This entry is the first in a series of entries focusing on numerous issues with note sales/purchases (the “Note Sale”) that are often presented.
A. Generally. Initially, it is important to define what a Note Sale is, as it is often one of the most misunderstood concepts in financing. A Note Sale is the sale by a lender (“Lender”) of all the Lender’s rights and obligations under a loan (the “Loan”), between the Lender and a borrower (“Borrower”), and any guarantor (“Guarantor”), to a third-party buyer (the “Buyer”). The Note Sale is an alternative method by which a Lender can dispose of a distressed or non-performing asset in contrast to a traditional REO Sale (as defined below).
B. A Note Sale is NOT an REO Sale. When a Lender forecloses on the property underlying and securing a Loan, and the Lender is the highest bidder at the foreclosure, the property becomes a real-estate owned asset (“REO Asset”) of the Lender. The Lender may sell the REO Asset to other third-party purchasers (the “REO Sale”). When a third-party purchaser buys the REO Asset from the Lender, the purchaser is actually buying the physical asset, i.e. the land, building and other improvements and property.
However, in the distressed real estate market, Lenders have become more sensitive to the fees, costs and expenses associated with foreclosure processes, in addition to the procedural delays and expenses as a result of bankruptcies, the time and expense of putting a receivership in place, and the uncertainty of prices in the real estate market. Therefore, Lenders have started to utilize Note Sales as their method of disposing their distressed or non-performing assets, as the Lender will have to deal with fewer of the costs and issues related to acquiring an REO Asset.
Given the move toward more Note Sales and fewer REO Sales, it is important for Buyers and Lenders to understand the distinction between the two methods of disposition. Primarily, and most importantly, when a Buyer enters into a Note Sale (as opposed to an REO Sale), the Buyer is purchasing the Loan, and all the rights and obligations of the Lender pursuant to the Loan. The Buyer is NOT buying the underlying asset in a Note Sale. The Buyer may be improving their bargaining position with respect to the underlying asset, but at the time of the Note Sale (absent some contemporaneous conveyance by the underlying Borrower), the Buyer only steps into the place of the Lender with respect to the Loan.
Second, the Buyer IS purchasing the Lender’s position in connection with the Loan. This is why due diligence on a prospective Note Sale must be done on two levels: (a) at the property level (i.e. what is the underlying asset worth relative to the Loan); and (b) at the Loan level (i.e. proper documentation, Borrower/Guarantor viability, and related issues). If the Buyer has not properly accounted for issues at the Loan level and has simply calculated their purchase offer based on the due diligence at the property level, then the Buyer may have severely underestimated their remaining issues with the Note Sale and overpaid for the Note Sale.
C. Conclusion. It is important for any Buyers and Lenders to understand the issues associated with Note Sales and to understand the major distinctions between a Note Sale and a traditional REO Sale.
Prior to using any concepts discussed in this entry, consult with an attorney.
Michael Riley is a real estate and finance attorney licensed in Arizona. You can contact him at mriley@rrlawaz.com.
Importance of SNDAs – Revisited
In a prior blog entry, I highlighted the reasons why the Subordination, Non-Disturbance and Attornment Agreement (the “SNDA”) is a critically important commercial lease document (available here: http://rrlawaz.com/2011/04/importance-of-sndas/).
As follow up to that entry, tenants should make sure to obtain the landlord’s lender’s approval (or even a new SNDA) for every lease amendment and renewal. The SNDA typically includes a standard provision that states that the landlord’s lender will not be bound by any amendment or renewal unless such lender has given its written approval of the amendment or renewal.
In my practice, I have seen two examples where a tenant’s lease has been voided after a foreclosure, and the lease would have been valid if the tenant obtained the landlord’s lender approval for a subsequent amendment or renewal, or a new SNDA. First, during a six month period, a bankruptcy court appointed receiver took over the leasing duties for an office project and renewed and/ or extended several tenants at below market lease rates. The lender then foreclosed on the project and elected to wipe out the below market rate leases. There are legal questions regarding whether a lease can be terminated by a lender when the lender knew of the lease amendment and did not object during the bankruptcy proceedings. However, none of the tenants were in a financial position to initiate litigation against the lender to challenge the lender’s actions. The lender used its leverage to obtain market rent rates.
In the second example, an “end-user” (i.e., a party that desired to occupy the project) purchased a note where the borrower was in default, and the note was secured by a deed of trust on an office project. After purchase, the end-user then foreclosed on the project and wiped out all of the leases. Most of the tenants were long-term tenants that were on renewal terms. Unfortunately for the tenants, none had SNDAs or approval from the landlord’s lender for the then-current renewal term. The end-user terminated the leases, evicted all of the tenants and now occupies the space for itself.
Prior to using any language or concepts from this blog entry, consult with an attorney.
Ryan Rosensteel is a real estate and construction attorney licensed in Arizona. You can contact him at rrosensteel@rrlawaz.com.
Types of Guarantees.
This entry focuses on issues with different types of guarantees (the “Guaranty”), executed by a guarantor (the “Guarantor”) of a loan (the “Loan”) between a borrower (“Borrower”) and a lender (the “Lender”). A Guaranty is a contingent promise of a Guarantor to pay the obligations of the Borrower in the event the Borrower fails to satisfy its obligations under the Loan to the Lender.
A. Recourse vs. Non-Recourse. In a non-recourse loan, the Lender is relying solely on the collateral (usually real property) pledged by the Borrower as its sole remedy. In that case, there is no need for a Guarantor to execute a Guaranty. Once the Lender exercises its remedies against the collateral (usually via foreclosure), it has no further remedies against the Borrower personally (or any Guarantor). In a recourse loan, the Lender may pursue the Borrower and/or Guarantor personally, for any deficiency that remains after the collateral is sold. In that case, it is necessary for the Lender to have a Guaranty executed by a Guarantor.
B. General Requirements. In most transactions, the Guarantor is related to the Borrower, either as a principal or a holding company. It is important for the Guarantor to have some benefit from the success of the Borrower in order to establish the consideration necessary to have a valid and enforceable Guaranty. The more distant the relationship between Borrower and Guarantor, the more likely a Guarantor could attack a Guaranty for not having valid consideration underlying the contract (i.e., the Guarantor gets no benefit from making the Guaranty in the first place, so there is no consideration, which makes the Guaranty unenforceable). A Guaranty must be in writing to satisfy the statute of frauds and be executed by the Guarantor.
C. The Non-Recourse Carveouts. One area that draws a lot of confusion is the “non-recourse” loan that is subject to carveouts (a.k.a. bad boy acts). Many Borrowers think at the term sheet stage, that all non-recourse deals are created equal. That is not the case. Often in long-term financing or other CMBS (commercial mortgage-backed securities) type financing, a Borrower will think it has a non-recourse deal until such time as it receives a draft Guaranty from the Lender. Generally in these types of transactions, the Loan is non-recourse, unless an enumerated set of events have transpired giving rise to liability for the Guarantor. Normally, a failure to repay the Loan is not reason enough to trigger the Guarantor’s obligation; rather the Borrower and/or Guarantor has to engage in some sort of “bad act” (i.e. fraud, misrepresentations, conversion, bankruptcy filing). In most cases, the “bad act” only triggers liability to the extent a Lender suffers a loss associated with the act (i.e. if the Borrower were to misappropriate condemnation proceeds); however, certain “bad acts” (i.e. bankruptcy filings) can cause a Guarantor to be liable for the full amount of the Loan. It is important in the negotiation stage for the Lender, Borrower and Guarantor to clearly understand what type of deal they have agreed to and to review the documentation carefully to make sure the documents accurately reflect the term sheet.
D. Types of Guarantees.
1. Full Repayment Guaranty. This is the most common type of Guaranty. The Guarantor agrees that the Guarantor will be liable for the full amount of the obligations of the Borrower. In most cases, the Lender may pursue the Guarantor at any time following a default under the Loan, although usually the amount of Guarantor liability will be offset by what the Lender receives enforcing its remedies against the collateral, thereby reducing the Guarantor’s overall liability (and subject to various state laws, including one-action type rules). The Guarantor will also usually be obligated to make certain representations and warranties, provide financial statements and subordinate any claims the Guarantor may have against the Borrower to the Lender. Any violation of the terms and conditions of the Guaranty will normally result in a default under the Borrower’s loan documents. It is important for the Guarantor and Borrower to understand the effect that a Guarantor’s action (or inaction) can have on the Loan.
2. Carve-Out (a.k.a. “Bad Boy”) Guaranty. As discussed above, a Carve-Out Guaranty will provide for Guarantor liability in the event a certain set of recourse events occur. Generally, the Guarantor is only liable for losses that the Lender incurs as a result of one of these events (e.g. misappropriation of condemnation proceeds). In most cases, a failure to repay the Loan (absent a particular recourse event) does not give rise to liability for the Guarantor under a Carve-Out Guaranty. However, in certain circumstances (i.e. bankruptcy) a Guarantor may be fully liable for the all of Borrower’s obligations. In the Carve-out Guaranty, the Guarantor will also agree to make certain representations and warranties, provide financial statements and subordinate any claims the Guarantor may have against the Borrower to the Lender. Additionally, any violation of the terms and conditions of the Guaranty will normally result in a default under the Borrower’s loan documents.
3. Completion Guaranty. In construction loans, a Guarantor may be required to sign a Completion Guaranty, in addition to a Repayment Guaranty. The Completion Guaranty provides that the project will be completed pursuant to the loan documents. In the event that the project is not completed pursuant to the loan documents, the Lender may pursue the Guarantor for obligations arising in connection with the completion of the project. In that case, the Lender may complete the project as planned with the Guarantor being liable for those amounts. A Lender may combine the Completion Guaranty into the Repayment Guaranty and include the appropriate completion terms and conditions in the Repayment Guaranty itself.
4. Environmental Indemnity. In connection with most Loans secured by real property, a Borrower and Guarantor will be required to execute an Environmental Indemnity. The Environmental Indemnity will indemnify the Lender from any environmental issues affecting the property that were caused by the Borrower and/or Guarantor. Normally, an Environmental Indemnity is limited to the acts caused by Borrower and/or Guarantor during the time they owned the property. It is important to understand that the liability arising under an Environmental Indemnity may exceed the total amount of the Loan, and the Borrower and Guarantor will be liable for the full amount of any damages caused by their acts with respect to the property (i.e. the Environmental Indemnity liability is not capped by the amount of the Loan).
D. Conclusion. It is important for any Lender, Borrower or Guarantor to know and understand the various issues associated with Guarantees and the recourse vs. non-recourse nature of their transactions during the negotiation stage of the Loan and to understand their rights and remedies under the different types of Guarantees.
Prior to using any concepts discussed in this entry, consult with an attorney.
Michael Riley is a real estate and finance attorney licensed in Arizona. You can contact him at mriley@rrlawaz.com.
Holdover Tenancies (Revisited)
Last year, I wrote the following blog entry on holdover tenancies and the right of the landlord to collect an increased rent rate during any holdover period: http://rrlawaz.com/2010/07/holdover-tenancies/ The increased rent rate is typically 125% – 200% of the last month’s rent rate.
From the landlord’s perspective, the right to collect increased holdover rent serves two primary purposes: (1) the increased rent allows the landlord to recapture some of the damages associated with a tenant’s failure to timely surrender the premises, and (2) the increased rent provides a disincentive to the tenant to wait until the end of the lease term to negotiate for a lease extension. Both of these purposes assume that the tenant is not welcome to continue as a month-to-month tenant upon lease expiration and that the landlord has a tenant ready to move into the premises upon lease expiration.
In practice, however, this is rarely the case. Landlords and tenants frequently agree that the tenant can continue as a month-to-month tenant after the expiration of the lease. The tenant may be considering its options, the landlord likely does not have another tenant waiting to move in, and often the parties may not be willing to commit to a rent rate for the next 1, 3 or 5 year period. It is mutually beneficial to continue as a month-to-month tenant.
These holdover rent provisions are being used by landlords as after-the-fact “gotchas.” The tenant continues to pay the same rent as a month-to-month tenant, sometimes for over a year, and then gets invoiced for the unpaid excess holdover rent.
The landlord likely has the contractual right to collect the holdover rent at any time under the lease, and the lease likely was negotiated at arms-length and is binding on both parties. Though the tenant has equitable arguments that the landlord is estopped from claiming the holdover rent due to failure to object when the rent payments are made, a court likely would be unsympathetic to a commercial tenant if the lease provides otherwise.
The reason I decided to revisit this topic is because I thought of a fair compromise. The holdover provision should state that the landlord is entitled to collect an increased holdover rent, but the landlord must provide at least 30 days’ advance written notice before exercising this remedy. Also, the landlord should not be permitted to deliver the notice more than 60 days in advance of any holdover tenancy (to avoid the landlord providing notice too far in advance so that the tenant does not remember receiving the notice). If the landlord fails to provide such notice, the tenant may continue to pay the same rent amount during its month-to-month tenancy. Tenants should consider negotiating for this compromise provision in their future commercial leases.
Prior to using any language or concepts from this blog entry, consult with an attorney.
Ryan Rosensteel is a real estate, business and construction attorney licensed in Arizona. You can contact him at rrosensteel@rrlawaz.com.
This entry focuses on the processes and issues with short sale (“Short Sale”) transactions that both the borrower (“Borrower”) and lender (“Lender”) should be concerned about. As a rule, a Short Sale is a transaction where the Borrower sells the property (the “Property”) to a third party for less than the full amount of the debt, the Lender consents to the transfer, and agrees to release its lien as a satisfaction of the debt (subject to any negotiated deficiency between the parties).
1. Short Sale Transactions.
A. General Process. Generally, a Short Sale starts when a Borrower lists their Property for sale with a broker. It is important to coordinate a Short Sale with a broker experienced in Short Sale negotiations. Short sales (particularly residential Short Sales) can often be a time consuming process and a broker with experience in Short Sales is usually better able to navigate the issues more easily. Once a buyer is found, generally the Borrower and/or broker will coordinate a purchase and sale agreement with the buyer that is conditioned on the consent of the Lender. Once that agreement is reached, the buyer’s offer will be presented to the Lender for their consideration and approval.
B. Lender Consent; Documents. Each secured Lender of the Property will have the opportunity to review and approve the Short Sale. In residential transactions, it is not uncommon for the Lender’s consent to come following the negotiation of the purchase agreement between the Borrower and the buyer. Often in commercial transactions, the Lender is involved in the negotiation between the buyer and the Borrower from the initial stages. Regardless, it is important that each Lender with a security interest in the Property be informed and updated consistently, as each will be required to consent to the Short Sale and to release its lien.
Once the buyer and Borrower have come to an agreement, the Lender will review the documents and often prepare documents (in varying forms) which will include terms and conditions including, without limitation, consents to the transaction, releases of liens and provisions dealing with deficiency issues. On residential matters, these documents are generally short, boilerplate style provisions and are usually not heavily negotiated. On a commercial transaction, these may take the form of a modification agreement, are normally attorney prepared and more often negotiated.
C. Deficiency Issues. Perhaps the most important issue to deal with on a Short Sale is the determination and the negotiation of the deficiency amount. On most residential transactions, a deficiency is not likely to exist. See my prior post on how a deficiency is determined (http://rrlawaz.com/2011/01/arizona-deficiency-law/). On most, if not all, commercial transactions a deficiency is likely to exist and the Borrower and Lender must determine in the Short Sale documentation how the deficiency will be dealt with. Generally, it will be handled similarly to a deed-in-lieu of foreclosure (the “Deed-in-Lieu”) transaction, i.e. the parties should establish the amount of the deficiency and the manner in which each Borrower Party will pay the deficiency amount to the Lender (i.e., lump sum payment at closing vs. new promissory note for deficiency amount), in the Short Sale documents.
D. Tax Issues. The Mortgage Debt Relief Act of 2007 provides tax relief to residential property owners for the forgiveness of debt. Generally, if a loan is non-recourse such that the Lender could not pursue the Borrower for a deficiency, then there will not likely be any tax liability for the debt forgiveness. In commercial Short Sales and residential Short Sales where the Lender could pursue a deficiency there can be potential tax liability for the forgiven debt. It is important in all circumstances that each Borrower Party consult with their accountant and/or independent tax advisors with respect to potential tax liability arising pursuant to a Short Sale and/or Deed-in-Lieu.
E. Title Issues. Generally, the buyer of a Short Sale Property is not going to take title subject to any of the Lender’s liens. Therefore, it is imperative that each Lender consent to the Short Sale transaction and agree to release its lien with respect to the Property that the buyer is buying.
F. Timing and Cost. Like Deed-in-Lieu transactions, a Short Sale does not have statutorily imposed periods that the buyer must wait before taking title to the Property. Additionally, there are no statutory requirements for notice and publication as there is with the trustee’s sale. However, residential Short Sale transactions can often be a slow process (even though generally less costly), from the marketing of the property to the point in which the Short Sale is consummated and the Lender consents to the Short Sale. Additionally, any broker employed by the Borrower in a Short Sale is going to get a commission in connection with the Short Sale (which cost is generally paid by the Lender). Commercial Short Sale transactions generally move more quickly although they can have similar issues as the residential Short Sale.
2. Conclusion. As the economy continues to recover, it is important to know and understand the various issues associated with Short Sale transactions as the number of these types of transactions is likely to increase in the near future.
Prior to using any concepts discussed in this entry, consult with an attorney.
Michael Riley is a real estate and finance attorney licensed in Arizona. You can contact him at mriley@rrlawaz.com.
This entry focuses on the processes and issues with a deed-in-lieu of foreclosure (the “Deed-in-Lieu”) transaction that both the Borrower and Lender should be concerned about. As a rule, a Deed-in-Lieu is a transaction where the borrower (“Borrower”) agrees to deed the real property (“Property”) to the lender (“Lender”) in return for a settlement of the debt (subject to any negotiated deficiency between the parties).
1. Deed-in-Lieu of Foreclosure Transactions.
A. General Process. Generally, Arizona law does not govern the procedure for a Deed-in-Lieu; provided, however, A.R.S. § 33-401 requires a valid deed that is written, signed by the grantor (Borrower, in this case) or an authorized agent, and acknowledged by a notary. Usually, a special warranty deed or a general warranty deed is used in Deed-in-Lieu transactions.
B. Documents. The Borrower and Lender will enter into a settlement agreement (or similar document) which contains the terms and conditions of the Deed-in-Lieu transaction, in addition to other ancillary documents, including, a deed, a bill of sale, assignments and other documents necessary to effectuate the transfer.
C. Release vs. Non-Recourse. The major issue when structuring a Deed-in-Lieu, is determining whether the Borrower, or any guarantor (collectively, the “Borrower Party”) will be responsible for any deficiency following the Deed-in-Lieu. The Lender and any Borrower Party will have to carefully determine whether a deficiency exists and what the likelihood of success in pursuing a deficiency would be. For a more detailed discussion about deficiency issues please see my prior blog entry (http://rrlawaz.com/2011/01/arizona-deficiency-law/). One advantage of the Deed-in-Lieu for any Borrower Party and the Lender is that the parties may clearly set forth in the settlement agreement any deficiency claim against any Borrower Party that is to remain post-Deed-in-Lieu.
Generally in a Deed-in-Lieu the Lender agrees to accept the Property in exchange for making the loan non-recourse to each Borrower Party. Making the loan non-recourse is very different than granting each Borrower Party an outright release and discharge of liability. In some cases, each Borrower Party may negotiate a release and discharge as opposed to the non-recourse structure. Alternatively, the Lender may require that each Borrower Party accept a negotiated deficiency amount, as opposed to making the loan non-recourse or granting each Borrower Party a release. In cases where the Lender and each Borrower Party agree that Lender reserves their right to pursue a deficiency, the parties should establish the amount of the deficiency and the manner in which each Borrower Party will pay the deficiency amount to the Lender (i.e., lump sum payment at closing vs. new promissory note for deficiency amount), in the settlement agreement.
D. Bankruptcy Issues. The Deed-in-Lieu should be structured to prevent the conveyance from being classified as a “fraudulent transfer” or an “avoidable preference”. If the deed of trust lien is released simultaneously with the acceptance of the Deed-in-Lieu and a bankruptcy is filed within a certain time period, there is the potential that the bankruptcy trustee may unwind the Deed-in-Lieu as an “avoidable preference” or a “fraudulent transfer”, in which case the Lender may no longer be considered a secured creditor. Generally, in order to limit this risk, the parties should agree that the Lender’s lien will remain (and the deed of trust will not be released) on the Property as long as the Lender owns the Property. Additionally, the Lender will coordinate with the title company to insure that the Lender’s ownership in the Property is subject to Lender’s lien. Finally, the Lender should also consider taking title in a separate entity wholly owned by the Lender to prevent merger of title issues.
E. Title Issues. A Lender takes title subject to any and all liens or encumbrances on the Property at the time of transfer, including subordinate liens, in a Deed-in-Lieu. This is a major issue that the Lender should consider when deciding between a Deed-in-Lieu transaction and a trustee’s sale. Pursuant to A.R.S. § 33-811, the trustee’s deed will transfer title to the Property free from any liens or encumbrances that were subordinate to the deed of trust at the time of the trustee’s sale. For more information regarding the trustee’s sale process please see my prior blog entry (http://rrlawaz.com/2011/02/the-trustees-sale-process-in-arizona/). In short, a Deed-in-Lieu will not extinguish subordinate lien interests and the subordinate liens become the responsibility of the Lender upon acceptance of the Deed-in-Lieu.
F. Timing and Cost. Unlike a trustee’s sale, pursuant to a Deed-in-Lieu the Lender does not have a statutorily-imposed time period that the Lender must satisfy to realize on their collateral. Generally, a Deed-in-Lieu is faster and less costly than a trustee’s sale, it does not require notice and publication like a trustee’s sale; however, a myriad of issues with respect to the Deed-in-Lieu may make it difficult to anticipate the precise time and costs involved with a structuring and negotiating a Deed-in-Lieu.
2. Conclusion. As the economy continues to recover, it is important to know and understand the various issues associated with Deed-in-Lieu transactions as the number of these types of transactions is likely to increase in the near future.
Prior to using any concepts discussed in this entry, consult with an attorney.
Michael Riley is a real estate and finance attorney licensed in Arizona. You can contact him at mriley@rrlawaz.com.
Recapture of Abated Rent If Tenant Defaults
In today’s market, it is common for landlords to give fully or partially abated rent as a lease concession to tenants. Occasionally the abated rent is staggered throughout the term (e.g., one month’s rent is abated every year), but more often the abated rent is front-loaded at the beginning of the term. Abated rent is factored into the overall economics of a lease deal, based on the tenant’s payment of rent during the entire length of the term. Landlords should make sure that the lease allows the landlord to recapture the abated rent in the event of a tenant default.
A common mistake that landlords make with respect to abated rent is to state that the rent during the abated rent period is $0, “free” or “abated.” Instead, the lease should provide for a rent amount but state that the rent is abated if tenant fully and faithfully performs for the entire term of the lease. If the tenant defaults, then the landlord can recapture the abated rent in its damages. Following is a sample provision for this concept:
Base Rent for the period commencing on [date] and ending on [date] shall be fully abated (the “Abated Rent”) and only payable by Tenant in the event of a default by Tenant. Tenant shall be credited with having paid all of the Abated Rent on the expiration of the Term only if the Tenant has fully, faithfully and punctually performed all of Tenant’s obligations under the Lease during the Term. If Tenant defaults and does not cure within the applicable grace period during the Term, the Abated Rent shall immediately become due and payable in full and this Lease shall be enforced as if there were no such rent abatement or rent concession.
Tenants should be careful to negotiate these provisions as well. First, the tenant should require that the landlord may only recapture the abated rent if the landlord terminates the lease due to a tenant default. The “full and faithful performance” language is ambiguous and a late payment of rent for 1 day (or similar minor breach) could be interpreted as a trigger event. It would be unfair for the landlord to claim that the abated rent is due unless the breach is material and the tenant has an opportunity to cure and fails to do so. Second, the tenant should negotiate that the landlord’s ability to recapture the abated rent is reduced over time, since the landlord is receiving the benefit of the lease over time. For example, if the lease has a 10 year term and tenant performs for 7 years before breaching, the tenant could negotiate that the landlord received 70% of the intended benefit of the lease and should only recapture 30% of the abated rent. This is a business issue for the landlord and tenant to negotiate.
Prior to using any language or concepts from this blog entry, consult with an attorney.
Ryan Rosensteel is a real estate and construction attorney licensed in Arizona. You can contact him at rrosensteel@rrlawaz.com.
Existing Superior Rights to Additional Space
When negotiating a right to additional space (e.g., expansion right or right of first refusal or first offer), tenants should confirm with the landlord that no superior rights exist to the same additional space. If other rights do exist, those rights will be superior and the tenant’s right will be subject to the existing rights. Typically, a tenant assumes that its rights are exclusive or superior to any other rights. That may not be the case.
Accordingly, as a part of lease negotiations, the tenant should require the insertion of the following clause in the lease: “Landlord represents and warrants that no other party has any existing rights to the [insert appropriate defined term for the additional space] that are superior to the Tenant’s rights as set forth in this Section.” At the very least, this will force the landlord to either agree to the representation and warranty, or disclose any existing superior rights. If there are any existing superior rights in which the tenant accepts, those rights be specified in the lease (or on a schedule to the lease) so as to avoid later confusion regarding which third party rights were existing and superior.
Prior to using any language or concepts from this blog entry, consult with an attorney.
Ryan Rosensteel is a real estate and construction attorney licensed in Arizona. You can contact him at rrosensteel@rrlawaz.com.
Continuous Operation
Most retail landlords (and some office landlords) require continuous operation clauses in their leases. Continuous operation clauses require that the tenant remain open for business during center hours during the entire lease term. With a continuous operation clause, a tenant must not only pay rent, but also must be open for business. Landlords require continuous operation because tenants in shopping centers are interdependent on one another for success. A full, open center benefits all of the tenants and enhances the value of the property.
However, most retail and restaurant businesses operate with a thin profit margin. Their businesses have high costs for labor and product. There may be instances where the tenant may lose money by being open instead of temporarily closing its doors. While the tenant must accept that it cannot just close down for the summer in Phoenix (for example) to the detriment of the center, there are instances where the ability to temporarily close may be appropriate.
First, in the event significant road construction adversely impacts the primary means of access to the leased premises and/or center, the decrease in customer traffic could be devastating to the tenants in the center. Second, in the event the shopping center has high vacancy, it would be unfair to force a tenant to open and stay open in an empty center. In either case, rather than force the tenants to be open during all center hours, it may be fair to allow the tenants to close during non-peak hours, certain days, or for certain periods of time. For example, a tenant could negotiate that if the center has 50% or more vacancy, the continuous operation clause does not apply. Then if the center has 51%-75% vacancy, the tenant may have reduced hours so long as it is open during 75% of the overall shopping center hours. This type of negotiation is particularly important for yet-to-be-built, speculative centers.
A compromise position is that the landlord may want the right to recapture the space in the event the tenant does not continuously operate for a certain period (usually 90 days or more). While this may seem fair, the tenant should consider its initial costs of construction and marketing the new location and require that the landlord pay a reasonable recapture fee.
Prior to using any language or concepts from this blog entry, consult with an attorney.
Ryan Rosensteel is a real estate and construction attorney licensed in Arizona. You can contact him at rrosensteel@rrlawaz.com.
Importance of SNDAs
The Subordination, Non-Disturbance and Attornment agreement (the “SNDA”) is a critically important document in commercial lease transactions, specifically for lenders and tenants. The SNDA provides that: 1) the lease is subordinate to the loan (important to the lender); (2) the landlord will not disturb the tenant’s occupancy so long as the tenant performs under the lease (very important to the tenant); and (3) the tenant will attorn (i.e. recognize) the lender as its landlord if a foreclosure occurs (important to the lender).
As discussed in a prior blog entry (http://rrlawaz.com/2010/09/impact-of-foreclosure-on-commercial-leases/), a lender typically has the right to wipe out existing leases upon a foreclosure. This is because a foreclosure eliminates subsequent encumbrances, including leases, unless approved by the lender. So, if the landlord is in default under its loan for a commercial project, and the lender forecloses on the property, the new lender has the right to accept or reject existing leases. The harsh consequence is that the tenant may be forced to move out. It is important for tenants to obtain the “non-disturbance agreement portion” of the SNDA to allow the tenant to continue its lease so long as the tenant does not default.
Tenants should carefully review the content of the SNDA and confirm that the lender or new landlord agrees to assume important obligations of the original landlord. The SNDA is a lender form document and very favorable to the lender. For example, SNDAs may carve out that the new landlord is not required to: (1) repay the security deposit unless transferred to the new landlord; (2) honor any pre-payment of rent that exceeds one months’ rent; and/ or (3) perform any tenant improvements or pay any tenant improvement allowance. All of these carve-outs should be objectionable to a tenant and negotiated with the landlord’s lender.
In addition, tenants should attempt to negotiate the SNDA at the same time as the lease, so that the SNDA will be executed contemporaneously with the lease. If the lease is executed prior to the SNDA, the tenant loses much of its leverage in obtaining the SNDA and practically all of its leverage in negotiating any changes to the SNDA.
Some landlords hold firm that they will not seek an SNDA from their lender until the lease is signed. If that is the case, the tenant should negotiate a lease contingency that allows the tenant to terminate the lease if the landlord is unable to obtain the SNDA within thirty days after lease execution.
Prior to using any language or concepts from this blog entry, consult with an attorney.
Ryan Rosensteel is a real estate and construction attorney licensed in Arizona. You can contact him at rrosensteel@rrlawaz.com.