A subordination, nondisturbance and attornment agreement (“SNDA”) is commonly used in real estate financing to clarify the rights and obligations between the owner of rental property (i.e., the borrower), the lender that provides financing secured by the property, and the tenant under a lease of the property in the event the lender forecloses or otherwise acquires title to the property. As suggested by its name, an SNDA has the following three primary components:
- Subordination. The lease is subordinated to the mortgage so that, in the event of a foreclosure, the lender has the first priority interest in the property. This is essential to a lender so that the lender may control the foreclosure process without interference from a party that has a superior interest in the property (which could be the tenant if the lease was executed prior to the mortgage).
- Non-disturbance. The lender agrees that, in the event it forecloses or otherwise acquires title to the property, so long as the tenant is not in default, the lender (or another party acting on behalf of the lender) will not disturb the tenant’s occupancy of the property and the lease will remain in full force and effect (with some exceptions).
- Attornment. The tenant agrees to “attorn to” or recognize the lender (or another party acting on behalf of the lender) as the landlord under the lease if a foreclosure occurs or the lender otherwise acquires the property.
In some cases, an SNDA is not necessary from a lender’s perspective because the lease contains acceptable language that automatically subordinates the lease to any future mortgages. Therefore, as an initial matter, the lender or its counsel should review the lease to determine (a) whether an SNDA is required to subordinate the lease to the mortgage and (b) if the lease contains automatic subordination, whether an SNDA would place the lender in a better position compared to the lease terms. Even if the lender determines that an SNDA is not needed, a tenant may request an SNDA to obtain the protections afforded by the non-disturbance provisions.
Assuming the lender has determined that an SNDA is needed or the tenant has requested an SNDA, the lender will seek an SNDA that sufficiently protects its interest in the property, usually starting with its preferred form. From a lender’s perspective, in addition to the primary components described above, key terms of an SNDA (and exceptions to the non-disturbance component of the SNDA) also include the following: (1) the lender, or successor owner, will not be liable for previous landlord defaults; (2) tenant does not retain the right to offset prior damages against the lender; (3) tenant does not receive credit for prepaid rent and lender is not liable for monies owed to tenant under the lease (i.e., a security deposit or tenant allowance); (4) lender receives notice for any landlord default along with a cure period at least equal to the period provided landlord under the lease; and (5) lender does not have any obligation or liability arising from a lease modification of amendment executed without lender consent.
SNDAs are often heavily negotiated between the lender and the tenant. Even though the landlord is also a party to the SNDA, the landlord usually takes on a secondary and facilitating role in the SNDA negotiations because, by its nature, the primary terms of the SNDA are intended to apply after the landlord is out of the picture. Tenants can be resistant to SNDA terms that modify the lease that it has negotiated with the landlord, but sophisticated tenants usually understand that financing is essential to a landlord’s business operations and are cooperative in the SNDA process for that reason. In addition, when appropriately drafted, an SNDA is protective of both the lender’s and the tenant’s interests, both of which are aligned with preserving the lease, including tenant’s payment of rent and continued occupancy of the property.
Hague Securities Convention Takes Effect – Implications for Securities Account Agreements
Clients often enter into securities account agreements and securities account control agreements (“SACAs”) in connection with secured financings. A securities account agreement is typically a bilateral agreement between a securities intermediary (e.g., a bank) and a customer to establish a securities account and the related business relationship. A SACA is a tri-party collateral agreement among a securities intermediary, a secured party and a customer (i.e., the debtor) to enable the secured party to perfect on a securities account by control for purposes of the UCC.
The Hague Securities Convention (the “Convention”), initially adopted in 2006, took effect in the United States on April 1, 2017, and provides new choice of law rules applicable to situations involving more than one country. Although often a technical legal point, the new rules can, under some circumstances, alter well-worn results under the UCC, including, importantly, the effect of perfection and priority achieved through a SACA. Secured parties in particular should review existing arrangements and forms to be sure that the Convention hasn’t upended desired results under their collateral documentation.
Under the Convention, choice of law issues will be governed by either the law in force in the country “expressly agreed in the account agreement” or, if the account agreement “expressly provides that another law is applicable to all such issues, that other law.” Such substantive chosen law in either case must be the law of a jurisdiction in which the securities intermediary has an office “engaged in a business or other regular activity of maintaining securities accounts” (i.e., a “qualifying office”).
Consider the following arrangement: in which perfection by control is desired, the related SACA is governed by foreign law, but the agreement expressly provides the securities intermediary’s jurisdiction is New York. Under the UCC, New York law would govern the effect of perfection (or nonperfection) and priority. However, under the Convention, the securities intermediary’s stated jurisdiction is disregarded and foreign law would govern the effect of perfection (or nonperfection) and priority (assuming the qualifying office requirement is satisfied in the foreign jurisdiction).
Other, more complicated, scenarios can yield further differences between UCC choice of law rules and (now-current) Convention rules. Careful analysis of the Convention’s rules is needed in any case involving intermediated securities transactions featuring an international nexus.
For account agreements and SACAs among parties from more than one country in which, say, New York law (including the UCC as adopted in New York), is desired to apply to choice of law issues, such agreement should state that: “This Agreement is governed by [New York] law.” If that language is inconsistent with the business deal, the account agreement may provide, more specifically, that: “[New York] law governs all issues specified in Article 2(1) of the Hague Securities Convention.” For an existing SACA where the related account agreement produces an undesired (or unknown) result, consider including amending language such as: “The customer and the securities intermediary hereby agree that the account agreement governing the account is amended as follow: ‘[New York] law governs all issues specified in Article 2(1) of the Hague Securities Convention.’”
Such language will help ensure that the Convention will not counter a desired choice of law result and provide greater certainty that the required steps are being taken to perfect on securities held by an intermediary.
Negotiating Most Favored Nation Provisions
In order to protect existing lenders from borrowers obtaining incremental loans at significantly higher interest rates (which could signal a deteriorating credit and/or over leveraging), most incremental facility provisions contain “most favored nations” (“MFN”) protections. Under these MFN provisions, if the all-in yield (as discussed below) applicable to an incremental loan is higher than the all-in yield for the then-existing loans, the margin on the existing loans will be increased to a level such that it is not more than a certain number of basis points (generally 50 basis points) less than the margin on the incremental loan. Specific aspects of the MFN provisions will vary based on deal size. For example, in larger deals, the MFN provisions may be subject to expiration after a set period of time. In a few recent upper market deals, the differential required in the all-in yield between the incremental loans and the then-existing loans for the MFN provisions to take effect was increased from 50 to 75 basis points and only applied for incremental loans in a principal amount above a certain threshold.
The all-in yield to which the MFN provisions apply typically includes interest rate margins, interest rate floors, original issue discount and upfront fees but excludes arrangement, structuring, underwriting and other similar fees that are not shared with all lenders.
Certain agreements are silent on how the all-in yield is to be increased if there is a difference in the interest rate floor between the incremental loan and the existing loans. Other agreements specifically provide that if the incremental loan includes any interest rate floor that is greater than the interest rate floor applicable to the then-existing loans, such excess amount shall be equated to interest rate margin for determining the increase required under the MFN provision. Such a provision may or may not explicitly require that the interest rate floor is applicable to the then-existing loans on the date of determination. Some agreements for larger deals go even farther and state that any increase in the all-in yield on the existing loans due to the application of an interest rate floor on any incremental loan shall be effected solely through an increase to interest rate floor applicable to the existing loans or, if no interest rate floor applies to such existing loans, one shall be added.
Perfecting Security Interests in Maritime Assets
Lending to a shipping company, and financing vessels and maritime assets, raises unique legal issues and practical risks—not the least of which is relying on collateral that often travels all around the world. What are the most common maritime-related security interests, how does one perfect security interests involving maritime assets, and how does lien priority work? As an initial matter, the maritime business is capital-intensive with a long and established history of secured lending and cross-border recognition of security interests. That said, the long history is marked by archaic laws and practices, a lack of uniformity, and peculiar traps for the unwary.
The most common security interest in a vessel is a ship mortgage. Like landside mortgages, in a ship mortgage, the vessel owner grants a security interest to the mortgagee, typically a lender, in the vessel. Mortgages are typically perfected by recording the relevant instruments with a governmental depository in the jurisdiction of a vessel’s registration (the registry in which the ship is “flagged”). Thus, a mortgage for a U.S.-flagged vessel would be recorded with the United States Coast Guard National Vessel Documentation Center. A mortgage for a vessel registered in another county—including “open registries” or “flags of convenience” such as a vessel flagged in the Republic of the Marshall Islands—would be recorded in the vessel registry of Republic of the Marshall Islands, which incidentally is operated out of Reston, Virginia, by a company called International Registries, Inc. Each vessel registry has specific requirements for the form of mortgage, mortgage contents, language, filing requirements, fees, and so forth, that can differ markedly in complexity and cost. However, in the vast majority of recognized registries, the security interest is deemed perfected with the filing, and in most respects recognized internationally via treaty (e.g., The International Convention on Maritime Liens and Mortgages) and respective national legislation.
Mortgages, however, do not secure everything. Maritime mortgages do not secure vessel revenue or proceeds, which in many financing structures are essential components of the collateral pool. And maritime mortgages are subject to unique statutory priority risks that, to the extent left unmitigated, can seriously reduce the value of the mortgage security.
First, a mortgage is a lien on a vessel and its appurtenances (i.e., items destined for use aboard the vessel which are essential to the vessel’s navigation, operation or mission), but not on revenue or proceeds associated with a vessel. Security interests in vessel insurance proceeds, vessel lease agreements (which are known as charters) and vessel earnings, for example, are not covered by a vessel mortgage. These security interests must be separately perfected under the law applicable to the relevant parties. In the U.S., separate assignment agreements, perfected with a combination of UCC filings and certain filings with the federal Surface Transportation Board, may be required.
Second, the express lien of a perfected ship mortgage is primed by certain liens implied by law—a category of “preferred maritime liens” that can be substantial, that arise and perfect without public notice, and that attach and run with the ship itself. The following types of liens need not be recorded to be deemed perfected, and for the most part can prime even a previously perfected mortgage: seamen’s wages (paying the vessel crew), salvage (services incurred in saving a ship or saving cargo), tort claims (collisions, personal injuries, damage to cargo, etc.), general average (a maritime rule apportioning costs of saving a vessel), vessel necessaries (such as fuel, supplies, repairs, towages), unpaid freight, pollution claims, and other statutory liens.
It is thus essential in maritime lending to perfect all relevant collateral in addition to a properly perfected vessel mortgage, and to include appropriate representations, warranties and covenants in lending documents targeting common conditions giving rise to priming liens.
DIP Financing: An Attractive Option for Distressed Investment
While lending to a distressed company to cure a liquidity crisis in bankruptcy may seem like throwing good money after bad, the opposite in fact may be true. Billions of dollars of loans were provided to companies in bankruptcy last year alone, and these loans are not minimal in size, with the largest few each exceeding $500 million.
These numbers reflect the general understanding in the common practice: it is often the case that banks and other lending institutions well-versed in the arena clamor to serve as a financer of a debtor in bankruptcy. When a company seeks bankruptcy protection, the company’s management typically remains in place and in possession of the business—i.e., as a debtors-in-possession of its assets (“DIP”). Thus, financing of such debtors-in-possession has been coined “DIP financing” or “DIP lending.” Such financing is typically sought and provided in order to fund the liquidity of the bankrupt entity through to the end of the bankruptcy case.
Generally, DIP financing takes the form of asset-collateralized, revolving working-capital facilities intended to ensure immediate liquidity to the debtor. As an added benefit, DIP financing provides additional support for customer and vendor confidences that the company has not ceased operations and that, generally, it is “business as usual” for the debtor.
Why the competition to provide distressed financing? There are a number of factors contributing to the attractiveness of DIP financing to a lender in the marketplace which include, but are certainly not limited to:
Priming – DIP financing may be secured by a lien on the debtor’s property equal to or senior to any existing secured lenders. This leapfrog in the priority line is referred to as “priming” the existing lender. In the instance where the DIP lender is also the existing lender, such lender may be afforded the added benefit of “rolling up” the amounts due on account of the existing credit facility into the DIP financing such that those obligations are afforded the same “priming” priority status as the DIP financing.
Finality of Loan – A DIP lender is provided ample protection from future attack by other creditors during a bankruptcy case. The Bankruptcy Court’s order approving the financing typically includes a finding that the loan was made in good faith and, as a result, is no longer subject to challenge.
Lender Protections – An existing secured lender may opt to provide DIP financing for reasons specific to the situation: to defend its position in the collateral and capital structure, maintain control over a restructuring or sale process and influence the timelines of the debtor’s progression within and out of the bankruptcy case. Such terms (including a cash flow budget against which loans are extended, rights to information regarding a sale and/or the dictation of important case deadlines) are typically negotiated as part of, and are contingent to, the provision of DIP financing.
Pricing – Assuming adequate collateral value is in place, the protections afforded to the DIP lender make the loans extended in the bankruptcy case relatively low-risk; accordingly, the fees and interest charged often dictate that a DIP provides an attractive return for lenders.
While extending financing to an entity in bankruptcy obviously carries inherent risks, these situations may also engender mutually beneficial financing opportunities.