Justin Leach-Waller: New Economy, New Worries: Protecting Leased Facilities from Foreclosure

By Justin Leach-Waller

Without a doubt, the new economy is bringing about new concerns. This is especially true for tenants who are investing heavily in upfit to their premises or for tenants whose facility locations are critical to their supply chain or other operational needs. All tenants, but particularly those in the aforementioned situations, should take a few steps to protect themselves against the effects of an increasingly prevalent occurrence in today’s market: a foreclosure.

Here are the steps I’d suggest:

 Know the owner and understand the capital stack. In the ordinary course of business, tenants sometimes fail to investigate the way a facility is held and financed. Often, tenants are lulled into a false sense of security when doing business with a “name brand” real estate operator. In some cases, tenants are not aware that the familiar, “blue chip” company merely manages the facility for another entity that may be quite troubled financially. Furthermore, in recent years, even highly regarded institutional landlords have been utilizing very aggressive debt structures in acquiring real estate assets. If a property is not well capitalized, the owner may not be in position to fund improvements or maintain the project adequately. Ultimately, if rents decline, vacancy rises or existing debt matures, the property could go into foreclosure. To help avoid the fallout of a foreclosure, tenants and their advisors should seek a thorough understanding of the ownership status, as well as the debt and equity structure on a facility, before renewing a lease or committing to a new building.

 Get an SNDA. This ancillary agreement – often overlooked and forgotten – has become a no-brainer for tenants in today’s financial environment. Regardless of the owner’s financial strength, when a facility is financed, it is important to obtain a subordination, non-disturbance and attornment agreement (SNDA) from the landlord’s lender. Requiring the SNDA at lease execution is the best practice to ensure that the SNDA gets signed, and also because that is typically the time when the tenant has the most leverage to negotiate revisions to the lender’s standard form. Although it seems illogical that a lender would terminate a lease and suspend its rental stream when foreclosing upon a property, in today’s environment some lenders are using the foreclosure process as a bargaining chip with tenants – threatening to terminate the tenant’s lease unless the tenant agrees to any number of concessions (e.g., increased rent, reduced parking, etc.). Having an SNDA in place will help prevent this unfortunate situation, where the lender has the power to renegotiate a lease for its benefit.

 Require an escrow for TI funds. Finally, in cases where a landlord provides a tenant improvement allowance, the tenant should require the landlord to escrow the funds or, alternatively, reserve the right to offset rent if the landlord defaults in payment. Furthermore, when negotiating the SNDA, it is important to require the lender to perform the landlord’s construction work, if any work remains incomplete, and to pay the allowance and/or recognize the tenant’s offset right, if the TI funds remain unpaid, upon foreclosure. These steps will ensure that the tenant receives the benefit of its bargain even if the property goes into foreclosure.

Justin Leach is a partner at Waller, Nashville’s largest and oldest law firm. He provides counsel to both landlords and tenants in all types of commercial real estate transactions and serves institutional users of real estate in a variety of industries, including healthcare, retail, office, manufacturing, logistics and hospitality.