The Bottom Line:

It is not uncommon for complex commercial real estate transactions to involve numerous parties and investors and overlaying agreements.  One such structure involves a master lease for commercial space and sublease to an actual end-user of that space.  The master lessor may sell interests in the master lease to third party investors based upon the income generated from the sublease.  To protect the interests of the ultimate owners/investors, the sublease may include an “attornment” provision whereby the subtenant agrees to allow the investor/owner to step into the master lease if the master lease is terminated.  Recently, in their decision in Green Tree Servicing, LLC v. DBSI Landmark Towers, LLC, __F. 3d__, 2011 WL 3802800 (8th Cir. Aug. 30, 2011), the Eighth Circuit strictly interpreted an attornment provision that is common in many subleases.  The effect of the ruling was to hold that the subtenant was not subject to an attornment when the sublessor rejects the lease in bankruptcy. 

What Happened:

The structure of the transaction was as follows:  DBSI Landmark Towers, LLC, the Landlord, acquired a 25-story office building in downtown St. Paul, Minnesota and leased it to an affiliate, DBSI Leaseco.  DBSI Leaseco then subleased the property to Green Tree.  DBSI sold fractional interests in the property to 28 tenants in common (“TICs”), as Landlord.  The sublease contained a provision providing for Green Tree to “attorn” to the Landlord when the Landlord “terminates the Master Lease” or “otherwise succeeds to the interest of DBSI Leaseco under the foregoing Lease.” Attornment is a concept dating back to feudal times, when the lord of the property needed the tenant’s consent before transferring or selling his remainder or reversionary interest in the property to a third party.  Simply, the tenant must agree to be the tenant of the new property owner.

DBSI Leaseco later filed for bankruptcy, and the master lease with the TICs and the sublease with Green Tree were ordered rejected by the bankruptcy court.  In its motion to reject the contracts, DBSI Leaseco indicated its intent that the sublease be terminated during the bankruptcy, specifically, upon the court’s approval of the rejection.  In response, Green Tree exercised its rights to treat the sublease as terminated pursuant to section 365(h) of the Bankruptcy Code and the TICs objected on the grounds that the terms of the sublease required Green Tree to attorn to them as landlord.  Green Tree then commenced a declaratory judgment action in state court against the TICs, as landlord, seeking a determination that Green Tree could vacate the office space after the rejection of the sublease in DBSI Leaseco’s bankruptcy notwithstanding the attornment provision.  The TICs removed the action to federal court and cross-claimed for a declaratory judgment affirming the sublease.  In upholding the District Court's ruling, the Eighth Circuit found that the events that trigger the sublease’s attornment provision did not occur in this case.  First, DBSI Leaseco, and not the TICs, as landlord, “rejected” the master lease in bankruptcy.  Second, the TICs as landlord did not “succeed to the interest” of DBSI Leaseco as DBSI Leaseco never assigned its contractual interest in the sublease to the TICs prior to DBSI Leaseco voluntarily extinguishing its rights in bankruptcy.  Accordingly, the Eighth Circuit found that Green Tree was not required to attorn to the TICs under these circumstances.  

Why the Case is Interesting:

This case is significant for landlords and leasing attorneys because it hinges on the interpretation of an attornment provision that is common in many sublease agreements.  Here, the Eighth Circuit strictly interpreted the attornment provision.  It held that rejection under section 365 is not termination – as required by the specific wording of the attornment provision.  Nor was the landlord the successor to the debtor because the master lease was not “assigned”.  Accordingly, landlords and practitioners should consider including language in the attornment provisions of their master and subleases requiring subtenants to attorn to the landlord in circumstances where the master lease and/or sublease is rejected under section 365 of the Bankruptcy Code.