§ 20.02 Subordination Agreements

• Jurisdiction: United States
• Publication year: 2022

§ 20.02 Subordination Agreements

In addition to protecting itself against the actions of the holders of superior title interests, the tenant must also concern itself with safeguarding its leasehold rights against the claims of subsequent lien holders to which it has subordinated its interests. Subordination is the action or process by which a party's or person's rights are ranked below those of another or all others. A subordination agreement is a document in which a party holding an otherwise senior lien or other real estate interest agrees to or consents to reducing its priority vis-à-vis another person holding an interest in the same real estate.¹

[1]—Impact of Subordination

Most office tenants will be asked to subordinate their interests to protect the rights of lien holders and other secured creditors of the landlord, primarily mortgagees such as permanent lenders or construction lenders,² in addition to the interests of superior title holders. This can occur either as a clause within the office lease itself, or as a separate subordination agreement after the lease is signed. It should be noted that a subordination does not afford any protection to a tenant. In fact, if the tenant agrees to subordinate its rights, it may find itself without any rights somewhere down the line.³ For instance, the landlord may default on its mortgage and go into foreclosure, leaving the tenant without any lease. It is essential, therefore, for the tenant to protect itself by seeking a non-disturbance agreement⁴ from any interest holder to which it is asked to subordinate.

If the tenant does not agree to subordinate, in all likelihood, the landlord will not be able to obtain the necessary financing for its building or project. Lenders typically require the income from leases in the building or project as security for the mortgage loan. More importantly, however, the lender's security may be jeopardized if there are any leases superior to its mortgage.⁵ Therefore, unless the tenant with a superior interest agrees to subordinate its interests to the lender, the lender will take its interests subject to those of that tenant.

While subordination is not an issue over which the tenant is likely to have much leverage during lease negotiations, the opposite may be true after the lease is signed. Because most lenders will insist on a subordination agreement with the tenants before they will agree to extend financing to a landlord, most landlords include general subordination clauses in their leases. With such a clause in place, the landlord will avoid having to approach the tenant at a later date when it may face some resistance when the tenant realizes that such an agreement is not in its best interests. After the lease is signed, a tenant will be in a much stronger negotiating position because it now has something the landlord wants and needs. Therefore, the landlord's cost in waiting until after the lease is signed may be high.

When a tenant agrees to a subordination clause, essentially the tenant is agreeing to allow another party to have its interests satisfied, possibly at the expense of the tenant's own interests under its lease. In the case of the landlord's bankruptcy or foreclosure, superior interests or those to which the tenant has subordinated its rights get paid first. When this occurs there may not be enough money to pay all lienholders, let alone to continue to provide tenant the benefits it is entitled to receive under its lease. There may not be enough money to run the building at the level that tenant had anticipated; there may not be enough money to complete the space for occupancy.⁶

Subordination changes the priority of the interests. Absent such a clause or agreement, once a lease is executed, the rights and commitments contained in the lease are generally superior to subsequent third party agreements entered into by either the landlord or the tenant.⁷ After subordinating, the tenant's interests will be in a junior position. More importantly, if the tenant has not protected itself with a non-disturbance agreement, the mortgagee can disaffirm the lease and evict the tenant in a foreclosure action.⁸

[2]—Agreement to Subordinate

Leases commonly contain a clause that subordinates the lease to any and all ground leases, mortgages or liens on the property that are of record or of which the tenant has knowledge. It is accepted practice that a lease is not subordinate to a mortgage that has been subsequently entered into unless the lease is expressly made so.⁹ In order to circumvent this general rule, the landlord may require the tenant to execute a subordination agreement or may have a subordination clause in the lease making the lease expressly subordinate to future mortgages.

The tenant should have a title search performed to ascertain the presence of all recorded interests to which its lease will be subordinated. The importance of careful due diligence, particularly before the lease is signed, cannot be stressed enough. A tenant can further protect itself by having the lease expressly state that the landlord represents that the lease is not subordinate to any lease or lien unless the landlord specifically identifies such in the lease.

The following is a typical subordination clause:

Example 1:

This lease is subject and subordinate to all ground or underlying leases and to all mortgages which may now or hereafter affect such leases or the real property of which demised premises are a part and to all renewals, modifications, consolidations, replacements and extensions of any such underlying leases and mortgages. This clause shall be self-operative. No further instrument of subordination shall be required by any ground or underlying lessor or by any mortgagee affecting any lease or the real property of which the demised premises are a part. In confirmation of such subordination, a tenant shall execute promptly any certificate that owner may request.¹⁰

This clause is used for several purposes. First, it shows the primacy of the space lease as compared to one that may be subject to a number of other agreements of which the tenant is not a party, mainly ground leases and mortgages. The self-operating nature of the subordination clause makes it binding upon the tenant without any further notice. Thus, the only notice that the tenant will receive of these agreements or extensions will be in the form of an estoppel certificate that the landlord will require the tenant to sign within a short period of time in the event that the landlord is seeking to finance or sell the building. Often, a landlord will try to use an estoppel certificate as a vehicle to expand upon the lease terms and the responsibilities of the tenant under the lease.¹¹

The following example is a more detailed, more complicated subordination provision stating that subordination is conditioned on the landlord providing the tenant with a satisfactory non-disturbance agreement.

Example 1A:

(a) This Lease is subject and subordinate to those ground or underlying leases and to those mortgages that may now affect such leases or the real property of which the Premises are a part listed in Exhibit F and which are the subject of a Non-disturbance Agreement executed by such ground lessor or mortgagee, as the case may be, in favor of Tenant. Simultaneously with the execution of this Lease, Landlord shall deliver, at Landlord's sole expense, to Tenant a Non-disturbance Agreement in recordable form and in form substantially similar to that in Exhibit F to the effect that in the event of termination of any such lease or foreclosure of any such mortgage, the landlord under any such lease or the holder of any such mortgage will not attempt to terminate this Lease, make Tenant a party defendant to any such foreclosure or, in any other way, foreclose or otherwise extinguish or interfere with the rights of Tenant under this Lease.

(b) This Lease shall be subject and subordinate to all future ground and underlying leases and to all future mortgages that may hereafter affect such leases or the real property of which the Premises are a part so long as Landlord delivers to Tenant a Non-disturbance Agreement in form and content satisfactory to Tenant executed by such ground lessor or mortgagee, as the case may be, in favor of Tenant. Such subordination shall not be effective until Landlord has delivered a satisfactory Non-disturbance Agreement to Tenant. Tenant shall notify Landlord promptly after receipt thereof whether such Non-disturbance Agreement is satisfactory.

(c) Subject to the provisions of subsections (a) and (b) of this Section, Tenant shall, if so requested, attorn to the landlord under any ground or underlying lease to which this Lease is subject and subordinate, attorn to the holder of any mortgage to which this Lease is subject and subordinate, attorn to the purchaser of the mortgaged premises in foreclosure, or attorn to any successor to Landlord's interest in the Premises.

(d) Landlord hereby represents and warrants that there are no interests superior to Tenant's, whether mortgages or leases, except as specifically set forth in Exhibit F or in a Non-disturbance Agreement to be delivered to Tenant at the time this Lease is executed.

[3]—Subordination, Non-Disturbance and Attornment Agreements

[a]—In General

A subordination, non-disturbance and attornment agreement (SNDA) is commonly included in most commercial leases and real estate financing transactions.¹² The SNDA regulates two competing interests in the same property—the tenant's right to possess its premises pursuant to its lease and the mortgage lender's security interest in the same premises.¹³

Generally, under the terms of an SNDA: (1) the tenant agrees that the subordination of its lease to the lien of the mortgage; (2) the lender agrees that if it forecloses on the collateral property or otherwise takes title thereto, it will not disturb the tenancy; and (3) in the event the lender takes title...