The Commercial Tenants BlogNews, Ideas, and Thoughts for Commercial Tenants

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The New York Times reported recently that Larry Silverstein, who leased the trade center complex six weeks before it was destroyed in the 2001 terrorist attack, and the Port Authority of New York and New Jersey just received the results of an arbitration hearing, with both of them claiming victory. Silverstein complained that he had been delayed in the construction of three new office towers by the actions of the Port Authority, and the Port Authority claimed that Silverstein had to begin construction immediately or he would lose the right to the lease. Silverstein lost on his claim of delay asking for damages, and the Port Authority lost on the demand that Silverstein commence construction. The parties were ordered to work out a reasonable construction schedule.

The reason I raise this issue is that the standard lease used by many commercial brokers in Southern California is the AIR COMMERCIAL REAL ESTATE ASSOCIATION standard Industrial/Commercial, Multi-tenant Lease, which gives the parties the choice of including or not including mediation and arbitration as part of the lease. If chosen, an Addendum pertaining to those clauses has to be attached to the lease.

As a tenant, you have to determine whether or not you want to provide for Mediation and Arbitration. This important decision is often dealt without much thought. YOU SHOULD DISCUSS THIS WITH YOUR COUNSEL.

Arbitration was once thought to be less expensive than litigation, but today as much expensive discovery and pre-arbitration work is involved as in litigation. You need to evaluate, with the help of counsel, whether mediation and arbitration will resolve matters more quickly, or be less expensive. Arbitration is usually private as opposed to public trial. Is that a consideration?

There are many other issues to be concerned with if you choose mediation and arbitration. Don’t agree to mediation and arbitration without careful consideration of the many issues that your counsel should review. If you’d like to discuss what issues you might want to raise with your counsel, I’m available at 760-230-1492 or at Lee@LeeSterling.com.

We now get to the A of SNDAs (Subordination, Non-disturbance, and Attornment Agreements in leases.) First a brief recap of Subordination and Non-Disturbance. You may remember from our previous articles that if you’re a tenant, and you’ve agreed to subordinate your interest in the lease to any mortgage, trust deed of other security device, and the holder of one of those security devices forecloses, your lease may be terminated. Leases usually provide for that subordination to security devises even if they are created after the lease commences. The non-disturbance clause protects you in the event of a foreclosure (or in the event the property is sold to another owner) by providing that if you’re not in default you’ll be able to keep your lease in effect.

The attornment clause stems from the old feudal law that there was a personal obligation between the lord of the manor and his tenants, and that those obligations were reciprocal. The consent of the lord was required for a sale of the tenant’s interest, and the consent of the tenant was required for alienation (sale/transfer) of the reversion or remainder interest in the property. Thus, the lord could not alienate his reversion or remainder interest without the consent of the tenant. The consent was called an attornment. The necessity for an attornment was abolished before the American Revolution by the English Statute of Anne. In California, the common law rule eliminating the requirement of attornment has been confirmed by statute. However, just to be sure, leases contain an attornment clause that provides that if title to the property is transferred by the Lessor or if title is acquired through foreclosure or termination of a Security Device the tenant will attorn to the new owner.

The language of the SNDA in each lease has to be examined carefully because there are differences that may result from the specific language of the three inter-related clauses. There are some interesting California cases involving the interpretation of SNDAs. Be sure to have the lease reviewed by California counsel before signing any lease.

Lee Sterling was a real estate lawyer in Colorado for 27 years. He is not licensed as an attorney in California. He does have a California real estate license # 01319489.

In the past I’ve written about the SNDA clauses typically found in commercial leases: Subordination, Non-Disclosure, and Attornment.  I’ve described the importance of the Non-Disclosure clause.  The terms of the Subordination clause and the Attornment clause are equally important. Today, I’m just going to discuss the “S” of the SNDA, the Subordination clause. I’ll save the Attornment clause for another blog post.

If a lease is recorded or a tenant takes possession of property before a lender records its lien, the lease will have priority.  A Subordination Agreement changes that priority.  Landlords typically will include a subordination clause in the lease because they know that their lender will not lend them money unless tenants are junior to the lien of the lender’s trust deed.  Often the Subordination language imposes subordination not only for existing loans, but future loans and for modifications, extensions, increases, renewals, and modifications etc. of those loans (for ease of reference, let’s call these the “mortgage”).

The lender’s subordination agreement may provide that your lease is subject to the terms of the mortgage.  You definitely don’t want that!  You don’t know the terms of the mortgage, and don’t want to be bound by what you don’t know. You can agree to be subordinate to the lien of the mortgage.

A tenant has to be concerned about the terms of the Subordination Agreement because it may give rights to the lender without corresponding obligations.  For example, if the landlord had agreed to pay for certain tenant improvements prior to a foreclosure, and the Subordination Agreement is silent on the obligations of the foreclosing purchaser, the foreclosing party may not be obligated to pay for those improvements.  The Subordination Agreement should give you the right to terminate the lease if such obligations are not met.

In the event of insurable damage or condemnation prior to a lender’s foreclosure there may be a dispute as to who is entitled to proceeds resulting from those events.  That’s another issue that should be covered in the Subordination Agreement.

We’ve covered just a few of the issues to be considered in reviewing a Subordination clause and the lender’s Subordination Agreement. Be sure you have the right advisor helping you review the lease terms.

The Subordination clause has to be considered in conjunction with the Non-Disturbance and Attornment clauses of the lease.  The terms of the SNDA are often overlooked by anxious tenants, and often accepted without negotiation by the unsophisticated.  Don’t fall into that trap.  There’s interesting California case law pertaining to SNDA Agreements, and you don’t want to become known by being cited in appellate cases!  For questions about these issues always see your counsel before signing a lease.

On Friday, July 10, 2009, we celebrated the opening of the new location for My Life Tees, Silk-Screen and Embroided Apparel, owned by Stacie and Paul Marotta. We helped them find the location and then negotiated the lease on favorable terms by being persistent despite the landlord’s reluctance. That’s Paul, Stacie, and me in the picture to the left. We’re having a delayed celebration of my turning the keys over to them for their new production and display facility.

When we first looked at the space, it was dreary, the toilet had a sign that we shouldn’t try to use it, and the warehouse ceiling cover had holes taped with duct tape. But, the location fronted on a busy street at 310 Via Vera Cruz in San Marcos, and we felt the price could be advantageous. However, despite the significant vacancy factor in the complex and the area, the landlord REFUSED to respond to our first Letter of Intent. The Property Manager explained that the landlord had owned the complex for years, and had never had to lower rents to the level we were offering. The Property Manager indicated a lease rate which she thought the landlord would accept. That was still too high in our estimation, and in our client’s budget. We prepared another letter outlining the reason for our revised offer that was still lower than the landlord indicated he was willing to accept. Finally, the landlord realized that we would “walk” from the location, and accepted our revised offer. You have to know your market, know your strength, and be prepared to walk away from unreasonable situations.

We were delighted to work with Stacie and Paul. We met Stacie as an active member of the Carlsbad Chamber of Commerce, and as organizer of TheMeetMarket, a networking group of entrepreneurs. Paul is a civilian radar expert for the U.S. Navy. Both of them recognized that they wanted to be entrepreneurs, and purchased My Life Tees, a great source fro sikl-screen and embroided apparel. Since buying the business they’ve had great success in expanding the business by concentrating on North County sports teams and expanding to develop Rhinestone embroidery for beautiful feminine t-shirts and blouses.

Stacie and Paul have done a wonderful job of redecorating and fixing up the space to show off their products and to efficiently produce their beautiful t-shirts and embroided apparel. Click here to go to their website where you can order on line.

I’ve mentioned the SNDA in previous posts (Subordination, Non-Disturbance, and Attornment). The ND portion refers to non-disturbance of the tenant’s right to have its lease recognized as valid in the event of the foreclosure of a senior trust deed. The S refers to the Subordination clause and the A refers to the Attornment clause. I’ll discuss the Subordination and Attornment clauses in separate blog posts. From the Tenant’s standpoint, the non-disturbance clause (“ND”) is most important.

The use of the Non-Disturbance Agreement depends on the timing of the recording of the trust deed and the recording date of the lease (or the recording of a Short Form Notice of Lease) ,collectively “Notice”. Usually neither the Tenant nor the Landlord want the whole lease recorded. The lease may or may not provide for the recording of a Short Form Notice of Lease. As a Tenant you may want a Notice recorded. Check with your attorney for advice.

California follows the race-notice theory of recording. The first legitimate document recorded has priority over subsequently recorded documents. If a trust deed is signed on January 2, but not immediately recorded, and the lease is signed on January 10 and its Notice is recorded on January 11, while the trust deed has not yet been recorded , the lease would have priority over the trust deed. If the trust deed were subsequently foreclosed, it would NOT have the right to evict the Tenant so long as the Tenant was not in default under the terms of the lease.

However, if the trust deed were RECORDED first the lease would be subject to the priority of the trust deed. If the trust deed were foreclosed, the foreclosing party could evict the Tenant! The reason most Tenants want the ND is that they usually have spent quite a bit of money on leasehold improvements, moving costs would adversely impact their bottom line, they may have spent substantial amounts branding their location, and they may be out of business while moving to a new location. A Non-Disturbance agreement should protect the Tenant in those circumstances.

Before entering into a lease, or when renegotiating a lease, the Tenant should determine whether or not there is a recorded trust deed encumbering the property. If there is, the Tenant should make it a condition of the lease that the Landlord provides a Non-Disturbance agreement signed by the lender. Obtaining a Non-Disturbance Agreement often depends on the negotiating position of the parties. A tenant leasing 1,000 square feet of retail space in a mall probably won’t be able to obtain the lender’s consent to a Non-Disturbance agreement. However, a major Tenant in a development should insist on an ND agreement. Merely having the ND clause in the lease will not protect the Tenant if the lender has not provided the signed agreement. The ND clause may provide that the Landlord will use its best efforts to obtain the lender’s Non-Disturbance Agreement. In the standard lease used by commercial brokers in Carlsbad and the rest of San Diego, the lease ND clause provides that if the landlord doesn’t obtain the ND agreement within 60 days, the Tenant may go directly to the lender to try to obtain the Agreement. Without the lender’s signed agreement, the Tenant is at risk. There are various forms of ND clauses and agreements. Be sure to have the language reviewed by your attorney if you want to protect your rights to retain your lease rights in the event of foreclosure.

If you have general questions about commercial leases, please send us a note at Lee@leesterling.com

Allan Koljonen, a fellow member of the Carlsbad Chamber of Commerce, and a knowledgeable real estate investor, read our blog about what happens to tenants when landlords file bankruptcy, and wondered about the effect on tenants when a foreclosure is filed against a landlord’s property.

It depends…isn’t that a typical lawyer’s response. California follows the rule that a properly recorded lien or interest in real property is superior to any subsequently recorded lien or interest in real property. So, if a lease is recorded before a trust deed is recorded then the lease is superior, and the foreclosure of the deed of trust does not affect the previously recorded lease.

If, however, the trust deed is recorded prior to the recording of the lease, then the foreclosure of the trust deed will extinguish the lease and the tenants and landlord of the property will be relieved of their respective obligations under their leases. However, the parties may change the effect of the law by a special agreement in the terms of the lease. Very often tenants want to retain their lease rights after a foreclosure. They may have built up a local market for their location, they’ve spent thousands, perhaps, making leasehold improvements, and they certainly don’t want to incur all the expenses of having to move. In some cases, it’s the foreclosing party who may not want to have the lease automatically extinguished by the foreclosure. The rents may be at market or higher than current market rents, the tenants may be well-financed and well able to afford the current rent even if it is now higher than current market rent, and the foreclosing party doesn’t want leases to be extinguished, which would result in vacancies. So, it may be in both parties’ interest to have an agreement in the lease that changes the effect of the automatic extinguishment of a subordinate lease in a foreclosure.

The protection available to tenants and foreclosing parties changes the California law in the lease agreement by using subordination, non-disturbance, and attornment clauses. These are commonly referred to as SNDA. If you’re a tenant, determine whether your lease was recorded prior to or after the trust deed affecting your leased property, and make sure you read and understand the SNDA because the consensus is that there are going to be increasing commercial foreclosures affecting lease rights. I’ll cover each of the clauses of the SNDA in separate blog postings. Check back often for updates or subscribe to the RSS feed above. If you any general questions about the SNDA or commercial tenant’s law please email me at lee@leesterling.com. As you know, I was a Colorado real estate lawyer for 27 years, but I’ve retired and I’m not licensed to practice law in California. For specific legal questions you should always consult a lawyer licensed in the state in which the property is located.

By the way, if you like the image at the beginning of this post you can click on it to go the web page of Donald Teel, a commercial real estate broker in Prescott, AZ for information about what’s happening in that part of the country! You can also go to Donald’s web site by clicking here.

Grubb & Ellis\BRE Commercial (“Grubb”) is one of the leading commercial real estate brokerage companies in the area representing landlords and commercial building owners. They put out research reports quarterly on the commercial real estate market. Their first quarter of 2009 report on the industrial market covers all of San Diego, but I’m most interested in what is going on in North County.

The Grubb Report indicates that there is a total of 14,255,418 square feet of industrial space in Carlsbad, 5,331,920 square feet in Escondido, 8,498,851 in Oceanside, 7,642,154 in San Marcos, and 12,971,905 in Vista.

The total vacancy factor in each community, which includes some space available for sublease, is: Carlsbad – 19% (with 4% sublease vacancy); Escondido 6.2%; Oceanside – 14.8%; San Marcos – 8.5%; and Vista – 7.5%.

To get a copy of the full report, go to http://is.gd/wCYP

With the high vacancy factors in Carlsbad and Oceanside now is a good time to acquire new space or renegotiate your lease at favorable terms. If you’d like assistance in that regard call me at 760-230-1492 or email me at Lee@LeeSterling.com for a no cost consultation.

General Growth, the owner or manager of more than 200 malls in 44 states, which also owns office buildings and is involved in the management and development of master planned communities, filed the LARGEST real estate bankruptcy in U.S. history. So, what happens to its thousands of tenants in those malls and office buildings?

The bankruptcy code (Code) allows the debtor-in-possession (the landlord, for example) or the trustee of the bankrupt estate (hereinafter we’ll use Trustee to indicate either) to accept or reject executory contracts and unexpired leases (Sec. 365). As a result, the Trustee will usually affirm leases that are at or above market rent and reject those that are below market rent. Of course, the lessee of a below market rent would like to make sure it continues to have the right to occupy that space, and the lessee may want to retain the space even if it’s at market rent because of significant improvements the lessee may have made or the cost of moving may be prohibitive. Fortunately, if the lease is rejected, Section 365 provides that the lessee’s possessory rights are protected. However, the Trustee may be relieved of other provisions of the lease, such as the duty to provide services to the lessee.

What if the Trustee wants to sell the property that you have leased? Section 363 of the Code allows the Trustee to sell the real property “free and clear” of any “interest,” in the property, and a lease has been held to be an “interest.” One case, in the Seventh Judicial Circuit, with its particular facts, has held that the right of the Trustee to sell the property free and clear of the lease under 363 of the Code trumps the rights under section 365 of the Code that gives the lessee the continued right to possession. The lessee, for some reason, had not objected to the sale; perhaps counting on the provisions of Section 365. The lessee lost the possessory rights to a warehouse they had built on the bankrupt’s property. In the First Circuit, in a different case, where the lessee had objected to the sale, the Court held that the lessee’s right to retain possession was not trumped by Section 363! If you’d like more information, an interesting discussion of the cases can be found at: http://is.gd/u8Sm and http://is.gd/u8qA

As soon as you hear that your landlord has filed bankruptcy or is contemplating filing bankruptcy, immediately contact competent bankruptcy counsel to protect your rights!

Read the lease before you spend any money on the new space you’ve found! It’s not uncommon to start spending money on inspections, space and decor planning, communications planning, furniture planning, and your time and staff time planning for the new space. Landlords sometimes count on your becoming so invested you’ll be forced to accept lease terms that you might not otherwise agree to. After there is agreement to the basic terms of a Letter of Intent (subject of another post to come) be sure to ask for a copy of the propsed lease! Then you can be sure that the terms are acceptable before you’ve spent your time and money!

I received this video from a long-time friend from high school days. It was so interesting that I wanted to pass it on to my friends here in Carlsbad and Encinitas: