Banking Brief: Financial Services Insights

When a commercial real estate loan goes into default, a lender's rights in the property are only part of the equation. The continued enforceability of tenant leases can significantly affect rental income, property value, and the lender's ability to maximize recovery. Uncertainty surrounding lease priority and tenant rights can create unexpected challenges during foreclosure or after a change in ownership. A subordination, non-disturbance, and attornment agreement (SNDA) helps address these issues by establishing the relationship between tenants and lenders before a default occurs. For Indiana commercial real estate lenders, understanding and properly negotiating SNDAs is an important part of protecting collateral and preserving the value of income-producing properties.

What Is an SNDA? Understanding Its Three Components

An SNDA establishes the rights and obligations of the tenant, landlord, and lender if ownership of a commercial property changes due to a foreclosure or other loan enforcement action. It generally addresses three issues:

• Subordination establishes that the tenant’s interest under the lease is subordinate to the lender’s mortgage.
• Non-disturbance generally provides that, so long as the tenant is not in default, foreclosure of the landlord’s mortgage will not by itself terminate the tenant’s right to remain in possession.
• Attornment requires the tenant to recognize the lender or successor owner as its new landlord if that party acquires the property and continue performing under the lease.

For lenders, an SNDA establishes the intended priority of its mortgage while preserving the ability to keep an important tenant in place following foreclosure.

How Indiana’s Recording Rules Impact Lease Priority

Lease priority can have significant implications for a lender's rights following a borrower default or foreclosure. Indiana law requires real estate leases exceeding three years to be recorded within 45 days of execution to protect the tenant’s interest against subsequent purchasers and mortgagees. A memorandum of lease containing the required information may be recorded instead of the full lease.

Before closing, the lender should identify all leases that affect the property and determine whether any leases or memoranda have been recorded. An SNDA for each identified lease allows the lender and tenant to establish their intended priority and post-foreclosure rights by agreement rather than relying solely on Indiana’s default rules.

Part of a lender’s due diligence concerning leases should include obtaining an estoppel certificate from each tenant pursuant to which the tenant certifies the factual details of the lease, such as the term, monthly rent, and amount of the security deposit, and that no landlord defaults exist.

Can a Tenant’s Lease Survive a Foreclosure?

A lender’s priority mortgage doesn’t necessarily extinguish every lease. In Myers v. Leedy, the Indiana Supreme Court recognized that when a foreclosing lender knows, or reasonably should know, that a tenant is in possession of the property, the tenant’s leasehold interest survives a foreclosure unless the tenant is made a party to the foreclosure action.

For lenders, the case is a reminder that tenants occupying the property should not be overlooked. A well-drafted SNDA can reduce uncertainty and avoid disputes following a foreclosure by establishing mortgage and lease priority, post-foreclosure occupancy rights, and successor-landlord obligations before a default occurs.

Considerations for Multi-Tenant Properties

For multi-tenant properties, obtaining an SNDA from every tenant may not always be practical. Lenders should focus on the leases that materially affect underwriting, collateral value, or post-foreclosure operations. This typically includes anchor tenants, significant rent contributors, long-term tenants, and leases containing material expansion, purchase, or termination rights. When obtaining an SNDA from all tenants becomes a post-closing  detail,  challenges may arise due to the loss of negotiating leverage once the loan is made.

Key SNDA Provisions Commercial Lenders Should Negotiate

Some of the most important SNDA provisions concern the obligations a lender or foreclosure purchaser will inherit if it becomes the landlord. Lenders should pay particular attention to provisions pertaining to:

• liability for defaults committed by the prior landlord;
• limitations on prepaid rent, offsets, credits, and security deposits;
• tenant improvement allowances and construction obligations;
• amendments, cancellations, or terminations of the lease without lender’s consent; and
• notice and cure rights.

These provisions can have a significant impact on a lender's rights and potential liabilities following a default, and can be tempered by addressing them in the SNDA. Working with experienced counsel to prepare and negotiate an SNDA can help preserve collateral value, maintain tenant relationships, and reduce post-foreclosure risk.