems may arise, this seemingly boiler-plate language can cause big trouble for a tenant. 

A subordinated lease is “under and subject” to a mortgage on the leased property.  At its most basic this means that the mortgage lender can strip the tenant of its lease if the mortgage lender forecloses on the mortgage.  This is particularly likely in the case where the lease rental is below market or otherwise thought by the bank to be too favorable to the tenant.  If the mortgage lender forecloses on the property and thinks it can get higher rent or a better deal from a new tenant, the mortgage lender may be highly motivated to terminate the tenant’s lease.  Conversely, if the lease is at a commercially reasonable rental that favors the landlord, the tenant is much more likely to be secure. 

As a result, a prospective tenant should take steps to protect itself.  If a prospective tenant is planning on doing a significant fit-out or otherwise investing a large amount of money in a space, he should ascertain whether his landlord has a mortgage on the property, and, if so, the prospective tenant should seek a “Nondisturbance Agreement” which would provide that in the event of foreclosure the lease would remain in full force and effect provided that the tenant is not in breach of the lease.  The prospective tenant is not always in a very favorable bargaining position when asking for such a Nondisturbance Agreement, however if the lender values the lease and wants to preserve the amount of lease revenue earned on the property, the lender will sometimes agree to such an agreement.   

Another situation involves a property where the lease is older than (prior to) the mortgage.  This happens most often when the landlord sells his rental property to a buyer taking out a mortgage for the purchase money or when the owner/landlord simply refinances the property.  In such a case, the mortgage is subordinate to the lease, meaning that a bank taking back the property or a buyer at a sheriff sale would be stuck with the tenant’s lease.  Banks and other  mortgage lenders  are seldom content with this situation.  The typical response of the mortgage lender is to provide a “Subordination, Nondisturbance and Attornment Agreement” to the tenant.  Under such an agreement the tenant agrees that the lease will be subordinate to the mortgage; however, if the tenant does not breach the lease, the mortgage lender or the buyer at a sheriff’s sale remains bound by the lease.   Generally, this is a mutually agreeable arrangement.  It gives the tenant the right to stay provided that he has not breached the lease. The lender/buyer, on the other hand, is now like any other landlord-it can get rid of a tenant that is in breach of its lease, but it gets the benefit of keeping the lease if the tenant is a good one.

This is only a general description of the effect and value of having (or not having) a “Nondisturbance Agreement” or a “Subordination, Nondisturbance and Attornment Agreement.”   The terms of these agreements vary from bank to bank, and the scope of the subordination clauses in leases vary from lease to lease.  If you are a prospective tenant about to sign a lease with a property that has a mortgage, it would be advisable to consult with an attorney, if only to clarify your rights with respect to the mortgage lender.  Moreover, if you are an existing tenant who is presented with a Subordination, Nondisturbance and Attornment Agreement by your landlord, it can be vitally important that you discuss it with an attorney.

— Rod Fluck



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