Tug of War: Lender vs. Tenant Priority in Commercial Real Estate

Lawyers Describe Lender/Tenant Priorities in California

California’s commercial real estate law, like that of many other states, has relatively straightforward rules when it comes to the priority of competing interests. Generally speaking, priority is based upon the timing of creation. For example, if a commercial lease is executed after the landlord’s loan, the loan will take priority and, in the event the landlord defaults on the loan, the tenant’s leasehold interest is generally extinguished by a foreclosure. Alternatively, if the lease is “older” than the loan, absent an agreement to the contrary, the tenant’s rights have priority over those of the lender.

Ordinary Priority Rules Can Cause Difficulty for Landlords and Lenders

Landlords, and particularly their lenders, are often dissatisfied with the ordinary rules of priority. While those rules may work for a lender providing construction financing – its deed of trust will generally be recorded prior to the execution of any leases – the situation is often different for the lender. If the lender provides permanent financing, those financial arrangements are often not finalized until after the execution of at least some leases, particularly those for anchor tenants. In short, the ordinary priority rules tie the landlord’s hands when it desires to:

•  Refinance its indebtedness, or

•  Sell the commercial real estate

In either of these situations, the new owner or new finance provider is typically going to require that it have absolute priority over other interests in the real estate. What the landlord (and lender) desires is a means of subordinating the interest of the tenant to that of the owner/lender.

Landlord’s Solution: Craft Special Provisions Giving Priority to the Lender

In virtually every instance, commercial real estate leases contain provisions that subordinate the rights of the tenant to the rights of any lender whose mortgage or trust deed encumbers the underlying property.

Tenant’s Solution: Nondisturbance and Attornment

A savvy tenant should not agree to subordinate its interest to that of a subsequent lender unless it has some protections of its own. Such protections are generally covered by a nondisturbance and attornment provision (often in the form of a separate agreement). In its basic form, the provision or agreement provides:

•  That in exchange for subordination by the tenant, the lender or lienholder will not disturb the tenant’s possession as long as the tenant is not in default under the lease; and

•  The tenant agrees that in the event of a default by the landlord, it will treat the lender (or a new purchaser under a foreclosure) as landlord for purposes of the leased premises.

In most cases, it is advantageous for both the lender and the tenant to sign a separate agreement setting forth each party’s rights, should the landlord default on its obligations to the lender.

General Rule: Forewarned is Forearmed

Prior to signing a commercial lease, a tenant should recognize the risks associated with signing a subordination agreement (or signing a lease containing subordination language). An ongoing tenant that pays its rent is an important asset for any landlord. Tenants often have more leverage than they think. While there may be no way around the subordination agreement itself, a tenant may be in a strong position when it comes to getting favorable nondisturbance and attornment language.

CKB Vienna: Experienced Attorneys

The law firm of CKB VIENNA has provided both legal and business consultation to landlords, commercial mortgage lenders, and commercial real estate tenants for years. Our attorneys know the sorts of risks and issues faced by those developing or purchasing commercial property, and we also possess keen perspective when it comes to tenant’s rights. In representing lenders, we have also drafted core loan documentation for numerous situations. We don’t use a cookie-cutter approach, since each landlord, tenant, or lender has specific and unique needs. Our firm is also skilled in all forms of litigation, should that become necessary. CKB VIENNA has offices in Rancho Cucamonga, San Bernardino, and Los Angeles. Contact us by telephone – 909.980.1040 – or complete our online form.