Commercial tenants these days have more to worry about than paying their rent. A thriving business could make every lease payment and still lose its space if the commercial landlord defaults on its loan. This risk can be eliminated through a non-disturbance agreement between the tenant and the lender.

A lease may look like a two-party agreement, but it’s a risky commercial instrument if there is a third party lurking in the shadows — namely, the landlord’s lender.

When a landlord defaults under its loan, the lender may step in and foreclose, effectively wiping out all leases signed after the loan was made.

To protect itself against an involuntary loss of its lease, a tenant negotiating for space or renewing its lease should inquire from the landlord about whether there is currently a loan on the property. If a loan exists then, as a precondition to lease term commencement, the tenant should seek to enter into a non-disturbance agreement with the landlord’s lender.

The landlord may also be a party to the non-disturbance agreement between the tenant and the lender. By including the landlord in the non-disturbance agreement, the tenant formalizes its knowledge of the landlord’s financial condition thus minimizing risk before it is locked into a lease. The tenant may decide to move forward and lease the space without a non-disturbance agreement if the lender is unwilling, but at least this will be a risk the tenant has consciously assumed.

A non-disturbance agreement, also known as a subordination, non-disturbance and attornment agreement, will typically involve three interrelated concepts. The first is subordination — the lender wants the tenant to agree that its leasehold interest in the property is secondary to the lender’s lien.

Tenants agree to this because of the second concept — non-disturbance. Since the tenant is agreeing to subordinate its leasehold, the lender agrees that it will not disturb the tenant’s possession provided the tenant is not in default under its lease obligations. This agreement overrides the automatic wipe-out of subordinate interests should the lender foreclose on the landlord.

As long as the tenant recognizes the lender as its landlord under the lease following a foreclosure, the tenant gets to stay, according to the terms of the lease. This is the attornment concept.

The takeaway here is that lenders generally do not want all tenancies to automatically terminate following a foreclosure. Good tenants enhance the value of the asset, and most of the time there will be little reason to a lender to shut off a source of income.

As a practical matter, not every tenant will be successful in securing a non-disturbance agreement with the lender. Tenants leasing one-thousand square feet of shop space in a large mall will not likely get the attention of the lender. If the lender is unwilling to negotiate a non-disturbance agreement and circumstances result in a foreclosure of the landlord’s ownership, there is nothing preventing either the tenant or the lender from approaching each other with a proposal for a new lease. The terms of the new lease may favor the tenant or the lender; hence, a non-disturbance agreement is a tool to minimize this risk.

The size of the risk for a tenant not protected by a non-disturbance agreement will be proportional to the amount of capital invested in its leased space and good will the tenant has built with its client base at that location. Not to mention the interruption of business resulting from the tenant having to box up its inventory and find a new suitable space. In a tight economy, a simple non-disturbance agreement can be the difference between success and failure of one’s business.

Contact John Kofron at jkofron@fclaw.com or (520) 879-6814 or David Vieweg at dvieweg@fclaw.com or (602) 916-5358. Both practice law with Fennemore Craig. Kofron practices in the area of construction transactions assisting developers in the residential, commercial industrial and health care markets. Vieweg practices in the areas of real estate acquisition and development, real estate finance and commercial leasing.