Congratulations!  Your Electronic Widget Business which started up in 2005 has been growing and prospering, despite the economic downturn and a steep decline in the Bay Area real estate market.  You continue to aggressively expand your sales and staff.  Your Widget Business has outgrown your present 4,000 square foot leased research and development/office space and you have recently signed a new lease with a new landlord at a very favorable rental rate (with a $12/square foot tenant improvement allowance paid by the new landlord) for 12,000 square feet of leased space in the Mid-Peninsula.  Your existing lease expires May 31, 2010 (with no right to continue to stay in possession) and you have commenced your tenant improvement work in your new premises.  You are well pleased.

KA-POW!!  A certified letter arrives from your new landlord’s lender informing you that the lender has foreclosed its loan on your landlord’s building, and further informing you that your new lease is being terminated by the lender.  Grossly unfair?  Is this legal, you ask?  YES.  Under California law, the deed of trust securing your landlord’s mortgage on the premises is first in time and superior in right to your rights under your lease.  The foreclosure of the lender’s loan will, in the lender’s sole discretion, terminate your lease.  Given the current environment of increasing commercial foreclosures, the foregoing scenario is becoming more and more commonplace.

How can a successful, reliable entrepreneur like you protect your interest under your lease from being terminated in a foreclosure proceeding by your landlord’s lender, bringing your business to a standstill?  SIMPLE ANSWER.  Require your landlord, as part of your lease negotiations, to have its lender to execute a Subordination, Nondisturbance and Attornment (“SNDA”) with you as the tenant.

An SNDA is simple but essential.  The following points summarize the basic components of an SNDA, with the protection of the tenant’s lease rights and continued right to possession being the essential thread.  An SNDA requires the tenant to (1) confirm the subordination of its lease to the lender’s deed of trust and any extensions or modifications to the deed of trust and (2) agree to attorn to (in layman’s terms, to recognize) the lender or a third-party purchaser of the building at the foreclosure sale as the tenant’s new landlord under the lease.  Conversely, and most importantly from the tenant’s perspective, the SNDA requires the lender and any purchaser of the building at a foreclosure sale (“purchaser”) to agree that so long as the tenant is not in default of the lease beyond any applicable cure period set forth in the lease, the lender or purchaser will recognize the continued validity of the lease and all rights of the tenant under the lease (including, for instance, the tenant’s right to extend the term of the lease for any option term(s) and/or expand the premises into additional space) and not disturb the tenant’s rights to possession and quiet enjoyment of the premises.  With an executed SNDA in place, you could require the lender to continue your lease for the balance of the term (and any extended term) and not disrupt your possession, absent a default on your part.

Most SNDAs contain more expansive provisions than those listed above, particularly in complex lease transactions.  The lender will generally require that the tenant certify that (1) the lease in full force and effect, (2) to the tenant’s knowledge, no lease defaults exist, (3) the tenant and landlord will not materially amend or terminate the lease without the lender’s consent, (4) no rents have been paid in advance and (5) the lender is not liable for the landlord’s defaults prior to foreclosure (although the tenant should require that the lender or purchaser be liable for landlord defaults which continue beyond the date of foreclosure, such as the ongoing failure to repair a leaking roof).

From the tenant’s perspective, the SNDA should provide that (a) the tenant will not be a named defendant in any foreclosure proceeding (costly for the tenant in terms of legal fees), (b) no property, furniture or fixtures owned by the tenant will be subject to any lender lien or to foreclosure, (c) upon foreclosure the lender or purchaser will permit insurance or condemnation proceeds to be used to restore the building and the premises (and not to pay down indebtedness) and (d) importantly, that the lender or purchaser agrees to pay the balance of any unfunded tenant improvement allowance agreed to be paid by the landlord to the tenant (this should already be a line item for funding in the foreclosed loan).

In our current real estate market where foreclosures have become commonplace, smart, well-advised tenants should seek to protect their rights not only with their landlord but also with their landlord’s lender.  Carr McClellan’s real estate attorneys negotiate SNDAs for tenants (both simple and complex) on a daily basis to protect our clients.  Please call us for advice.  Don’t have your Widget Business gravely impaired by a foreclosure against your landlord.