Everyone accepts that property owners borrow money for their businesses. Very few properties are unencumbered by a mortgage. Other than in a very, very limited number of situations, tenants readily, perhaps automatically, accept that their lease will be subordinate to at least the lien of a mortgage. If a tenant can be insulated from the bad effects of a lender taking over a property or from the fallout of a foreclosure, it will or should be somewhat indifferent to having a lender or a new owner step in when its then-landlord can’t financially support the property any longer. Yes, it is messy, but think about the alternative of having a landlord without the financial resources to maintain the property, perhaps without the resources to pay real estate taxes. Put that way, having a strong lender to back up a landlord can be a benefit to the tenant. Even where there is a foreclosure sale, a new owner, with fresh capital to protect, in at a lower “price” and thus with what is almost always lower debt service, will help a tenant just exposed to a landlord on its last legs.
Certainly, tenants should get the protection that a well-negotiated SNDA (Subordination, Non-disturbance, and Attornment Agreement) can bring. Given, however, that the property wouldn’t likely exist in the first place without mortgage financing, and based on what we’ve presented in the paragraph above, tenants should (and in fact, do) accept that landlords have lenders. [For Ruminations’ thoughts on what an SNDA might or should cover, click HERE and then HERE and then HERE.]
By this time, readers should be universal in thinking: “What’s the big issue here? We knew all of that already and Ruminations is in its third paragraph already.” Yes, all we’ve done thus far is to acknowledge that landlords borrow money secured by their interest in real property. But, what about tenants? Don’t they need to borrow money (at times) for their business needs? And, don’t lenders “like” secured loans? And, don’t tenants also have interests in real property? Of course all of that is true. That being the case, why do landlords kick and scream when a tenant wants to borrow against its assets, especially when that asset is the tenant’s interest in the lease or the tenant’s interest in property within the leased space?
In November of 2012, we posted: “How Should A Landlord Respond To A Lender’s Request For A Consent And Lien Waiver; Should A Tenant Care?” You can revisit it by clicking HERE. What we didn’t do then was to explain why a landlord should, on balance, be pleased that a lender or equipment leasing company will be assisting a tenant’s success by providing funding. What does a landlord have to lose if a tenant leases equipment or uses its own property to secure a loan? While it is true that a landlord (in some jurisdictions) may have a “landlord’s” lien on some property of certain kinds of tenants, how often is that a useful remedy? Large, multi-location tenants will file for bankruptcy protection before a landlord even gets close to “grabbing” a tenant’s inventory, equipment or other personal property. In the case of small, single location tenants, what do you think will be left behind?
Lenders assess borrower credit. Lenders care about the purpose for which the “new” money is going to be used. They do not knowingly throw money down a pit, meaning they do not lend into a hopeless situation (which is one where the tenant isn’t going to around long enough to repay the loan or pay rent). In return for furnishing capital to a tenant, they are going to tie up all of the borrowing-tenant’s assets, including what is within the leased space. Why would or should a landlord thwart its tenant, already “credit verified” as a good lending risk, from borrowing money to build its business?
Interestingly, landlords are nearly universal in stepping aside (quite readily) when a large tenant requires its landlord to agree to subordinate its interest in the tenant’s property to that of a lender or leasing company. What about the smaller tenant without the same bargaining power (or without a leasing negotiator who recognizes the issue)? Don’t some small tenants borrow money or lease equipment to aid their businesses? Why make it an issue? Just as tenants always agree to subordinate their interest in the lease to a fee mortgagee’s lien or even to the entire mortgage, landlords should agree, in the lease itself, to do the equivalent when it comes to loans taken by their tenants. Of course, just as in the case of SNDAs, where tenants need to negotiate for a “balanced” set of rights (as you might have seen when you clicked on the link, above, to our SNDA posting), Landlords need to negotiate for a balanced lien waiver (as you might have seen when you clicked on the link, above, to our lien waiver posting).
What about leasehold mortgages? Should tenants be able to obtain financing in that way? Let’s begin by narrowing the question. Small tenants do not get leasehold mortgages. Their lenders don’t dabble in such security and the transaction costs are too high. Then, there is a certain kind of tenant that relies on leasehold mortgages for financing. That include ones who build on leased land and borrow for that building itself or for the next building elsewhere. [In which case, they borrowed on the last property to build this one.] Everyone in the business of leasing to these tenants already accepts that the lease will permit leasehold mortgages.
In other cases, multi-location tenants sometimes borrow large sums of money, for business purposes, and their lenders secure the loans with all of the tenant’s assets, including the tenant’s interest in its leases. Here, the reception among landlords is mixed. Some landlords “get it” and just make sure that the right “balance” is struck in the lease’s provisions that permit such financing. We’re not going to address those landlords and we’re not going to give any “nuts and bolts” help to anyone seeking to negotiate these provisions.
What we are going to do is explain why Ruminations thinks landlords should stop defending their standard, boilerplate “no mortgaging of tenant’s leasehold interest” clauses.
Except in a limited number of deals, where this is known up front to be the basis of the deal itself, a leasehold mortgage does not trump the landlord’s fee mortgage and does not come “ahead” of the lease itself. A tenant cannot use the landlord’s interest in the lease as security. It can only use its own interest. Yes, there are different leasehold interests, one of the landlord’s and one of the tenant’s. Basically, a lender-mortgagee that takes over its borrower’s (the tenant’s) interest in a lease is just like a pre-approved assignee – it becomes the tenant. The lease has value as collateral because “someone” wants to operate from the leased space, even if that isn’t the lender itself. All the lender gets is a lease to “sell” or “assign” to a replacement tenant. And, unless the lease gives the lender special rights in that regard (with few leases doing so), the lender has no “better” lease to assign that the original tenant had to “assign,” and has no greater right to choose that assignee than did its tenant-borrower.
But, a leasehold lender isn’t just “any other” replacement tenant, it is one that has the financial wherewithal and interest to keep the lease alive – to pay rent for an empty space. Also, “going dark” isn’t a business strategy for a lender that chose to take the lease over – it only took it over for the purpose of getting someone to assume the lease and use the space.
If the lease has no value at the time the tenant “falls down the well,” a leasehold lender won’t step in and take over. In such a case, the landlord is in no worse position than had there been no leasehold mortgage in the first place. If there is value (meaning the current fair market value of the lease exceeds the “cost” of the lease in a tenant’s hands), the landlord gets to keep the bargain it made – the rent it planned on receiving when it originally made the lease. In the meantime, there will be no loss of rent (or additional rent) when a leasehold lender steps in because the deal is that the lender will cover past defaults and keep paying the rent until a new tenant is found. Basically, a landlord gets a “credit” tenant (the leasehold lender) at the very time its original tenant is far from that “status.”
If, down the road, the spirits move us, we’ll dig into what might be an appropriate balance between a landlord’s legitimate needs and those of a leasehold lender, but those spirits are nowhere near us today.