Friday, January 27, 2012

Special Blog Post By John Clark: Non-Distrubance Agreements

Today we have our first ever guest blog post. John Clark, Partner at Clarks Barristers & Solicitors in Windsor, Ontario, will provide us with a post from a legal prespective, as part of our leasing series:

In negotiating leases for commercial landlords, clients often ask me about non-disturbance agreements. They are often after-thoughts for those in the process of purchasing commercial rental properties. They shouldn’t be.

Take this scenario:
Akim has agreed to purchase a 5 unit commercial plaza. To finance the purchase he arranged a new first mortgage with Easy Money Mortgage Co. Three of the units in the development were rented with written leases in place when Akim bought, and he knew that he had two prospects wanting to rent from him once he took ownership and possession. The Easy Money mortgage made no reference to the leases, and none of the old or new leases made any reference to the Easy Money mortgage. All tenants paid their rents on time each month and honoured the terms of their leases.

Akim later runs into financial difficulty with another investment. He uses the rent from this development to pay off his other obligations and as a consequence defaults under the Easy Money mortgage. Easy Money puts the matter into the hands of its favourite receiver, Stripette, Bayer and Sellit, and foreclosure proceedings are begun. In that case, what of Akim’s tenants? In the absence of any agreement between the tenants and Easy Money, here’s what happens:

1. The leases that were in place before Akim purchased, and therefore before Easy Money took a mortgage, have priority over the mortgage. Easy Money has to honour the leases whether they like the tenants or not. And the tenants have to stay, whether or not they like Easy Money. In most cases, the tenants would also have to stay after the sale to the new purchaser that Stripette, Bayer and Sellit finds for the property on behalf of Easy Money.

2. There is a different result for the two leases put in place after the purchase, and therefore after the Easy Money mortgage. And, it’s a double-edged sword, both for Easy Money and for the tenants. As the mortgage has priority, Easy Money can instruct Stripette, Bayer and Sellit to terminate the leases and offer the property to prospective purchasers with those two units vacant. This may be attractive to a prospective purchaser if the market has improved since the time the two leases were entered into, allowing a new purchaser to negotiate higher rents than the displaced tenants were paying. Obviously, this improves the price that Stripette, Bayer and Sellit can command on behalf of Easy Money. From the tenants’ point of view, they stand to lose the cost of remodeling and other changes they put into the units other than improvements that might be considered fixtures in law.

The other edge of the sword is this: if the tenant wants, in circumstances where he has not invested a lot in improving the premises, he can flee. He can look for a more stable development, which might be very attractive if the market has softened, as he may be able to secure premises at a lower rental rate.

To bring more certainty and perhaps to enhance the marketability and value of the development, Akim and Easy Money should have considered subordination agreements and non-disturbance agreements at the time Akim purchased the development. These are contracts entered into between mortgage companies and tenants, who otherwise have not contracted with each other (ie, the mortgage or the leases).

A non-disturbance agreement typically provides that a tenant may remain in possession of the rental premises, despite any power of sale or enforcement actions taken by a mortgage company upon a landlord’s default, so long as the tenant keeps paying the rent and honouring the other terms of the lease.

A subordination agreement typically provides that a mortgage company would have priority over a lease. Often in subordination agreements there is a specific attornment provision. Under that provision the tenant recognizes and acknowledges the mortgage, the mortgagee’s rights upon default, and agrees to pay rent to the mortgagee regardless of the landlord’s default.

As you might imagine, there is a lot of room for negotiation in these agreements, and in some cases the mortgage companies or tenants would rather not enter into these agreements, and for good strategic reasons.

For example, in our scenario, the three original tenants already have priority over the mortgage, and a non-disturbance agreement would be redundant. It is already secure in its possession rights. You might ask why a tenant would ever agree to subordinate. Here’s why. Recall that if neither the mortgage or a lease references each other, and there is no non-disturbance or subordination agreement, both parties are stuck with each other. From Easy Money’s perspective, it has to honour the lease so long as the tenant keeps paying rent. And, if the tenant attempts to flee, or refuses to pay rent, Easy Money can sue to recover any unpaid rent, and may also be in a position of terminating the lease and suing the tenant for the rent that otherwise would have been payable during the balance of the term.

In the absence of a mutually acceptable settlement, each of the parties has the option to look for better lease terms. If the parties negotiate subordination and non-disturbance agreements at the time the mortgage is being put into place, the tenant may include provisions (which mortgage companies tend to avoid) that the mortgage company will honour all terms of the lease; not just those permitting further possession if the rent is paid. If in our scenario, Akim had agreed to repave the parking lot within 4 years, one of the original tenants whose lease had priority over the mortgage, might require Easy Money to assume that responsibility; otherwise, it might have no other incentive to sign. Mortgage companies typically resist such requirements, unless the tenant is a very strong one whose continued presence in the development would improve the market value of the development. Bear in mind, that the improved market value would also have worked for the benefit of Akim himself, had he not defaulted.

In most cases, Easy Money would not agree to these extra terms, and would prefer to negotiate with tenants if and when there is default, based on the economic circumstances of all parties and the marketplace at that time. From the tenant’s prospective, it would likely, depending on its strength in the marketplace, also prefer not to enter into any specific subordination or non-disturbance agreements.

In retrospect, Akim should have sought the consent of his vendor to speak to the original three tenants and determine their wishes so far as subordination and non-disturbance agreements are concerned. That would have led to early negotiations between Easy Money and the tenants, which may have improved the mortgage terms that Akim received from Easy Money.

If the new tenants were informed by Akim and Easy Money that Easy Money would extend non- and your lender. The time you invest early may save you in terms of interest rate, and enhance market value.disturbance agreements to them, Akim may have been able to secure better lease rates from them. The tenants, in turn, recognizing that they were protected, would have been more inclined to invest in improvements to the premises. The overall market value of the development may have increased as a result.

So, when considering the purchase of a commercial rental property, consider the relationship between the tenants.

Special thanks to John for his contribution. To learn more about his legal services, visit his website at

Thursday, January 19, 2012

Letter of Intent vs. Agreement to Lease

Next up in our Leasing Series…Letter of Intent vs. Agreement to Lease.

There are generally two methods by which an initial agreement is struck between a Landlord and Tenant. The first is a ‘Letter of Intent’ (LOI), and the second being an ‘Agreement to Lease’ (ATL). Although both can accomplish the same objective, there are significant differences which have implications for both parties.

The LOI is often a short summary of terms and conditions as proposed by the Tenant and forms the basis for a final lease agreement. Key items such as rental rates, square footage, deposits, possession date, landlord’s work, signage (etc.), are normally included as terms within the letter. However, there is most often a disclaimer contained in the letter which indicates something to the effect of - ‘the LOI is not binding on the parties and is pursuant to a final lease agreement’. In short it most likely has no legal weight, and depends almost exclusively on the goodwill of the parties. If used, and they are used effectively throughout the commercial leasing world, the goal should be to move to the final/executed lease agreement as quickly as possible.

Alternatively, the ATL becomes an actual contractual agreement between the parties, and generally spells out the details of the proposal in greater detail. Even though it is still subject to the signing of a final lease agreement, it will have legal consequences on the parties in the event of any sort of default. The benefits beyond the legal weight issue include - the ability to give possession prior to a final lease being signed, that the ATL can become the actual agreement on the premises (should a final lease not ultimately be agreed upon), and better justification for the time/costs of the parties involved in pursuing a deal. Generally the more complex the deal, the more an ATL makes sense.

Again, seek out experienced commercial realtors with solid leasing backgrounds in your market to assist you in the area of LOI vs. ATL.

Wednesday, January 11, 2012


Next segment in our Leasing Series…Zoning.

In leasing commercial premises, Tenant’s need to pay particular attention to the zoning bylaw, and specifically how it applies to their proposed use. Often times, assumptions are made by Tenants that based on a commercial zoning designation on a site – that their particular use is permitted. After the fact, this erroneous assumption can be both costly and problematic to resolve. It should also be noted that generally landlords place the obligation of confirming the ‘Use As Permitted’ upon the Tenant, and the Lease Agreement speaks to this as a Tenant obligation.

But there are other factors to consider:

i) Does the existing bylaw allow for changes in the business?
ii) Does the bylaw speak to exactly the use by definition?
iii) If not, can you obtain written confirmation allowing the use (from the appropriate city/municipality)?
(iv) Is the bylaw marketable for purposes of sub-let/assignment?
(v) Does the Landlord need to approve any change-of-use (and the implications of that consent)?
(vi) Costs associated with obtaining a re-zoning to allow a use (application fees/ legal costs etc.)?

On the final point above, this assumes that the site does not allow for the use proposed. Although time frames will vary depending on your jurisdiction - rest assured that the process will involve months, not weeks - and the parties are going to face a delay in moving forward on the lease proposal. The other key point, is often times, uses are specifically not included within a zoning bylaw by design. Meaning the governing authority may infact not be interested in including that use within the list of those permitted.

Again, seek out experienced commercial realtors with strong leasing backgrounds, to assist you in the area of zoning compliance with respect to your use.

Thursday, January 5, 2012

Ability to Sublet

Next segment in our Leasing Series…Ability to Sublet.

The area of subletting premises is generally provided for as a standard leasing term in most lease documents. In cases where Tenants wish to relocate out of a particular area or wish to cease business operations, this gives them the opportunity to market the space to other commercial users for the balance of the current term.

Areas to be clearly considered from the Tenant’s perspective are as follows:
1. Ensure your existing lease contains a term allowing a sublet.
2. A Sub Lease cannot be granted for a term exceeding the Head Lease Term.
3. All terms of your Head Lease should be incorporated into the Sub Lease Agreement (most practically, by attaching the Head Lease to the Sub Lease Agreement).
4. Obtain written consent from the Landlord on any Sub Lease Agreement.
5. Approach the deal as if you were the Landlord – particularly with respect to due diligence on the prospective Tenant, security deposits, and monthly payment arrangements.
6. Legal Costs and Real Estate fees will apply.

Landlords typically are not fond of allowing sublet arrangements on their premises, but understand circumstances change and that a Tenant may no longer require premises for which they have an extended lease obligation remaining. Given this reality, the Landlord will ensure that they not only approve of the Sub Lease Agreement itself, but keep the original Tenant clearly in a position of liability with respect to the Sub Lease Agreement.

Tenants looking to sublet may also consider negotiating an early termination settlement with the Landlord to avoid all of the liability issues involved. For instance - if only 2-3 years remain on the term, a termination may be better for both Tenant and Landlord, as such limited lease terms are not as marketable to prospective Tenants. This possibility will be dependent on the strength of your particular market, but certainly worth a discussion.

Again seek out experienced commercial realtors with strong leasing backgrounds, to assist you in working through your sublet requirements and objectives.