Non-disturbance agreements gaining popularity.

If an owner loses a building to a mortgage holder, are the tenants protected under terms of their existing leases? This question is one of the main reasons why "non-disturbance and attornment" agreements have become an increasingly common component of commercial leases in the last few years, says John Loehr, a partner in the New York City law firm of Wien. Malkin & Bettex.

A non-disturbance agreement is made between a tenant and the owner of a position, interest or claim having priority over that of the tenant's direct lessor, such as the mortgagee or the fee owner (if a building is subject to a long term lease).

Under such an agreement, the holder of the superior interest agrees not to disturb the tenant's possession of the space under its lease, while the tenant agrees to "attorn to the grantor" - i.e., recognize the grantor as landlord and be legally bound to that party under the tenant's lease if the grantor ousts the landlord and succeeds to its interest.

"In a sense, the non-disturbance agreement is like an insurance policy protecting the tenant against someone else's catastrophe," says Loehr. "However, in reality, institutional mortgagees seldom seek to join tenants in foreclosure proceedings - which would deprive a building of the rent stream the tenant represents - unless the rent is egregiously low in relation to the market."

Non-disturbance agreements have become more popular for two reasons. "In general, commercial tenants are much more sophisticated than they ever were," says Loehr. "In addition, many tenants are nervous about the financial stability of their landlords, given the problems the real estate industry has had in recent years."

A typical instance in which the absence of a non-disturbance agreement can hurt a tenant is as follows, says Loehr: The owner of a building's long-term lease cannot keep up his rental payments, and the building reverts to the fee owner. As a matter of law, the subleases of individual subtenants without non-disturbance protection automatically terminate (unless the occupancy lease pre-dates the ground lease). The landlord is then free to obtain a higher rent from new tenants for all terminated space.

Sometimes, Loehr notes, two mortgages exist - one on the fee interest, and one on the long-term lease. "In this case, what's key is a non-disturbance agreement with the mortgagee of the long-term lease, not of the fee," says Loehr. "The mortgagee of the leasehold is generally an insurance company or bank, and is unlikely to walk away from its security by allowing the lease to terminate."

In theory, he adds, "In the absence of a non-disturbance to the ground lessee, the holder of the fee mortgage can cut off the ground lease, thereby terminating the leasehold mortgagee's security and the space tenant's lease. But this scenario is unlikely."

When a building's value is much greater than the mortgage on it - often the case with an older property - the absence of a non-disturbance agreement is not as significant, since the possibility of foreclosure is minimal, says Loehr.

While non-disturbance agreements are much more common today than even five years ago, he says, they are not used everywhere. For example, Loehr points out, a landlord may not be willing to seek such an agreement if it requires going to the mortgagee for a small tenant. "For whatever the reason, such as an indelicate relationship between landlord and mortgagee, a tenant in such an instance will have to live without the agreement," he says.

However, in other cases, a tenant may have enough negotiating power to insist that it have the right to cancel its lease if the landlord cannot get a non-disturbance agreement. "In instances like this," adds Loehr, "the landlord will have to try his absolute best to get that agreement from the mortgagee to avoid the risk of losing an important tenant."