At the end of December, there were $1.6 billion in bank-owned retail properties, according to New York-based research firm Real Capital Analytics. As more retail properties end up in the hands of court-appointed receivers, tenants are entering uncertain territory when it comes to their rights and responsibilities.
The growing number of receiverships is shedding new light on a lease clause that got little attention during the industry’s boom years: subordination, non-disturbance and attornment (SNDA) agreements. Such agreements protect both lenders and tenants in the event that a lender forecloses on a property or moves to have a receiver named.
The SNDA agreement is actually three clauses in one:
• The subordination clause is one in which a tenant agrees that its lease is subordinate to the mortgage on the property, or that a lender’s interests come first if a landlord runs into trouble.
• The non-disturbance piece is a guarantee from the lender that in the event of a foreclosure it will not disturb a tenant’s occupancy and will recognize the rights of the lease.
• The attornment piece of the clause is an agreement by the tenant that if a lender forecloses, the tenant will recognize the lender or a court-appointed receiver as the new landlord.
In best-case scenarios, SNDA agreements protect lenders by guaranteeing that income-generating tenants stay in place. Likewise, tenants are protected against an early termination of their lease. In stronger agreements, other provisions the tenant may have negotiated, such as rent abatements or tenant improvement allowances are locked in.
But the strength of the non-disturbance agreement depends on a retailer’s bargaining power, according to Jim Bieri, president and CEO of the Detroit-based real estate consulting firm Bieri Co. For instance, regional and national retailers are more likely to have their rights protected than mom-and-pop operations.
As a result, there can be clauses that are not covered by SNDAs that can trip up tenants in the event of a receivership. For example, offsets such as abatements and tenant improvement allowances may not be covered by SNDAs. That means that when a receiver comes in, it will obligate a tenant to pay its full rent, but the tenant may not receive the offsets that it had agreed to with the prior landlord.
“That’s something that you have to put in the lease separately,” Bieri says. “You have to negotiate to get that right to have offsets in case you don’t get your allowance. It is all about relative bargaining power.”
Receiverships can also be a bigger issue for projects in development than they are for properties that are already operating. If a property is open, a receiver’s duty is more straightforward. It’s there to make sure vendors are paid, the mall is kept clean and that rent is collected. The picture gets much more complicated if a receiver is brought in during the middle of the development.
“It is cumbersome to continue development or construction in the context of a receivership,” says Jim Beard, a partner at DLA Piper, based in Chicago. A receivership is an officer of a court and thus has to act under court supervision, which means the court has to sign off on all leases. This can slow down the development process. It can be unwieldy “when there are day-to-day decisions to be made, unlike in a fully income producing mall,” Beard adds.
There are also ways developments in receivership can trigger other provisions. Lifestyle center leases, for example, are structured with heavily interlocked co-tenancy clauses in which each retailer has a list of other retailers that must be in the project for it to continue to operate.
Co-tenancy clauses in themselves are not tied to whether a project is in foreclosure. But there can be scenarios where an anchor has a stronger lease, giving it a right to close its store in the event of a foreclosure and that in turn could trigger co-tenancy clauses on other leases resulting in a cascade effect of tenants closing up shop, according to Bieri.
As receiverships proliferate, more of these clauses will be tested. Perhaps more importantly, in the current climate, SNDAs and other clauses that take into account the question of distress will be an increasing part of lease negotiations.