What happens to tenants in commercial foreclosures?

Operating a business represents a significant investment of both time and money. Many businesses spend a significant amount of that time and expense finding a place to open their doors and then buying necessary equipment and remodeling the property to make it satisfy their particular needs. A growing issue that may put this investment at risk and affect a commercial tenant's ability to operate its business is foreclosure of a commercial property as a result of the landlord's failure to service its debt on the property. Foreclosure can have a serious effect on a commercial tenant, including the potential termination of the lease in certain circumstances.

In Nevada, the foreclosure of a mortgage or deed of trust can extinguish subsequent interests in the property, including leases that were entered into after the mortgage or deed of trust. If the lease was recorded before the mortgage or deed of trust, or if the lender actually knew of the lease before entering into the loan agreement with the landlord, however, then a foreclosure will be subject to the tenant's pre-existing leasehold interest. In either event, foreclosure introduces a degree of uncertainty to the tenant's business as the tenant tries to establish its rights with respect to the foreclosing lender. Even if a commercial tenant's leasehold survives the foreclosure, the tenant must deal with the foreclosing lender, or the lender's successor. While the foreclosing lender may want the tenant to stay on, there is no guaranty that the lender will agree to the same lease terms.

If a commercial tenant's lease is extinguished by foreclosure, then the tenant's rights under the lease terminate and it can be evicted by the new owner of the property. After service of a three-day written notice, the new property owner may file an unlawful detainer action seeking an order for possession of the property. A tenant possessing a subordinate leasehold interest faces the likely prospect of eviction at the end of such a proceeding.

In many situations, however, it may be in both the tenant's and the new owner's best interests to continue the lease. Continuing the lease allows the tenant to carry on its business operations, and it benefits the new owner by maintaining both the occupancy of the property and the revenue generated by the property. Obviously, the tenant will benefit from the termination of the lease if the foreclosure provides the tenant with an opportunity to get out from under a rental rate that is higher than the tenant could get by finding another space in the open market. Similarly, a foreclosing lender will be inclined to maximize the value of the property by terminating any subordinate leases that are below market.

In any event, both the lender and the tenant may be better served by avoiding the uncertainty that follows a foreclosure proceeding. A tenant can protect itself against the loss of its lease and the lender can ensure continued occupancy of the property after foreclosure if the tenant and the lender enter into a subordination, non-disturbance, and attornment ("SNDA") agreement. These SNDA agreements typically address three separate, but related, legal issues.

The first issue that is resolved by an SNDA agreement is the subordination of the lease to the lender's security interest in the property. The subordination language allows the lender to protect its interest in the property without being subject to a prior lease interest and, combined with the attornment discussed below, allows the lender to enforce the lease. This addresses a major concern of a lender financing a commercial property.

A tenant's interests are protected in an SNDA agreement by the non-disturbance agreement. The non-disturbance provision bars the landlord or its successors including the foreclosing lender from disturbing the tenant's possession of the premises as long as the tenant continues to pay rent and comply with the terms of the lease. This ensures the survival of the lease in the event of a foreclosure, even if the tenant's leasehold is subordinate to the lender's security interest. This also serves the lender's interests in most instances as well, as it ensures continuity in occupancy and revenue at the property after the foreclosure.

The final legal issue that an SNDA agreement addresses is attornment. Attornment is a common-law principle in which a tenant acknowledges the rights of a new owner or landlord. The tenant and the lender essentially agree that the terms of the lease will not be extinguished by a foreclosure. This benefits the lender and the tenant by extending the terms of the lease and clarifying the rights and responsibilities of each after foreclosure. Without an attornment provision, both the tenant and the lender could have difficulties enforcing the provisions of the lease because the lender was not a party to the original lease.

Taken together, the provisions of an SNDA agreement allow both the lender and the commercial tenant to avoid uncertainty in the event that the commercial landlord fails to meet its obligations to the lender. By setting out their rights and obligations in the event of a foreclosure, both the lender and the commercial tenant are protecting their interests and minimizing the potential adverse effects of the foreclosure. While not every commercial tenant will be able to negotiate an SNDA agreement with their landlord's lender, being aware of these issues will allow a tenant to be more mindful of the potential risks in the event of a foreclosure.

Michael D. Knox is an associate with Lionel Sawyer & Collins' litigation department. Contact him at 788-8666 or mknox@lionelsawyer.com.