Many owners take out loans to help finance their purchase of real estate. Over time, those original loans may be refinanced, or the owners may take out additional loans, at which times new lenders enter the picture. Generally, these lenders agree to fund the purchase or refinance of the property in exchange for taking back the real estate as collateral. If the owner defaults, the lenders have the right to foreclose on the property and become the new owners. With that in mind, lenders take steps to ensure that their real estate collateral is not encumbered by anything that could reduce the property’s value or income stream. One such step is to ensure that the property is not subject to any leases that contain problematic provisions. In some cases, owners enter into leases prior to taking out a loan on the property. For example, an owner may buy the property with cash, and later apply for a loan. In such cases, the owners should keep in mind that if they want to take out a loan in the future, the lenders will require certain terms in their leases to ensure that the collateral will be valuable. Here are five things to consider when negotiating a lease for property that is or will be financed by a lender.
1. Lease Provisions. There are some provisions that lenders definitely do not like. For instance, adding an option to purchase or a right of first refusal can impair the alienability of the property. Among other problems, if the landlord defaults on the loan, the lender may want to be able to recoup its investment by selling the property, and those types of rights make it more difficult for the lender to do so. Lenders also want to be sure that there is a steady stream of income, so landlords should try to limit provisions that allow tenants to reduce or offset their rent, terminate the lease early, or go dark. There are also provisions that lenders like (and may even require) leases to include, such as clauses that require tenants to give the lender notice of any landlord default, and that allow the lender to cure such a default before the tenant can exercise its remedies. Lenders also prefer that the lease allows the lender to have control over insurance proceeds and how they are utilized in the event of a casualty.
2. SNDA. Owners who may want to obtain future loans on the property should include language in their leases that makes the lease subject to any future lender’s rights. These types of clauses have been held to be enforceable. To avoid the risk that the lease will be terminated following a foreclosure, tenants often ask for a subordination, attornment, and non-disturbance agreement, or SNDA (which we discussed in our February 2012 Dirt Report), but depending on the size of the transaction and the leverage of the tenant, the lender may or may not be willing to entertain such a request, and when they do, they often require that the SNDA be on their form. Once an SNDA has been executed, it is important to remember that the lender will likely need to consent to any future amendment to the lease, even if the loan documents themselves don’t require lender consent.
3. Consent. Lenders won’t necessarily care about every lease the landlord wants to enter into, but there is usually some threshold, whether it’s the size of the premises, the length of the term, or some other measure, and when a lease falls into that territory, the lender must consent before the landlord can enter to that lease, or else the landlord will be in default of the loan. In addition, when amending a lease, the landlord should be aware of whether the lender’s consent is needed. Generally, if the lease initially required the consent of the lender, the landlord will likely need the lender’s consent again in order to amend it, at least if the amendment is considered material. This seems simple enough. But what if the lender’s consent wasn’t required for the original lease? In that case, the landlord probably will not need to get lender consent to amend the lease, unless the terms of the amendment kick it over the consent threshold and turn the deal into the type of lease that the lender would need to approve if the parties had originally negotiated it with the new terms added by the amendment. For example, if the landlord agrees to give some rent relief to the tenant under the lease, but in exchange wants to increase the length of the term, that could turn an otherwise “minor” lease into something requiring lender approval.
4. Requirements. Be sure to review all of the loan documents carefully to understand all of the requirements. There are often special ways in which notice must be given to the lender in order for the notice to be effective, or the loan may require that the lender receive copies of all the leases on the property, even if the lender doesn’t have approval rights over all leases. The loan documents might also require the landlord to provide additional information that isn’t part of the lease itself, but will aid the lender in reviewing the lease, such as the tenant’s financial statements.
5. Ground Leases. When the lease involved is a ground lease, the tenant may also be borrowing money in order to finance its development of the property. This situation has different considerations, as the lender’s concerns have shifted. For example, it will be thinking about what it will be able to do with the property in the event the tenant defaults under the loan and the lender then becomes the tenant. In that case, the lender is likely to be concerned about provisions such as assignment and subletting. In addition, if the tenant defaults under the ground lease, the lender needs the ability to cure the default; otherwise the lender risks losing its investment if the lease is terminated before the loan is repaid.