This article discusses attornment, subordination and nondisturbance clauses in nonresidential lease agreements, and their use by landlords and lenders to alter the priorities of leases and trust deeds.

One grim hallmark of a recessionary market is the ensuing tidal wave of foreclosures on commercial properties — a spectacle with which mortgage lenders are all too familiar. The ongoing 2020 recession is no exception.

Given their historic losses accelerated by the COVID-19 pandemic, commercial landlords are scrambling to manage the priorities of their properties’ leases and trust deeds. This article discusses how to achieve this with attornment, subordination and nondisturbance clauses in nonresidential lease agreements. Read on to learn how to secure the most favorable terms for clients through this recessionary period and beyond.

Which has priority?

It is critical for a landlord to understand lease and trust deed priorities in order to maintain their obligations, as foreclosure can potentially upset these obligations.

A common example of this can be found in a trust deed recorded secondary to a commercial tenant’s occupancy of secured real estate that is subsequently foreclosed upon. In this case, the tenant’s lease is undisturbed by the foreclosure since it was recorded before the trust deed. Therefore, the tenancy remains in full effect under the terms of the lease agreement. At the foreclosure sale, the buyer who acquires title of the secondary trust deed does so “subject to” the lease. Since the tenant’s lease holds priority, the buyer is to perform the landlord’s obligations under the tenant’s lease agreement should the tenant seek to enforce them.

Contrastingly, if a tenant’s lease is acquired secondary to a recorded trust deed or judgment lien   that is then foreclosed upon, the tenant’s lease is completely voided as a result. Following the elimination of their lease at a foreclosure sale, the tenant loses their right to possession of the premises. [Hohn v. Riverside County Flood Control and Water Conservation District (1964) 228 CA2d 605]

Understanding priority is critical for tenants as well, who have limited options in a foreclosure. Invoking frustration of purpose presents a prohibitively high bar to clear and force majeure is unlikely to apply. And yet, most commercial tenants have continued to operate during the pandemic, often in a limited or altered capacity. These leases typically don’t allow for a tenant to withhold their rent regardless of the circumstances. At most, a lender and tenant may agree to decrease or delay rent payments, as is being advised by Coldwell Banker with most new lease agreements in the wake of COVID-19.

Lenders, on the other hand, have a few tools in the form of provisions that ensure their interest in a property takes priority. Commercial lease agreements often contain boilerplate provisions such as a lender subordination clause, a future subordination clause, a nondisturbance clause and an attornment clause. These provisions bundled together are collectively known as an SNDA agreement. They relate to the priority of the lease against trust deeds present and future and confirm the rights of lenders to foreclose and receive rents.

Subordination provisions make the lease secondary or subordinate to mortgages and trust deeds in favor of the landlord’s lender in the event of a loan default. Unless a tenant’s lease agreement was entered into before a lender’s trust deed was recorded or their loan was subordinated a tenant’s leasehold interest is eliminated upon completion of a foreclosure sale.

Subordination clause

A lender subordination clause gives a trust deed lender the right to make subordinate the tenant’s lease by written notice to the tenant. Thus, the lease would not be wiped out by a foreclosure of the lender’s trust deed since the trust deed has been subordinated and the lease has priority. A lease agreement containing both a lender subordination clause and an attornment clause allows the lender the maximum flexibility for preserving an advantageous lease by either:

  • electing to subordinate their trust deed to the lease before the foreclosure sale; or
  • completing a foreclosure saleand electing to enforce the lease agreement within the attornment election period.

What about a landlord who expects to further encumber their property in the future? Under a future subordination clause, the tenant agrees to subordinate their lease to a trust deed to be recorded in the future. Here, the tenant remains involved since they need to sign a specific subordination agreement to give the trust deed priority to their lease. The subordination clause is rarely optional for a tenant, and for this reason, is often coupled with a nondisturbance clause.

Nondisturbance clause

When included, a nondisturbance clause entitles the tenant to receive a signed writing from a new trust deed lender agreeing that the lease will remain in effect for its full term. This is in spite of the fact that the tenant concurrently signs a specific subordination agreement giving the lender’s trust deed priority.

In this scenario, a lender forfeits their independent ability to change lease terms or rent after the foreclosure sale, thereby haunting the lender in an economic downturn when foreclosures occur. A nondisturbance agreement is a sort of self-destruct provision in that it negates the effect of the subordination. It achieves this by reversing the very priorities agreed to in subordinating the lease to the trust deed. In the execution of a nondisturbance agreement by a lender, an attornment clause serves no purpose and becomes superfluous.

Attornment clause

The attornment clause is another crucial tool for managing lease and trust deed priority. It allows an owner-by-foreclosure to unilaterally avoid the elimination and unenforceability of a junior lease and instead obliges a tenant to recognize the new property owner as their substitute landlord.

There are a few rules to keep in mind when considering an attornment clause. The new owner loses the right to enforce the attornment clause if no time period for enforcing recognition of the new owner is specified or the new owner does not elect to enforce the lease within a reasonable period of time. Additionally, the owner-by-foreclosure may choose to extinguish the lease under the attornment clause and notify the tenant to vacate the premises through a three-day notice to quit due to foreclosure.

Note that attornment clauses are often preceded by a due-on provision in the trust deed stating the owner may not sell, lease or encumber the secured property without the prior consent of the lender. This provision is also referred to as a transfer or alienation clause. In our earlier example regarding the changing priority of a lease or trust deed, the containment of an attornment clause might have benefitted a tenant whose lease was secondary to a trust deed, should the owner-by-foreclosure choose to enforce it and restore their eliminated lease.

Enforcement of an attornment clause

Upon their acquisition of the property, the lender may choose to enforce the attornment clause. In this case, the lender is to mail a written notice to the tenant stating they are their new substitute landlord under the lease agreement and rents are to be paid to them. The attornment clause contracts around the permanent elimination of a junior leasehold interest on completion of a foreclosure sale by a senior trust deed lender. It allows the purchaser at the lender’s foreclosure sale to restore the extinguished lease as though it were unaffected by the foreclosure sale.

The lease is restored and reattached to title after the foreclosure sale when the lender (or other purchaser at the foreclosure sale) exercises the right given under the attornment clause to enforce the lease agreement as the new substitute landlord. [Miscione v. Barton Development Company (1997) 52 CA4th 1320]

On the other hand, an attornment clause agreed to by a tenant to recognize the buyer as their landlord is not exercised until the buyer elects to enforce those provisions. It does not give a tenant the reciprocal right to enforce the lease agreement against the buyer at a foreclosure sale. Therefore, a tenant has no assurances their lease will be restored or that they will be able to remain in possession after a foreclosure sale.

It is a common misconception by tenants that an attornment clause is likened to a nondisturbance clause with the lender, but it is not as the lender is not a party to the lease agreement. A lender is unlikely to enforce a junior lease when either the new owner acquired it to occupy it as a user or the rents due under the lease are significantly under market rate.

A tenant’s few saving graces

Together, these clauses are especially helpful during an economic downturn. The likelihood of these events converging during a recession warrants SNDA agreements for lenders and landlords. For a tenant to avoid the unilateral adverse economic impact of an attornment clause upon entering into a long-term lease under an agreement containing the clause, the tenant needs to:

  • obtain an abstract of title or lessee’s policy of title insurance to ascertain the trust deeds and other liens of record and the risk of loss they present to the tenant;
  • obtain a beneficiary’s statement on the loanss/liens of record;
  • record a Request for Notice of Default; and
  • record a Request for Notice of Delinquency on the lender. [See RPI Form 412]

With these documents, a tenant can take steps to protect their interest when the landlord defaults on senior liens or the underlying ground lease, long before any foreclosure sale occurs. This strategy represents the tenant’s best protections against a business foreclosure due to COVID-19.

Armed with the knowledge of how to properly execute SNDA agreements, licensees can help protect their landlord clients’ interests and secure the most favorable terms even in an economic downturn.