What Is A Subordination Clause?
In legal terms, subordination ranks a claim on property behind another claim. A subordination clause is a term in an agreement which ranks a claim on property behind another claim on the same property established in another agreement with another third party.
Why Is A Subordination Clause Important?
A subordination clause is important in commercial real estate with respect to real estate finance and lease agreements. The reason is both mortgages and leases establish claims on real property. The claims may come into conflict in the event of default on a debt. The subordination clause establishes and clarifies the priority of these claims, and under what conditions.
Subordination Clauses in Mortgage Agreements
In some cases, there may be more than one mortgage on a property. In the event of default, there needs to be a means of establishing which mortgage takes priority over the others. This establishes who will get paid first from the proceeds of the sale of the property in the event of default.
Subordination Clauses in Commercial Lease Agreements
Investors finance and refinance their investment properties. Lenders face a risk of default from these investors. However, what are the consequences to the tenant if an investor defaults on their mortgage? The lender will want to foreclose on the property to recover their money, but what about the tenant's lease with the landlord?
As a condition for financing, commercial lease agreements may contain a subordination clause that subordinates the tenants interest in the property to the lender in the event of a foreclosure. The problem then becomes the tenant losing their space if the lender forecloses. For this reason, the tenant has the option of pursuing a non-disturbance agreement that will allow the tenant to remain in the space under the conditions of the agreement.