Imagine that your company rents space in a commercial building and just found out that your landlord stopped paying the mortgage. The building is in foreclosure, your lease isn’t ending soon, and it doesn’t address a foreclosure. What happens to your commercial lease if the building is sold in a foreclosure auction?
When a commercial property owner defaults on its mortgage and the lender forecloses, a tenant should determine whether its lease was entered into before the foreclosed mortgage was recorded, as tenants retain interests in leased property if a lease predates a foreclosed mortgage. Generally, the “First in Time, First in Right Rule” recognizes agreements respecting real estate with effect given to the “first in time” agreement. In other words, a prior recorded mortgage that predates a lease, will permit the mortgagee to foreclose on the property and terminate the tenant’s lease, irrespective of the otherwise enforceable agreement between the defaulting landlord and the tenant. On the other hand, a lease that predates a recorded mortgage will remain in effect after foreclosure, so long as the lease itself contains no contrary provision.
While the “general rule in Massachusetts is that entry by a mortgagee in possession under a mortgage granted prior to execution of a lease ousts the tenant and terminates the lease,” the inquiry doesn’t end there. Tenants subject to a mortgagee’s title should consider whether the mortgagee exercised rights as a landlord over the tenant subsequent to the original landlord’s default on the mortgage. Foreclosing mortgagees may acquire and exercise the landlord’s interest under a lease through an assignment of leases and rents from the debtor and demanding rent from the lessee as the landlord. Similarly, the mortgagee may exercise rights as landlord through an attornment provision contained in the lease or through a separate attornment agreement with the tenant. Attornment provisions can be found commonly in commercial leases, and express the tenant’s agreement to recognize mortgagees and/or subsequent purchasers as successor landlords to the tenant. In the event that a tenant attorns to the mortgagee or a subsequent purchaser as its new landlord, or the mortgagee exercises rights under an assignment of the lease, the tenant will remain in possession of the leased space.
Absent such an assignment or attornment, the foreclosing mortgagee may terminate subordinate leases under the doctrine of paramount title. Once asserted, paramount title requires entry, the demand rent be paid and actual or constructive eviction. In to terminate a lease effectively, mortgagees acting in a dual capacity as both a mortgagee and landlord, must be cautious to articulate specifically its intended role so as not to afford subordinate tenants unintended rights permitting such tenants the right to carry on in prior existing leases.
In the rare instance that a commercial mortgage is subordinated to a lease, a lease would not be extinguished upon foreclosure of such a mortgage. Instead, the purchaser of the commercial property would take possession subject to the tenant’s tenancy, and require the tenant to attorn to the purchaser as its new landlord, develop a new lease or vacate the premises.
If your commercial space is sold at foreclosure, all is not lost. The terms of your lease, along with timing of its execution in relation to the foreclosed mortgage will govern your rights and remedies as a tenant. While it’s always a better course of action to address this issue when negotiating your lease it’s likely that you’ll retain some rights as a tenant despite a foreclosure. In order to determine and preserve your rights under a commercial lease conclusively upon notice of a foreclosure, it’s important to consult with an experienced real estate attorney promptly.