Thorny Legal Questions and Answers in Net Lease

NEW YORK CITY—What are some of the tricky legal issues with net lease deals and contracts?

“There’s always a fight in larger net lease transactions and financings over the subordination, non-disturbance agreement and right of first offers and first refusals on the actual sale of the building,” says Robert Koen, a member of the law firm Mintz.

He’ll be moderating the panel “Engaging the CRE Tenant” at GlobeSt.com’s Net Lease conference scheduled for April 3-4 in New York City. He previewed some of the subjects he anticipates covering at the event.

Koen points out if a bankruptcy occurs or if a mortgagee forecloses on the asset they want the ability to have the tenant to stay on the lease. But he has seen issues arise when the tenant will say something along the lines of: “I was supposed to get a rent credit for the years three through 10, and the landlord owes me X amount of dollars.” The bank can then respond saying that they don’t want that responsibility.

Buying a net lease that was put in place prior to the sale can be a tango, Koen says. Sometimes there were deals that the parties felt had to get done. “So the tenant says, ‘Look I’ll sign the lease but that’s my subordination non-disturbance agreement,’ and they slap in an agreement which gets the thing closed.”

But when the owner tries to sell the property and the next lender comes in, it can be a different lending environment. The lender might say, “I’m not taking that.” So they’ve got to go back and draft a different SNDA (subordination, non-disturbance agreement). Otherwise the buyer can’t acquire the building, he explains.

Koen’s colleague, Stephen Friedberg, another member at Mintz, is serving on the same panel at the conference.

“Non-disturbance is a big issue for the tenant, just as subordination is the big issue for the landlord. The landlord wants to make sure that the lease is subordinate to its mortgage and also in the event of a foreclosure that the tenant respects the lease,” says Friedberg. “But the tenant wants to know that they won’t get disturbed as long as they are paying the rent, even if the landlord gets foreclosed on.”

If the tenant is constructing the building, they generally will take the position: “We built the building. We spent our money. So, landlord, you don’t have any interest in it,” explains Friedberg.

The attorneys need to make sure the documents protect their respective clients.

“From the landlord side I want to make sure if I’ve invested money or if I’ve given an allowance in the building which is financed by some lender that I get to protect that before the tenant gets anything. It’s usually a very tough negotiation,” says Koen.

Both attorneys say this relatively simple document, usually five to seven pages, can take an inordinate amount of time to negotiate—because of the differing interests.

In addition, as net leases are generally financed, there usually is a leasehold mortgage on it by the tenant who is doing the construction. “There are rating agency concerns for the leasehold mortgagee that have to be addressed in the lease,” says Friedberg. “It adds a big layer of complexity to the lease because the lease is partially a financing document as much as it is a lease.”

Many landlords have trouble getting their arms around what the rating agencies and the mortgages require, he adds.

Koen states that a fourth issue often arises as to who is on the lease. “Is there a parent company guarantee or is there a burn off after a couple of years? Some of the tenants have significant termination rights or others leave a parent on for three or four years,” Koen says. A subsidiary, by itself, might be a creditworthy entity but doesn’t rise to the strength of the parent company.

Many of the leases will give a guarantee for the entire term, which is a more salable product. When somebody wants to sell a particular property or their interest, it is a much easier to sell when the tenant has the parent behind it, says Friedberg.

Koen and Frieberg will be joined on the panel by Gene Colley, EVP at Embree Asset Group and Rob Walters, principal at Quattro Development. Other questions will address the new accounting rules. They will ask who are the growing tenants, owners and lenders in the net lease space? Also, where do the panelists see WeWork and alternative uses fit in the net lease space?

➤➤ Join the 17th Annual GlobeSt Net Lease Conference (formerly a RealShare event) on April 3 & 4 in NYC alongside the industry’s most influential and knowledgeable real estate executives from the net lease sector. Click here to register and view the agenda.