Draft a Lease Your Lender Will Approve

By Alan M. Cohen, Esq.

A lender making a loan secured by a mortgage or deed of trust against income-producing commercial real estate typically reserves the right to approve leases for space at the property signed after the loan closing. Most loan commitments to landlords of commercial property are contingent on review and approval by the lender of existing leases and lease forms used by the landlord as borrower. Lenders review lease forms and reserve the right to review and approve new leases to make certain the owner will be able to service the debt and to make certain the tenant mix will maintain or improve the value of the property. Additionally, lenders reserve the right to review and approve leases to make certain the terms and conditions include legal protections for the lender.

Loan agreements and related loan documents restrict the rights of the landlord as borrower and impose certain obligations on it, but they establish no direct obligations on the tenants. Accordingly, it is important to most lenders that leases include provisions obligating the tenant to the lender even prior to a foreclosure, at which time the lender assumes the landlord’s position under the lease.

Protect Lender’s Interests

Most commercial landlords use lease forms that cover the general legal concepts of concern to lenders, but landlord lease forms do not always include language that recognizes the rights of the lender and that obligates the tenant to the lender. Loan closings frequently are delayed to enable owners to seek lease amendments and/or Subordination, Nondisturbance, and Attornment agreements (SNDAs) from their tenants to address lender concerns. (An SNDA is an agreement whereby the tenant agrees that its lease is subordinate to the lender’s mortgage/deed of trust, the tenant agrees to attorn—or formally make or acknowledge a transfer of its lease—to the lender in the event of foreclosure or deed in lieu of foreclosure, and the lender agrees that as long as the tenant is not in default of the lease, its rights under the lease shall not be disturbed.)

To expedite loan closings and avoid the need for lease amendments, owners are advised to include in their leases the lender protections discussed below and in our Model Lease Clause: Include Important Lender Protections in Lease.

Indemnity and insurance benefit lender. Landlords should make sure that indemnity and insurance provisions benefit the lender in addition to the landlord. Most commercial leases obligate the tenant to indemnify, defend, and hold harmless the landlord from certain claims, damages, and losses that can arise from the landlord-tenant relationship. Leases usually include general indemnity provisions pertaining to claims, damages, and losses sustained by the tenant and its customers, clients, suppliers, and others injured on the property while visiting the tenant. Leases also include provisions dealing with “hazardous substances” present on the property arising from the tenant’s operations that include defense and indemnity obligations in favor of the landlord.

Because most tenants at one time or another will perform maintenance, repairs, or renovations to the leased premises, leases include lien indemnity provisions that obligate tenants to indemnify, defend, and hold harmless the landlord from mechanic’s, contractor’s, and materialman’s liens and from personal injuries and property damages arising from construction.

Just as a landlord wants indemnity from claims and damages arising from a tenant’s operations and occupancy of the leased premises, so too does a lender. Accordingly, in every lease provision obligating the tenant to indemnify, defend, and hold harmless the landlord, landlords are advised to include language obligating the tenant to indemnify, defend, and hold harmless the landlord’s lender.

Although most tenants agree to the indemnity provisions above, many do not have the assets to satisfy their indemnity and defense obligations when claims arise. It is for this reason that commercial leases virtually always require the tenant to purchase insurance to protect the tenant and the landlord from claims, losses, and damages arising from the tenant’s operations and occupancy of the premises. Both liability and property insurance insuring the tenant’s property and the tenant improvements typically are required. In some instances, a tenant is required to insure the building where the premises are located.

Landlord lease forms require that the landlord be named an additional insured under the insurance policies required of the tenant, that the landlord be provided copies of the insurance policies required of the tenant (or a certificate of insurance), and that the landlord be provided written notice prior to modification or cancellation of the insurance policies required of the tenant. Language should be included to require that the landlord’s lender also be named an additional insured, provided copies of insurance policies required of the tenant (or a certificate of insurance), and provided written notice prior to modification or cancellation of the insurance policies required of the tenant [Clause, par. 3].

No future agreement to subordinate by tenant. Landlords should also specify that subordination of the lease and attornment by the tenant shall not require future agreement of the tenant. The lease provision that is most important to commercial lenders is the “subordination” provision. Most commercial lenders will not make a loan secured by a mortgage or deed of trust against real estate unless the mortgage/deed of trust is superior in rank to all other liens, leases, and encumbrances against the property.

The reason for this is simple: The lender wants to be able to foreclose against its lien without interference from others possessing an interest in the property. Although most landlord lease forms include a subordination provision, most subordination provisions are contingent on execution by the lender and the tenant at a later date of an SNDA. Landlords are advised to include language in the subordination provisions of their lease forms so the lender obtains most of what it requires without the need for an SNDA.

While most lenders still will require an SNDA, some may lend without one if the subordination provision includes certain language. The subordination language that is most critical is the language that makes the subordination of the lease to any existing and future mortgage/deed of trust self-operative and that gives the landlord power of attorney to subordinate the lease to any current or future mortgage/deed of trust [Clause, par. 1].

Landlords should make sure that their subordination provision incorporates these concepts designed to provide the landlord and lender relief in the event the tenant fails to sign an acceptable SNDA. Many tenants refuse to sign lender SNDA forms or simply do not move as quickly as the landlord and lender would like. By including language to make subordination of the lease to the mortgage/deed of trust self-operative, and by giving the landlord power of attorney to act in the event tenant fails to act, the landlord ensures that its loan will not be delayed by the tenant. Also critical to the subordination provision is language that makes the lease subordinate to any existing mortgage/deed of trust, any renewal or extension of the mortgage/deed of trust, and any future mortgage/deed of trust [Clause, par. 1].

Right to termination for casualty. The landlord should also have the right to terminate in the event of a casualty if the lender requires that insurance proceeds be applied to the loan. In the event of damage or destruction to a lender’s collateral, most commercial loan agreements give the lender the right to require that insurance proceeds recovered by the borrower be applied to the loan, rather than used to restore the premises. This loan requirement conflicts with “casualty” provisions in most commercial leases that obligate the landlord to repair and restore the premises following damage or destruction. Although some casualty provisions reserve for the landlord the right to terminate during the last 12 months of the lease term or if greater than 50 percent of the property is damaged, many lease forms do not contemplate the possibility that insurance proceeds will not be available to the landlord to repair and restore the property.

If a landlord has given its lender the right to apply insurance proceeds to the loan balance, and at the same time promised its tenant it will rebuild following a casualty, the landlord may be unable to comply with its restoration obligation. Accordingly, landlords are advised to reserve the right to terminate following damage or destruction to the premises in the event landlord’s lender requires that insurance proceeds paid on account of the loss be applied to the loan balance. Without this reservation, a landlord may be obligated to make repairs even though it has no money to do so.

Notice to lender of default and opportunity to cure. The lease should also provide notice to the lender of landlord default and an opportunity to cure [Clause, par. 2]. Commercial lenders loan funds secured by mortgages against income-producing properties based on the strength of current or anticipated tenants. Accordingly, lenders dislike vacancies as much as landlords dislike vacancies. It is extremely important to most commercial lenders that they receive notice and an opportunity to cure a lease default by the landlord before the tenant has the right to terminate the lease.

Landlords typically require 30 days’ advance written notice of default prior to termination. Language should be inserted to require the tenant to provide the landlord’s lender written notice of landlord’s default via certified or registered mail and at least 30 days to cure any default by the landlord.

If due to the nature of the default it cannot reasonably be cured within 30 days, the lender should be allowed the right to cure within a reasonable period of time. Because the landlord’s lender typically is not associated with day-to-day activities at the property, a lender generally requires more time than a landlord to mobilize in the event of default. In addition to notices of default, lenders like to receive copies of all required notices under the lease, so landlords should include language in the “notice” provisions of their leases to require that copies of notices be sent to the landlord’s lender.

Consent to amendment and termination. The lease should not be terminated or amended without the lender’s consent. Borrowers generally agree with their lenders that leases will not be terminated or amended without lender consent. While most landlord lease forms include “entire agreement” provisions that make clear that the lease can be modified only by written agreement of the landlord and tenant, a written amendment by the landlord and tenant that is not approved in writing by the landlord’s lender may give rise to a default under the landlord’s loan agreement.

Accordingly, landlords are advised to include language in the entire agreement sections or the subordination sections of their lease forms to make clear that no agreement amending, modifying, or terminating the lease shall be effective without the prior written consent of the lender.

Consider Future Lenders’ Requirements

Before loaning funds secured by a mortgage or deed of trust against an income-producing property, commercial lenders like to ensure that the leases in place, or which will be executed in the future, include the above lender protections. While many lenders refuse to close loans without lease amendments and/or SNDAs, some lenders will close in the absence of a lease amendment or SNDA if the lease in place includes language to ensure that:

• The lender will be indemnified and defended with respect to any losses arising from the tenant’s occupancy;
• The lender will be named an additional insured under the tenant’s liability insurance and provided confirmation of coverage;
• The lender’s mortgage/deed of trust will be superior in rank to any leases existing on the date of the mortgage/deed of trust, and to any future leases;
• The lender will be afforded notice of landlord default and a reasonable opportunity to cure before exercise by the tenant of its rights; and
• The lease will not be amended or terminated without the lender’s consent.

It’s important for landlords to keep in mind that while it’s necessary to meet their current lender’s requirements, tailoring new tenants’ leases to only those requirements could create terms that are too narrow. When drafting a lease, landlords should consider the interests of current and future lenders so their ability to borrow is not hindered later if future lenders require different or broader terms.

Alan M. Cohen is a real estate, construction, and renewable energy attorney with the Austin, Texas law firm of Stahl, Bernal, Davies, Sewell & Chavarria. His commercial leasing experience includes representation of national landlords and tenants throughout North America. He is admitted to practice law in Texas and Louisiana.