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CREDIT TENANTS GET WISE TO SNDAS

By David P. Kassoy

Lenders love the financial strength of creditworthy national and regional chain stores, or "credit tenants." They often find problematic many of the favorable lease provisions that tenants, because of their financial strength, are able to negotiate. Although leases with credit tenants are the best assurance that loans will be repaid, borrower defaults cannot be ruled out.

Therefore, shopping center owners seeking to finance or refinance their centers regularly ask credit tenants to sign Subordination, Nondisturbance & Attornment Agreements for the benefit of their lenders. In fact, securing SNDAs from credit tenants is routinely a contingency to the funding of a loan.

Terms of the SNDA

Understandably, a lender wants to be sure, if it has to resort to foreclosure, that the proceeds from the sale of the shopping center first are applied to the repayment of its loan. Therefore, lenders require that the lien of the mortgage or deed of trust on a shopping center have priority - not only over other liens but also over existing lease agreements.

Under an SNDA, a lease entered into after a loan is made is deemed to be junior in priority to the loan (i.e., a junior lease). Correspondingly, a lease already in existence at the time of the loan has priority over the loan, but it likewise can become a junior lease if the tenant agrees to it being subordinated to the loan.

That, of course, is one of the intended effects of an SNDA. A junior lease, like a junior lien, can be "wiped out" (i.e., become unenforceable) as a result of the foreclosure of a senior lien.

In the case of a junior lease, the tenant can lose its lease as a result of a foreclosure - even if it wants to remain in possession under the terms of its lease and is willing to continue paying rent after the foreclosure. The new landlord (the "foreclosure purchaser") is also in jeopardy if a creditworthy or other valuable tenant exercises its right as a "wiped-out" tenant to vacate the premises with no further obligation to pay rent.

For a lender, it's not enough simply to have lease provisions that obligate tenants to be bound to the foreclosure purchaser. Instead, lenders generally want an agreement directly with the tenant, via an SNDA, before they will make the loan to the landlord.

In a typical SNDA, the tenant agrees to subordinate the priority of its lease to the lender's loan. The tenant also agrees that in the event of a foreclosure by the lender, it will attorn to the foreclosure purchaser (i.e., become contractually bound to the foreclosure purchaser under all terms of the lease).

In exchange, the lender agrees that the foreclosure purchaser will not disturb the tenant's right to possession of the premises - even if the lease has by virtue of the SNDA been rendered junior to the loan - so long as the tenant is not in default under the terms of the lease.

Lender-Drafted vs. Tenant-Drafted

In some lender-drafted SNDAs, however, attornment is applied in only one direction: The foreclosure purchaser isn't required to assume all of the landlord's obligations under the lease, even if the tenant pays the rent and otherwise complies with all of its obligations under the lease.

In other lenders' forms, the foreclosure purchaser may be required to attorn to the tenant, but only if certain landlord obligations are waived in the event of a foreclosure. Usually, the lender's form will provide that certain new provisions, for the benefit of the lender and the foreclosure purchaser, be deemed added to the lease.

The conflict arises when the lender wants the tenant to continue to comply with all of its lease obligations, but the lender is reluctant for a foreclosure purchaser to be similarly obligated, particularly if landlord obligations require a foreclosure purchaser to spend money.

Indirect use of an SNDA to alter the terms of a lease is what lenders' representatives call "cleaning up the lease," as if provisions favorable to the highly desirable credit tenant will somehow besmirch the pristine character of the lease. Ideally, lenders want the tenant's signature on an SNDA to transform the lease into a "bond lease," as it relates to any foreclosure purchaser. If the lenders had their way, the foreclosure purchaser's only obligation would be to deposit the rent check.

From a lender's perspective, the lender drafted SNDA form shifts to the tenant what the lender regards as unacceptable credit risks under the loan. Depending on how the lender perceives the magnitude of its own leverage in a loan transaction, the tenant may be asked in the SNDA to waive, among other things:

• Its right to demand completion of tenant and/or common area improvements by the foreclosure purchaser;
• Its right to recover its security deposit from the foreclosure purchaser upon expiration of the lease term;
• Landlord warranties in the lease respecting use, zoning and title;
• Its right under the lease to free rent;
• Its right under the lease to any unpaid arbitration award;
• Its right under the lease to a purchase option; and
• Its right under the lease to a reduction in rent or to terminate the lease prior to expiration of the term.

In recent years, many big-box retailers have insisted upon including their own form of SNDA as an exhibit to their leases, thus nailing down and limiting the extent of their obligation if asked by the landlord to sign an SNDA. Here, landlords usually accommodate credit tenants.

Lenders, too, typically acquiesce - or at least put up less resistance - to the use of such pre-agreed SNDA forms when the issue is addressed at the outset of an underwriting.

Other credit tenants choose to use their sophistication and leverage to negotiate changes in lender-drafted SNDA forms.

The Lender Mindset

The lender, when negotiating SNDA terms with a credit tenant, wants the right to cure landlord defaults that could otherwise result in an interruption in rental. The lender also wants to make sure that, after a foreclosure, the tenant will attorn to the foreclosure purchaser. Credit tenants should not have a problem accommodating the lender on those two issues. However, in my opinion, the SNDA should not entitle a foreclosure purchaser to get rid of a credit tenant or to use that power as a threat to increase the rent. Nor should the foreclosure purchaser be exempt, necessarily, from any of the landlord's obligations under the lease after a foreclosure.

In practice, however, it may make a difference who the lender is and whether the landlord is negotiating a short-term construction loan or a long-term permanent loan. Other variables include whether the tenant is stand-alone or in-line; the kind of insurance available to the parties on that particular real estate; and whether the loan goes into the lenders' portfolio or is being packaged for sale to an originator of commercial mortgage backed securities.

The lender mindset historically has been to dispose of non-performing (i.e., delinquent) loans at a deep discount, rather than advance the money and furnish the operational expertise needed to turn a shopping center around--even when it is blessed with a credit tenant, and even when this faintness of heart can result in compounding the lender's losses.

In this age of credit lease securitization and the resulting influence on the real estate market of Wall Street credit rating agencies, the tension between lenders and credit tenants over SNDAs is not likely to abate soon. But as credit tenants become more resistant to one-sided SNDAs that expunge their hard-won concessions and lease provisions, lenders will be compelled to re-examine their requirements.

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David P. Kassoy is a senior partner in the Real Estate Department specializing in acquisitions, development, financing, investment, leasing.

This article appeared in the May 2000 issue of Shopping Center World and is reprinted with permission here. Others seeking to reprint this article should contact Shopping Center World.

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