Protecting Landlords, Tenants and Brokers in Current Market Conditions by Stanley K. Barth

Over the course of the last year, we have seen with increasing frequency landlords, tenants and real estate brokers experience adverse situations brought about by the current market conditions, which might have been avoided with proper planning.

Landlords

            Recently, a client approached our firm with a situation many landlords have experienced, or may soon experience themselves. One of his tenants had vacated and abandoned the leased premises leaving behind a considerable amount of fixtures and equipment.  For several months after the tenant vacated, the holder of the perfected security interest in the tenant's fixtures and equipment failed to either remove the personal property or pay the landlord rent for storage.  Short of costly litigation, the landlord was left with few choices.  The question is: What could the landlord have done to avoid this situation?  We recommend that all landlords retain a contractual landlord's lien in their lease documents and file a UCC-1 financing statement to perfect the security interest.  Even if the landlord is not particularly interested in obtaining the additional security of a lien on the tenant's personal property, this process has benefits.  Specifically, by the landlord obtaining the security interest, any creditor of the tenant without a superior interest in the collateral will be forced to deal with the landlord in obtaining a subordination of the landlord's contractual lien.  Within the subordination agreement the landlord will have the opportunity to obtain the creditor's contractual assurances as to compliance with landlord's "move-out" policies; an outside date for the removal of the collateral; the creditor's payment of rent; and the creditor's indemnity for damage to the leased premises.

Tenants

            Particularly in economic times such as these, any tenant should ask itself what are the effects of a prospective landlord's mortgage default or bankruptcy.  Under these market conditions we are seeing situations where a tenant signs a lease, invests considerable dollars anticipating a financial contribution by the landlord and then discovers that the landlord has no funds available and even perhaps that the leased premises are subject to foreclosure due to the landlord's failure to satisfy the requirements of its mortgage.  Careful planning may avoid such unanticipated problems.  First, the tenant can include a provision in the lease allowing for the tenant to recoup any sums owed by the landlord for tenant improvements by offsetting the amount from future rent payments. The tenant needs to be careful to consider that the holder of the mortgage (and its successor) may not be subject to the offset in the event of a foreclosure.  Hence, the tenant should insist upon receipt of a subordination, non-disturbance and attornment agreement ("SNDA") from the mortgagee whereby the mortgagee agrees to acknowledge the offset in such a case.

Brokers

            In most lease transactions, payment of a portion of the commission is deferred until the tenant takes possession of the leased premises.  Before the payment of that commission, the landlord's lender may foreclose its lien, in which case the broker is left with a monetary claim against the landlord who is unable to meet its financial commitments.  There are some procedures we recommend a broker follow. First and foremost, underwrite the ability of the landlord to pay the commission.  By doing so, the broker will not only protect itself, but the brokerage community will seek out and favor dealing with the landlords that can offer some protection.  We have seen brokers include within their commission agreements covenants of the landlord that the lease itself will allow the tenant to pay the commission in the absence of the landlord's timely payment and allow the tenant a right of offset against the rent in order to recoup this cost.  We do caution, however, that in the absence of the mortgage holder agreeing to this concept in the SNDA, in the event of a foreclosure, the tenant could be left with having paid the commission and the lender not allowing the offset.  Certainly, the broker should consider including a provision in the commission agreement expressly allowing the broker's lien afforded by statute for leases in the State of Texas. 

In the absence of careful planning, all parties to a lease transaction can suffer; the landlord, the tenant and even the broker.  From the very beginning of the lease transaction, all parties should give attention to forecasting the scenarios which may affect them and those they represent.