Clients sometimes overlook the importance of obtaining a title report on the property being leased. While some reasons for doing this may not be critical in the case of a lease of space in a major shopping center, certain matters reflected in a review of the lessor’s title are equally applicable to national landlords as to a lessor whose sole venture into real estate may be the strip center or convenience store he or she is leasing.
For example, in a recent lease of a convenience store and gas station, sitting on a large two-acre lot, a title report reflected that there were not one but two mineral leases of the entire property (from different lessors as owners of the severed mineral rights) supposedly both in effect together with 90 surrounding acres. This obviously could not be, but there was no reflection in the county records of a transfer of the mineral rights which had been severed back in 1951 and through various assignments had ended in the hands of the first of the lessors. If the client was purchasing the property, this would need to be resolved, if for no other reason that no lender would lend with this title confusion. But while a tenant could perhaps say “not my problem,” what would in fact be his problem would be the possibility that the lessee of mineral rights might set up a drilling pad, as might be his right to do, right next to the client’s store. And it would have the right to do so unless it had executed a “waiver of surface rights,” meaning it could not do anything on the land, but only reached the sub-surface minerals via horizontal drilling from other property.
This could only be revealed by a title search. None of this was “theoretical” because the client’s property sat right in the heart of the Barnett Shale formation. The only hope had we not reviewed title and ultimately obtained a waiver of surface rights from the current lessor of the property (who was entitled to grant it because it also turned out that the mineral rights lessee had failed to maintain continuous production as required by its lease and had therefore forfeited its rights under) would have been that oil prices remained at the distressed levels of late 2015-early 2016 which made shale fracking uneconomic. That this would be so for the length of the lease (10 years plus renewals) would require an ill- advised gamble against long odds.
An equally important reason to review a landlord’s title is for purposes of seeing whetehr there is a mortgage encumbering the Landlord’s property. Why would a tenant care? Because the lender holding the deed of trust on the property has the right to take title in the event of a foreclosure “free and clear” of all tenant leases executed after the mortgage. Such a lender, or more likely the entity acquiring the property from the lender may or may not wish to keep a particular lease. One would hope that a lease made at a then market rate, and for a term meeting the new owner’s plans for the property, and for a business which is not at odds with the new owner’s intended “mix”, and for a space which is not in conflict with the new owner’s negotiations with prospective new tenants would not be disturbed, but even when satisfying all of those requirements, there can be no assurance.
So what is done by competent counsel is to obtain a Subordination and Non- Disturbance Agreement which as far as the client is concerned means (provided it is drawn and revised if necessary by lender’s counsel to assure, without conditions or unacceptable qualifications, that in the event of a foreclosure, the lease will remain in all respects in place and the tenant will not be “disturbed,” meaning that the landlord’s default under its loan will not impact the tenant in any way. The only way to know if there is mortgage financing in place is either that Landlord will fully disclose all loans, or else through a title report. If the landlord discloses its financing and agrees to have its lender provide an SNDA, then a tenant can be reasonably confident that there are no other loans which would require a like SNDA, but it would still be important to have lender state that its mortgage loan covers the property.
Yet another instance why review of the landlord’s title is important for a lessee relates to rights to acquire the property, under either an option to purchase or a “right of first refusal” whereby a landlord can sell its property but only after allowing the tenant an opportunity to match a prospective third party’s offer. Assume again that convenience store or a dry-cleaner, whether or not they are stand-alone properties or part of a strip center. Often a tenant signs a lease with the intent that it may acquire the property at some point, perhaps as soon as it can obtain financing. This right may be documented in an option to purchase and the lease might even be structured on the basis of lease rent equaling the amount of a theoretical mortgage payment. The “tenant” may actually make a substantial down payment just as though it were
purchasing the property and the monthly “rent” might be well above what would be considered fair rental value because it actually is a disguised principal and interest payment. In either the true lease at fair rental value or the disguised purchase, there is an intention or at lease a good possibility of purchasing the property. So the same need to examine title exists here as would exist in a straight purchase. Perhaps more so, because there is no title insurance policy being issued in connection with this lease. So the tenant without having examined title is unprotected both with respect to what would have been reflected in the title commitment and what the title commitment might have not shown, which is where the title insurance comes into play.
So what might have been revealed? For one thing, the usual issues–does the named landlord have good title to the property, or is he or she perhaps part of a partnership group or acting without authority?; is there a loan on the property, and if so, is the amount less than the possible purchase price?; is the loan secured not only by this property but others as well, which might indicate a larger loan?; is this property “cross-collateralized” with other property and loans, meaning that a default under some other loan securing other property would be a default under this loan as well? But as importantly, the title report would reveal whether anyone else has a right to purchase the property, such as a neighbor who has the right to match your purchase price under a right of first refusal, or the right to simply purchase at a pre-agreed price. Without doing the title work, the tenant intending to buy this property at some point down the line might as easily write a check to someone on the street corner seeking investors without doing due diligence.