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, a tenant who is leasing a portion of a building that is already subject to a mortgage can be assured that he can at least face a potential problem from the landlord’s mortgage lender in the event that a foreclosure occurs.
A subordinated lease is “under and subject” to a mortgage on the leased property. Essentially this means that the tenant is likely to lose its lease in the event that the mortgage lender forecloses on the mortgage. This is particularly likely in the case where the terms of the lease are 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 for commercially reasonable terms that favor 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 as of the date of the foreclosure. The prospective tenant is not in a very favorable bargaining position when asking for such a Nondisturbance Agreement; however, if the lender mortgagee 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. It will serve a prospective tenant well to seek the Nondisturbance Agreement as a part of early negotiations, so that the landlord will make it a priority to obtain it.
The alternative situation involves a lease placed on the property before the mortgage. This happens most often when the landlord sells his rental property to a buyer who obtains a mortgage for the purchase money or when the landlord simply refinances the property. In such a case, the mortgage is actually subordinate to the lease (unless the lease provides to the contrary which is not uncommon). Where the mortgage is subordinate to the lease, a bank taking back the property, or a buyer at a sheriff’s 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 lease is made 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 on the property provided that he has not breached the lease (which is exactly what the tenant was expecting). 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 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 actual terms of these agreements vary from bank to bank. 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