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Sunday, June 6, 2010

Rolling the Dice By Failing to Include Tenants as Defendants in Commercial Foreclosures

Rolling the Dice By Failing to Include Tenants as Defendants in Commercial Foreclosures

With all  the foreclosures going on these days, sooner or later one of these cases is bound to affect a tenant leasing all or a portion of the premises being foreclosed.  So what happens to a tenant in these situations?
The answers depends upon factors such as
  • what the lease says, i.e. does it say that it is subordinate to any mortgage
  • whether it was the lease or mortgage whcih was executed first
  • whether it was the lease or the mortgage which was recorded first
  • whether the tenant is joined as a party defandant to the foreclosure
So let's start with what the lease says.  Nearly all commercial leases in Ohio are likely to say that the lease is subordinate to any existing or subsequent mortgage financing by the owner of the real property.  In the unlikely event that a commercial lease does not have this provision, the tenant's lease will generally ride thorough the foreclosure if it was executed before the mortgage or at least recorded before the mortgage.  If the mortgage was executed before the lease, then it will depend on whether the tenant is named as a party defendant to the foreclosure and what rights of the tenant are at issue.
The BIG issue is what happens if a lease is executed after the mortgage, but the tenant is not made a party defendant to the foreclosure.  In Ohio, the definitive case is New York Life Ins. Co. v. Simplex Products Corp.,135 Ohio St. 501, 21 N.E. 2d. 585 (Stark Cty. C.P., 1939).  That case said that since there was no privity between the tenant and the purchaser at Sheriff's sale and the tenant's interest came from the property owner's interest which was auctioned, the lease was terminated - regardless whether the tenant was made a party to the foreclosure. 
However, as is often the case, the facts of the Simplex case left the door open for creative lawyering because it involved a foreclosure sale purchaser interested in  enforcing a lease of a tenant not named in the foreclosure.    In Davis v. Boyajuan, 229 N.E.2d 116 (C.P. 1967), the Stark County Common Pleas Court took the out and held that if the purchaser wanted to evict the tenant.  the lease remained in force with respect to a tenant not made a party to the foreclosure.  Consequently, if the tenant was not named as a party to the foreclosure but was in compliance with its obligations under the lease, the purchaser at a foreclosure sale could not kick the tenant out.  But see Prudential  Ins. Co. of America v. Bull Market, Inc., 420 N.E.2d 140 (C.P. Montgomery Cty. 1979)  ("[T]his court concludes that the Supreme Court  [of Ohio] did in fact announce in Simplex. that this state follows the minority rule to this effect that foreclosure terminates a lease of the mortgagor  for lack of priority between the lesee and the mortgagor.")
So these are mere Common Pleas Couty decisions - isn't there anything more authoritative?  More recently, the Ohio Court of Appeals for the Eighth Appellate District in Cuyahoga County has weighed in.  In Victoria Mortgage Corp. v, Williams, 1996 WL 200160,  involving a foreclosure sale purchaser attempting to evict a tenant with an oral lease who was not joined as a party to the foreclosure, the Court succinctly explained the majority rule  not followed  by Ohio:
The rule in a majority of jurisdictions regarding the survival of a lessor's rights when the lessee is not joined in a foreclosure action is that the lessee does not lose his or her right to possession  or quiet enjoyment.   A judicial sale is treated as a reversion which is subject to the lease, and the purchaser  acquires the rights and duties of the mortgagor thereby becoming the new lesser.
However, because Ohio follows the minority rule, the Court ultimately found that the lease was junior to the mortgage and was extinguished at sheriff's sale.
But what if the lease contains attornment provisions, as is common?  These provisions essentially say that the tenant will recognize any purchaser as stepping into the shoes of the seller/lessor, at least so far as it comes to continuing to pay rent.  In Brandon/Wiant Company v. Teamor, 125 Ohio App.3d 442, 708 N.E.2d 1024 (1998), the Eighth Appellate District Court of Appeals  in Cuyahoga County held that the lease as a contract was clear and unambiguous in stating that the tenant had agreed to accept subsequent purcahsers of the property as lessor.  While the case involved a lessor trying to collect rent from the tenant, in dicta, the Court noted:
[The tenant]  certainly has a right to enforce the obligations owed him bythe lessor against [the purchaser at foreclosure].  The lease is in full effect against both parties to the agreement.
The Fifth Appellate District Court of Appeals out of Muskingham County has consideted the foreclosure purchaser wishing to terminate a lease situation.  In First Federal Savings and Loan Association of Zanesville v. Rig Oil Company, Inc., 1983 WL 7013, the Court acknowledged Simplex, but found the reasoning in Davispersausive.  The Court said:
there is a significant difference between a nonjoined party being given the benefit that miight accrue from nonjoinder and denying him rights not litigated as a result of non-'joinder.  
Clear as mud, right?  So let''s try some general guidelines...
Consider obtaining a SNDA Agreement, short for Subordination, Non-Disturbance, and Attornment Agreement.  These agreements provide more certainty for commercial tenants when the landlord is in default, but the tenant is not and wishes to remain in place.  For more on how this works, vist the Ohio Real Estate Advisor Blog's post "Don't Forget the 'ND' and the 'A' in 'SNDA's'"
Check the lease for attornment language.  If none, and perhaps even if there is, best to have tenant named as party defendant.
If you are in Stark County, definitely include tenants as defendants if there is going to be a desire to evict them following foreclosure.  If you are in Cuyahoga County, don't worry too much  about it.  Elsewhere in Ohio, it just depends on your judge, although to be safe, tenants should probably be included as defendants.  Of course, if the lease contains subordination language, you may be O.K regardless  on contractual grounds.
And of course, sometimes, there may just be too many tenants to make notification and addition as party defendants practical.  There's also the additional wrinkle that in some counties - Lucas Countywhich includes Toledo comes to mind - local rules actually require teants be notified

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