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Troubled shopping center: tenant beware.

In these uncertain economic times, it is essential that shopping center tenants carefully review the so-called "subordination" provisions of any lease they plan to execute. The failure to do so may result in the rejection of the tenant's lease, eviction from the shopping center and the loss of the tenant's investment in the store in the event the landlord defaults under its mortgage and such mortgage is foreclosed. This article examines the typical shopping center subordination clause and some common problems (and some suggested solutions) when a tenant, especially an anchor tenant negotiates a "so-called" subordination and non-disturbance agreement with a landlord's mortgagee.

The usual landlord-prepared form of shopping center lease provides for automatic subordination of the lease to the lien of any mortgage affecting the shopping center, whether the mortgage was executed prior or subsequent to the execution of the lease. This clause is for the benefit of the landlord's mortgagee who wants to be certain that, if it must foreclose on the shopping center, the mortgage will have priority over the lease and could therefore be cut off in the foreclosure proceeding.

In the past, landlords were in such a dominant position that most tenants (other than the strongest of anchor tenants) were forced to accept the standard subordination clause, and until recently most tenants did not think much about the possibility of a mortgage foreclosure on the shopping center.

These days, however, tenants must consider the risk of entering into a lease without providing for something more than the standard subordination clause without modification.

Depending upon the bargaining strength of the tenant, the standard subordination clause can be modified in several ways to be more palatable to the tenant. Most frequently subordination will be conditioned upon the tenant and the landlord's mortgagee entering into an agreement known as a "subordination and non-disturbance agreement" whose basic purpose is to recognize the priority of the mortgage lien while at the same time preserving the tenant's rights under the lease.

Today lenders are willing to enter into a non-disturbance agreement with a good tenant who has a market-rate tenant to sign the lease and they recognized that the lease is an asset they would want to preserve in the event of a foreclosure. Lenders accomplish this by including in the non-disturbance agreement a so-called "attornment clause" that binds the tenant to the mortgagee under the terms of the lease in the event of a foreclosure. Technically, without the attornment clause, a tenant could, after foreclosure, treat the lease as terminated.

An anchor tenant in a shopping center will usually receive some form of non-disturbance agreement from the landlord's mortgagee. The form of agreement given varies from lender to lender and the willingness of lenders to modify their standard form of non-disturbance agreement often depends upon the importance of the particular tenant to the shopping center.

All tenants, however, should at least request the landlord to modify the standard subordination clause to protect the tenant in the event of a foreclosure by requiring the tenant to subordinate its lease nly if certain specified conditions are met, usually including the entering into a non-disturbance agreement.

It should noted that I have assumed above that there is not already a mortgage on the shopping center at the time the lease is executed because, it such is the case, a recorded mortgage will automatically have priority over the new lease. A careful tenant will order a title search to discover the existence of any recorded mortgages and then require a non-disturbance agreement from the existing lender.

The first requirement of an anchor tenant is that it will agree to subordinate its lease only to an institutional first mortgagee (the word institution must be defined in the lease). The reason for the requirement that the mortgagee by an institution is to prevent a dishonest landlord from colluding with a dishonest or non-arms-length non-institutional mortgage lender to bring a sham foreclosure action to disaffirm a tenant's unfavorable lease. Also, an institutional lender is more likely to have done a thorough financial check on the landlord in order to minimize the possibility of a foreclosure. It is also obviously not advisable for a tenant to agree to subordinate to more than the first mortgagee (and possibly a second mortgagee). No tenant (nor for that matter, any first mortgagee) should allow any junior mortgagee to evict the tenant if it is not in default.

An anchor tenant will also insist on the usual non-disturbance language in the agreement. Typically, the mortgagee agrees that, so long as the tenant is not in default under the lease the mortgagee will not name the tenant as a party-defendant in a foreclosure proceeding and after foreclosure, will continue the lease as a direct lease between the mortgagee and tenant subject to all of the provisions and obligations of the lease (except certain provisions discussed below). Anchor tenants should also insist that all condemnation and insurance proceeds be applied in accordance with the lease provisions (as oppsoed to any contradictory provisions of the mortgage) so that such proceeds be used to rebuild its store (for which it has probably made substantial and costly improvements) whereas most mortgage mortgagees have probably given themselves the option under the mortgage to apply such proceeds to reducing the mortgage, rather than rebuilding the store.

Much of the negotiation between the tenant and the mortgagee centers on whether the mortgagee will be responsible for the obligations of the prior landlord. Obviously, the mortgagee does not want to be responsible for any of these obligations in the event the mortgagee becomes the new owner of the shopping center. Anchor tenants usually agree that the mortgagee will not be bound by any fixed annual rent which the tenant might have paid to the prior landlord for more than the current month, nor be bound by any amendment of the lease made without any required consent of the mortgagee. Mortgagees, however, usually insist that it should not be liable for any act or omission of the prior landlord, nor be subject to any offsets or defenses which the tenant might have had against the prior landlord. The reason for this is, that it does not want to be subject to claims it was not even aware of. It is unfair, however, to expect the tenant to give up all of the rights it might have for obligations of the prior landlord e.g. leaking roof, hazardous wastes, excess payments of percentage rent, etc.). A frequent compromise is to bind the mortgagee to acts of the prior landlord of which the tenant has previously notified the mortgagee and given the mortgagee the opportunity to cure (usually for a period of time greater than that provided to the prior landlord under the lease) the default. This allows the mortgage and also puts the mortgagee on a notice as to any claims the tenant might have before foreclosure.

In fact, if the claims are so great (e.g. environmental claims) the mortgagee might even decide not to forclose and possibly instead proceed personally against the prior landlord (or any guarantors) to collect the mortgage indebtedness. Some mortgagees suggest instead that, if the tenant wishes to have some recourse against the prior landlord for prior lease defaults, it should obtain a separate indemnity from the prior landlord (or a guarantor). Yet another compromise is to hold the mortgagee liable for acts of the prior landlord only to the extent of the rent payable under the lease so that the mortgagee at least knows it will not be out of pocket beyond these rents. Since most leases already provide that the landlord will not be personally liable, the mortgagee knows its liability to the tenant will be limited to its interest in the shopping center.

In conclusion, all tenants (especially an anchor tenant who will spend substantial amounts of money inimproving their premises) should be especially wary that, in the event the landlord runs into financial difficulty and a foreclosure ensues, its lease will continue with whomever takes over on terms it bargained for and can continue to live with.

Stuart M. Pack is a graduate of the State University of New York at Cortland and St. John's University School of Law, and a senior associate with Fink Weinberger P.C., a full service law firm of more than 75 attorneys, with offices in Manhattan, White Plains, New York and Clifton, New Jersey.
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Title Annotation:Property Management Supplement
Author:Pack, Stuart M.
Publication:Real Estate Weekly
Date:Oct 2, 1991
Previous Article:Complications in foreclosing a condo unit.
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