Daily Development for
Monday, March 24, 1997

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law

The guest reporter for today's case is Dale Whitman. Dale is a "giant" in the area of real estate finance, but in this case the editor disagrees (with some trepidation) with Dale's analysis of this case.)

LANDLORD/TENANT; MORTGAGES; ATTORNMENT: Tenant attornment clause in lease is binding on tenant. Miscione v. Barton Devel. Co., 61 Cal.Rptr.2d 280 (Cal. App. 1997)

Barton was the general partner of Equities I, which borrowed $7.6 million from Coast Federal Savings, giving a trust deed to Coast as security. The money was used to build and operate an office building. Nearly two years after the loan, Equities I entered into an office lease with Barton Development Co., which was also controlled by James Barton. The trust deed prohibited Equities I from entering into leases without Coast's approval, but apparently no approval was actually sought or given for the Barton lease.

The lease contained four provisions, summarized as follows: (1) Attornment. In the event of foreclosure of the building, Tenant shall attorn to the purchaser, provided that the purchaser acquires and accepts the Premises subject to this Lease. (2) Subordination. Upon written request of Landlord of first mortgagee, Tenant shall subordinate its rights to the lien of any first mortgage. (3) Nondisturbance. Before giving such a subordination, Tenant shall have the right to obtain from the lender a nondisturbance agreement. (4) Optional unsubordination: A lender with priority over the lease may elect, at its option, to make the lease prior and the lender's lien subordinate to the lease.

Four years later Coast foreclosed its trust deed and acquired the property. It sent letters to all tenants (including Barton Devel.) requesting that they sign estoppel statements confirming the terms of their leases. However, Barton Devel. did not give such a statement, and six months later, Barton Devel. vacated its space and refused to pay further rent. Miscione bought the building from Coast and sued Barton Devel. for rent due and unpaid on the lease.

The court's analysis is quite simple: It first notes that Coast's trust deed plainly was superior in priority to Barton's lease. In the absence of any other agreement, a foreclosure of the trust deed simply would have destroyed the lease, allowing Barton to walk away free and clear. The California Court of Appeals had previously held in Dover Mobile Estates v. Fiber Form Products, Inc., 270 Cal.Rptr.183 that California is an "automatic" state, in the sense that in the absence of a contrary agreement, all subordinate interests, including all junior leases, are automatically wiped out by a foreclosure, and that there is no method by which the foreclosing mortgagee can "pick and choose" among the leases, wiping out some and not others. The present court confirms this view.

The court then observes that the subordination clause in the lease (clause 2 above) is unnecessary and irrelevant from the lender's viewpoint, since the lease was already subordinate anyway. As a result, the nondisturbance clause (clause 2 above) is irrelevant as well. The two clauses are clearly tied together: the tenant is required to give a subordination only if the lender will give the tenant a nondisturbance. In the present case, however, the lender didn't need to get a subordination from the tenant (since the tenant was already subordinate), and therefore there was no occasion for the lender to give a nondisturbance. Likewise, the lender never exercised its "optional unsubordination" rights under clause 4 above, which it didn't need to do because the attornment clause served much the same purpose.

The only clause that's relevant, when the dust settles, is clause 1 above. It states unequivocally that the tenant will attorn to the foreclosure purchaser. Coast was the foreclosure purchaser, and Barton Devel. must attorn to it. The attornment clause in the lease overrides and supersedes the usual "automatic" wipeout that occurs when a prior mortgage is foreclosed against a junior lease. Barton Devel. is stuck with liability on the lease, and can't walk away from it.

Barton had argued that the attornment promise was conditional upon the foreclosure purchaser's "acquiring and accepting the Premises subject to this Lease." Barton asserted that this meant Coast had to give notice under the "optional unsubordination" clause, which Coast never did. The court says, however, it means nothing of the sort; it merely means that Coast had to acknowledge and agree to be bound by the lease, which Coast did by sending the tenant the request for an estoppel statement, and also by a notice sent to the tenant the very day of acquisition, advising the tenant that Coast was the new owner and that all future rents should be paid to Coast.

The court also points out that Coast didn't need to "accept" the lease until after it had completed the foreclosure. Barton argued that Coast should have done so before the foreclosure, but the court points out that such a position is illogical, and not called for by the clause itself. Coast's acts of acceptance after the foreclosure were entirely sufficient. In effect, the lender had two different ways of preserving the lease: either by giving notice that it was "optionally unsubordinating" the lease, or by merely relying on the attornment clause. The lender actually used the latter method, which had the effect of keeping the tenant "on the hook" without giving the tenant technical priority.

The court notes that there might be several reasons the lender would not want to give the lease priority: to do so might elevate clauses in the lease dealing with condemnation, insurance proceeds, etc., ahead of analogous clauses in the trust deed. (The court doesn't mention it, but some lenders might also be subject to "first lien" requirements of their regulators agencies, such as state banking commissioners, and might worry about elevating the lease's status above the trust deed's for that reason.)

The dissenting judge argues that the attornment clause was conditional, and that Barton Devel. only had to attorn if Coast exercised its "optional unsubordination" power. However, there's simply nothing in the agreement itself that ties these two features together; the attornment clause is, on its face, unconditional. Moreover, the majority points out that James Barton controlled both landlord and tenant when the lease was drafted; hence, it's a little difficult to construe the lease in favor of the tenant in order to let it off the hook here.

Reporter's Comment: The reporter views the court's analysis as correct.

The court refers to the combination of clauses described above as a "Subordination, Nondisturbance, and Attornment Agreement." In a sense, it is. However, the combination of clauses in the lease is a bit like giving a party at which the guest of honor never shows up. The lender was not a party to the lease, and there was no separate SNA agreement signed by the lender. Indeed, the lender apparently didn't even approve or know about the lease when it was signed. The usual SNA agreement takes the position that what's sauce for the goose is sauce for the gander: It's fair for the lender to agree not to throw out the tenant in the event of a foreclosure (nondisturbance) if the tenant will agree not to try to wriggle out in the event of foreclosure (attornment). But no agreement of this sort can be reached without the participation of the lender, and the lender simply wasn't there in this case.

Given the initially subordinate position of the lease in this case, the attornment clause in the lease simply gave away rights that the tenant should have kept. Moreover, it was unnecessary to give these rights away. The attornment clause presumably was not inserted to facilitate the getting of financing, since the financing for the office building was already in place. If a possible future refinancing was the issue, Barton should simply have waited to see if a new lender insisted on an attornment clause; after all, he controlled both the landlord and the tenant. Finally, if the "condition" that Barton Devel. tries to get the court to impute to the attornment clause had actually been spelled out clearly, there seems little doubt that Coast simply would have complied with the condition, exercised its "optional unsubordination" rights, and kept Barton Devel. on the hook. Thus, the supposed condition is simply a "back door" way for Barton to try to wiggle out of the lease, and the court properly won't permit it to do so. The moral of the story: an SNA agreement is a three-party deal (although admittedly the landlord's interest in how it is structured isn't very strong). You can't get the same results without the lender's participation.

Editor's Comment: The editor disagrees with the case and with the reporter concerning the proper interpretation of this situation. The lease clearly was junior to begin with. The only way it became "non-subordinate" is if the lender took some affirmative action. Clearly the language of clause 1 did not make the lease "non-subordinate" without some act of the lender. The letter and spirit of the Dover case require that the lender make its election to alter the automatic consequence of foreclosure by notice to the tenant *prior to the foreclosure.* The idea is that the tenant ought to know what the consequence of the foreclosure will be prior to its occurring. The tenant, after all, has a valuable property interest, which it has standing to protect by intervening in the foreclosure action and possibly even by curing the default and obtaining subrogation. It is appropriate for the tenant to know whether its lease will "live or die" after foreclosure, and it is unfair for the parties to expose the tenant to uncertainty on this vital point.

Coast's request for the estoppel certificate, apparently was made after the foreclosure. At that point the foreclosure had already wiped out the lease, and the tenant was not bound to any provision of the lease, including the attornment requirement.

The editor understands Dale's point that Coast was not a party to the lease, and therefore arguably should not be bound by its provisions. But if it is to benefit from the provision, then it should abide by the conditions upon which the condition operates. Here, the condition says that the mortgagee must elect to be bound by the lease before taking advantage of the subordination. It is proper to read the language here as requiring notice of the mortgagee's election before foreclosure as a condition of attornment.

The next issue, of course, is whether parties can ever set up a situation in which the tenant clearly is "hung out to dry" with the foreclosure purchaser having a complete option. As a general believer in freedom of contract, the editor, pressed, would concur that a very clear provision in the lease establishing this possibility ought to be enforced. But the court should not strain to interpret language that falls short of complete clarity to impose this result. Further, regardless of the editor's views, the Dover did not give complete freedom of contract in this case.

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