How Stable is Your Landlord? 3 Steps to Protecting Your Rights as a Tenant

When a landlord faces default, it can have major repercussions for the tenant, threatening a tenant’s ability to remain in their space, to receive agreed-upon improvements and to remain insulated from sudden changes to their lease terms. Particularly in these soft commercial real estate markets when vacancy rates are high, prospective tenants need to understand their landlord’s vulnerabilities and develop a strategy to mitigate their real estate risk when securing space.

Tenants exploring new office options should pay special attention to specific sections in the letter of intent and lease document to ensure that they retain their ability to stay in their space even if the landlord or sublandlord defaults on his or her financial obligation. Furthermore, tenants should take steps to protect themselves against the loss of any economic concessions they are owed, including tenant improvement funds.

Below are three key risk factors tenants need to understand and protect against when leasing space:

1. Subordination Non-Disturbance Agreement (SNDA): The SNDA is an agreement between the tenant and the lender of the real estate, and it ensures that the bank will honor lease terms negotiated between tenant and landlord should the bank repossess the property. Without an SNDA, the bank does not have to honor a tenant's lease after taking control of the property and has the right to remove the tenant or negotiate a higher rate if the tenant wants to remain in the space after the owner defaults. SNDA documents are often difficult to obtain for smaller spaces. However, for companies leasing 10,000 SF or more, companies who invest a significant amount in tenant improvements or companies who simply cannot afford any disruption to their business, this agreement is essential to have in place.

2. Recognition Agreement: Subletting might provide a tenant with favorable lease terms, but it can also place the company in a risky position if the sublessor defaults. A Recognition Agreement can provide much-needed protection. While it is similar to the SNDA, this agreement is between the subtenant and the landlord. Under the terms of the contract, the landlord agrees to honor sublease terms negotiated between the subtenant and the sublandlord should the sublandlord default on the master lease. Without this agreement, the landlord is free to evict the subtenant or demand a higher rate than the discounted sublease rate. This document is often more difficult to obtain than a SNDA because the landlord is already receiving rent from the master tenant so they have no motivation to honor a discounted rate. Building owners prefer to leave lease terms up to fair market value if the master tenant defaults—and fair market value will typically be higher than sublet rent.

3. Rental Offset: The Rental Offset provides the tenant protection from losing their tenant improvement allowance, security deposit or any other economic concession that they have negotiated. When tenants or subtenants execute a lease or sublease, they expect to receive certain benefits in return—including tenant improvement dollars and the return of their security deposit. But what happens if the landlord or sublandlord can't produce these agreed-upon funds? Aside from lengthy legal proceedings, the tenant or subtenant has little recourse for recouping those funds. This is where a Rental Offset can help. Under a Rental Offset, tenants can counterbalance improvement dollars or a security deposit they are entitled to but have not yet received from monthly rental payments.

It's not always favorable for occupants to use their own money to improve the space and deduct these expenses from monthly rent, but it is far better than chasing after funds from a defunct entity. And tenants who do obtain a SNDA agreement should make sure that this agreement also honors the rental offset provision.

Of course, companies looking to sublease a small space at a highly discounted rate might not be able to obtain all of these protections. But businesses renting larger spaces and/or committing to long leases will be in a critical position if the worst case scenario happens so they need to understand the risks involved when securing space in the current market. By putting these contracts in place, tenants will drastically reduce their risk and protect themselves against eviction or lost funds no matter how their landlord’s financial picture changes. As a final note of advice: a SNDA or Recognition Agreement takes time to put in place. Be sure to request it up front during the beginning of lease or sublease negotiations.

Anna Kaplan Amanda Chung Michael Capek John Jarvis

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