By Robert M. Steeg

According to Managing Partner, Robert M. Steeg, whether you are a landlord or a tenant, the recordation of a Memorandum of Lease has very significant consequences that you need to understand.

Anything Not Shown on the Public Records is Not Binding on the Buyer or Lender

When a buyer purchases property, or a lender places a mortgage on property, they take the property “subject to” whatever matters are shown on the public records. If a matter is shown on the public records, then the buyer or lender must accept that matter.

Conversely, anything not shown on the public records is not binding on the buyer, even if the buyer or lender had actual knowledge about it. If the matter is not recorded, then a buyer or lender is free to disregard it, and they acquire their interest in the property “free and clear” of this matter.

The Only Thing That Matters is What is in the Public Records

A Memorandum of Lease (actually called a Notice of Lease in Louisiana) is one of those matters that is covered by this doctrine. If the Memorandum of Lease is recorded, then parties (like a buyer or a lender) acquiring an interest in property (for example, through a sale or a mortgage) take the property “subject to” the lease.

If a Memorandum of Lease is not recorded, then these parties take their interests in the property “free and clear” of the lease, regardless of these parties’ actual knowledge of the existence of the lease.

The only thing that matters is what is in the public records.

Memorandum of Lease – A Simple Document That Can Make a Big Difference

A Memorandum of Lease is a very simple document. It does not contain the economic terms of the lease. The required contents are set forth clearly in the law. They are: a declaration that the property is leased; the names and addresses of the landlord and tenant; a description of the leased premises; a statement of the date and term of the lease; a statement of whether there are any options to renew or extend the term of the lease; and a description of any rights of first refusal. List all this information in a document, entitle it “Memorandum of Lease” or “Notice of Lease,” and have it signed by the landlord and the tenant. That is all that is needed – except of course for recordation of the document in the public records.

Recordation is Crucial

And that recordation is crucial. It determines whether a buyer or lender acquires their interest in the property “subject to” the lease or “free and clear” of the lease. If they acquire their interest “free and clear” of the lease, they are not bound to respect the lease at all, and can evict the tenant. If they take their interest in the property “subject to” the lease, then the tenant has the right to remain in the leased premises, subject to the terms and provisions of the lease itself.

The Lesson for the Tenant

The lesson, from the tenant’s point of view: if you want to be able to remain in your space, record a Memorandum of Lease. Take, for example, the situation in which a buyer is purchasing a piece of property. Even if the buyer looks the tenant square in the eye and knows that the tenant is operating its business at the property, if the tenant has not recorded a Memorandum of Lease, the buyer acquires the property free and clear of the lease, and can bring an action to evict the tenant. It does not matter that the buyer has interviewed the tenant, or has reviewed a rent roll that shows the tenant’s premises, or even has read the tenant’s lease.

Again, the only thing that matters is what is recorded in the public records.

The Landlord’s Perspective

From a landlord’s perspective, there are several considerations. If the landlord wants to be able to sell the property free and clear of all leases, then the landlord will not want any Memorandum of Lease to be recorded. If, on the other hand, the economic value of the property is tied to the continued existence of the lease, then the landlord may well want the Memorandum of Lease to be recorded.

The Implications for the Landlord’s Lender

There are important implications for the landlord’s lender, as well. The critical question is which document was recorded first – the lender’s mortgage or the Memorandum of Lease. If the Memorandum of Lease was recorded first, then if the lender forecloses, it must take the property subject to the lease. This is why a lender, before it takes a mortgage on a piece of property, will want to know what leases are protected by a recorded Memorandum of Lease. The lender will want its mortgage to rank ahead of the lease, and will require a “subordination agreement” under which the tenant agrees that, even though its Memorandum of Lease was recorded first, the mortgage nevertheless ranks ahead of the lease.

Sophisticated tenants will negotiate a “Subordination, Non-Disturbance and Attornment Agreement,” which subordinates their lease, but obtains from the lender an agreement to allow the lease to remain in effect despite a foreclosure.

A Word of Caution

One word of caution: check the public records immediately before your sale or mortgage transaction. A tenant with his ear to the ground, who learns that a sale or mortgage of the property is imminent, may rush to the courthouse and record a Memorandum of Lease (or even the entire lease, to serve as a Memorandum of Lease). If the tenant does so before the act of sale or mortgage is consummated, the buyer or lender acquires their interest in the property subject to that recorded lease.

The only way for a buyer or lender to protect himself is to check the public records immediately before the sale. And, the buyer needs to make sure that his purchase agreement entitles him to conduct this late title review, and gives him rights and remedies in case he does find any newly-recorded items.

Filed under: Commercial Real Estate, Industry News, Leases, Residential Real Estate
Archives >