Landlords' Liens and Waivers

Depending on the state, there are usually three ways that landlords obtain lien or other security interests in the tenant's personal property. The first method is not a lien, per se, but involves the exercise of the traditional common law rights of distress and distraint, which enable a landlord to seize and sell a tenant's personal property located at the premises in order to reimburse the landlord for the amount of unpaid rent and other liability. In Virginia, the landlord must file a sworn petition with the court that demonstrates the justifications for the attachment of the levy as set forth in the Code of Virginia. The landlord, however, must state that the tenant intends to flee, conceal itself from creditors or sell or destroy the property. If the court approves the petition, the sheriff will either take possession of the property or the tenant will be unable to sell, move, destroy or dispose of the property without facing legal consequences.

The second method is available in about half of the states, where landlords have been given statutory landlord's lien rights. The statutory lien rights differ from state to state as to timing, priority and limitations, but typically provide the landlord with a lien on all of the tenant's personal property located within the demised premises as security for the tenant's obligations under the lease. In many states, these statutory liens replace or supplement the common law remedies of distress and distraint. In some states, the statutory lien rights are limited to a specific amount or period of time and many states provide that the landlord's lien is subordinate to any perfected security interests in the tenant's personal property existing before such property was transferred to the premises. There is no uniform or model landlord's lien law and reference must be made to the specific statutes in each applicable jurisdiction.

For example, in the District of Columbia, the statutory lien terminates three months after the rent owed became due or upon the termination of any action seeking such unpaid rent brought by the landlord within that three-month period. By comparison, the statutory landlord's lien in Virginia is quite strong, relating back to the commencement of the lease and superior to any other lien upon the tenant's property located at the premises, except for liens attaching prior to the commencement of the lease term and tax liens. Maryland has no statutory lien rights in favor of a landlord, so a landlord would have to pursue an action for distress with the ability to then lien the personal property if successful in obtaining a judgment. In all of the states, enforcement of the statutory landlord's lien rights requires the landlord to file a court action and follow very detailed procedures designed to afford the tenant adequate due process prior to losing its property. While the statutory landlord's lien provides additional security for the landlord, it is also a cumbersome process that is expensive and time-consuming, limited by statute and subject to avoidance in the event of a tenant bankruptcy.

The third way that a landlord may obtain a lien against the tenant's personal property and fixtures is through a consensual security interest under Article 9 of the Uniform Commercial Code (the UCC). Since a written security agreement is required to create the security interest, the landlord must include language in the lease setting forth the security interest and adequately describing the collateral. The landlord must then perfect the security interest by filing a UCC financing statement in the appropriate state filing office ' the financing statement may be filed without the tenant's signature provided the filing is authorized by the tenant. Without the required filing, the landlord's security interest would be unperfected and subordinate to any creditor who has a perfected security interest in the same personal property.

After a tenant defaults, the landlord may foreclose on the property pursuant to the procedures set forth in the UCC without filing a court action or exercising other judicial process. The UCC security interest offers significant advantages over both the common law rights of distress and distraint and a statutory landlord's lien. It provides the landlord with greater flexibility in enforcing the lien while giving the landlord the right to immediate possession and control over the tenant's secured property without the need for judicial action. Thus it is a much less burdensome process than enforcing a statutory landlord's lien or pursuing an action for distress. Additionally, in the event of the tenant's bankruptcy, a landlord maintaining a perfected UCC security interest would be treated as a secured creditor, subject to the automatic stay and other bankruptcy protections offered the tenant as debtor.

One caveat for landlords is that UCC financing statements are only valid for five years, so the landlord may want to implement a tracking system in order to safeguard against the failure to file the necessary continuation statements prior to their expiration.

Landlord Waiver Agreement in Favor of Tenant's Lender

As noted above, the tenant's lenders will also want a security interest in the tenant's personal property to secure the repayment of the tenant's loan obligations, thus creating a conflict between the lien rights of the landlord and the lender. Because of this conflict, as a condition to the financing, a lender will typically request that the landlord execute a waiver of its security interest. Landlords may push back at this request, but will often agree at least to subordinate their landlord's lien rights to that of the lender's security interest.

The landlords recognize that financing is a critical need for their tenants, without which the tenant would not be able to operate its business and generate the revenues needed to pay the rent. Consequently, they typically agree to the waiver or the subordination of their lien rights for larger, creditworthy tenants.

The landlord would obviously prefer the subordination over the waiver, as a secondary secured position could at least provide some limited recovery in a default situation. In any event, landlords would be wise to pay close attention to the form landlord waiver presented by the lender, as such forms often grant lenders favorable rights with regard to the leased premises and place burdensome obligations on the landlord. The tenant is not typically a key party in the negotiation of the landlord waiver, as their main role is to serve as referee between their landlord and lender. However, the sophisticated tenant would be wise to include the form of their lender's required waiver form as an exhibit to their lease agreement, to save time and expense later. Note that the landlord could likely pass its legal fees incurred in negotiating the landlord waiver onto its tenant. Five key landlord-friendly points that should be addressed in the landlord waiver/subordination document are set forth here:

• First, the landlord should try to subordinate its landlord's lien instead of an outright waiver. The true value of a secondary position may be questionable, but there could be some recovery and it is better for the landlord to be a secured creditor in the event of a bankruptcy.
• Second, the landlord should try to retain control over the process of the lender removing the collateral. For example, the lender should only remove the collateral after business hours and from designated loading areas. The lender should also agree to pay for any damage caused by the removal, and indemnify landlord in case of third party claims resulting from the lender's entry into the premises for such purposes. The landlord could also insist that the lender furnish evidence of insurance before entering onto the premises to remove the collateral.
• Third, the parties need to make clear what equipment is part of the collateral. The landlord should agree that personal property remains personalty (and not part of the real estate) in exchange for the lender agreeing not to pursue its security interest against building systems such as plumbing and HVAC or other fixtures. The landlord could violate the terms of its own mortgage were it to waive its interest in these items. Further, the landlord will want to make sure that the tenant's leasehold interest in the premises is not part of the collateral. Lease provisions dealing with the assignment of the lease by the tenant are typically very landlord-friendly and the landlord does not want the tenant to do an “end run” around those provisions by including the lease itself as part of the collateral package to which the landlord has consented in the waiver/subordination document.
• Fourth, the lender will want notice of tenant's default under the lease and an opportunity to cure on behalf of the tenant. This presents an administrative burden for the landlord, so the number and cause of notices should be limited, if possible, to notices that may result in a termination of the lease. With respect to giving the lender an opportunity to cure the tenant's default, the time period should be short and limited only to monetary defaults.
• Fifth, the lender will request a period of time following the termination of the lease (perhaps up to 60 or 90 days) to take inventory and remove the collateral. Such a request by the lender may not be unreasonable, but the landlord should insist that the lender pay the amount which would otherwise be payable as rent under the lease during such period.

Conclusion

Subject to the terms of their lease agreements and the applicable state law, there are many kinds of lien rights available to landlords in the personal property of their tenants. Landlords would be wise to learn the lien laws of their respective states and draft their leases accordingly. At the same time, lenders for the tenants will object to these broad landlord's liens as they will look to secure their loans against the same personal property. The resulting conflict is best resolved through a fair subordination of landlord's lien agreement, which should be attached to the lease as a pre-approved form to save time, expense and aggravation later.

John G. Kelly, a member of this newsletter's Board of Editors, is a partner with Bean Kinney & Korman in Arlington, VA. He represents national retailers and regional landlords, and can be reached at [email protected].

Commercial real estate landlords and the lenders for their tenants have competing interests with respect to the tenant's personal property located at the demised premises. The landlord is looking to secure the tenant's rental obligations by taking a lien against the tenant's fixtures, inventory, and equipment located in the space, which may be particularly valuable in the case of retail and restaurant tenants. The tenant's lender, which is providing premises fit-out and/or working capital financing, desires a security interest in the same property. The landlord's lien may be created either by contract under the terms of the lease or through operation of law, and allows the landlord to levy the property located at the demised premises of a tenant who has failed to pay rent.

While the tenant would rather not allow either party to maintain a lien against its personal property, the tenant's action in this regard is often dictated by the requirements of its lender. While national retailers with strong credit typically have the leverage to insist on the waiver or subordination of their landlord's lien rights, most smaller or regional tenants must navigate between their landlord's and lender's competing interests. This article discusses the varied interests of the landlord and the tenant's lender in the tenant's personal property, and offers suggested compromise solutions.

Landlord's Methods of Redress

Depending on the state, there are usually three ways that landlords obtain lien or other security interests in the tenant's personal property. The first method is not a lien, per se, but involves the exercise of the traditional common law rights of distress and distraint, which enable a landlord to seize and sell a tenant's personal property located at the premises in order to reimburse the landlord for the amount of unpaid rent and other liability. In Virginia, the landlord must file a sworn petition with the court that demonstrates the justifications for the attachment of the levy as set forth in the Code of Virginia. The landlord, however, must state that the tenant intends to flee, conceal itself from creditors or sell or destroy the property. If the court approves the petition, the sheriff will either take possession of the property or the tenant will be unable to sell, move, destroy or dispose of the property without facing legal consequences.

The second method is available in about half of the states, where landlords have been given statutory landlord's lien rights. The statutory lien rights differ from state to state as to timing, priority and limitations, but typically provide the landlord with a lien on all of the tenant's personal property located within the demised premises as security for the tenant's obligations under the lease. In many states, these statutory liens replace or supplement the common law remedies of distress and distraint. In some states, the statutory lien rights are limited to a specific amount or period of time and many states provide that the landlord's lien is subordinate to any perfected security interests in the tenant's personal property existing before such property was transferred to the premises. There is no uniform or model landlord's lien law and reference must be made to the specific statutes in each applicable jurisdiction.

For example, in the District of Columbia, the statutory lien terminates three months after the rent owed became due or upon the termination of any action seeking such unpaid rent brought by the landlord within that three-month period. By comparison, the statutory landlord's lien in Virginia is quite strong, relating back to the commencement of the lease and superior to any other lien upon the tenant's property located at the premises, except for liens attaching prior to the commencement of the lease term and tax liens. Maryland has no statutory lien rights in favor of a landlord, so a landlord would have to pursue an action for distress with the ability to then lien the personal property if successful in obtaining a judgment. In all of the states, enforcement of the statutory landlord's lien rights requires the landlord to file a court action and follow very detailed procedures designed to afford the tenant adequate due process prior to losing its property. While the statutory landlord's lien provides additional security for the landlord, it is also a cumbersome process that is expensive and time-consuming, limited by statute and subject to avoidance in the event of a tenant bankruptcy.

The third way that a landlord may obtain a lien against the tenant's personal property and fixtures is through a consensual security interest under Article 9 of the Uniform Commercial Code (the UCC). Since a written security agreement is required to create the security interest, the landlord must include language in the lease setting forth the security interest and adequately describing the collateral. The landlord must then perfect the security interest by filing a UCC financing statement in the appropriate state filing office ' the financing statement may be filed without the tenant's signature provided the filing is authorized by the tenant. Without the required filing, the landlord's security interest would be unperfected and subordinate to any creditor who has a perfected security interest in the same personal property.

After a tenant defaults, the landlord may foreclose on the property pursuant to the procedures set forth in the UCC without filing a court action or exercising other judicial process. The UCC security interest offers significant advantages over both the common law rights of distress and distraint and a statutory landlord's lien. It provides the landlord with greater flexibility in enforcing the lien while giving the landlord the right to immediate possession and control over the tenant's secured property without the need for judicial action. Thus it is a much less burdensome process than enforcing a statutory landlord's lien or pursuing an action for distress. Additionally, in the event of the tenant's bankruptcy, a landlord maintaining a perfected UCC security interest would be treated as a secured creditor, subject to the automatic stay and other bankruptcy protections offered the tenant as debtor.

One caveat for landlords is that UCC financing statements are only valid for five years, so the landlord may want to implement a tracking system in order to safeguard against the failure to file the necessary continuation statements prior to their expiration.

Landlord Waiver Agreement in Favor of Tenant's Lender

As noted above, the tenant's lenders will also want a security interest in the tenant's personal property to secure the repayment of the tenant's loan obligations, thus creating a conflict between the lien rights of the landlord and the lender. Because of this conflict, as a condition to the financing, a lender will typically request that the landlord execute a waiver of its security interest. Landlords may push back at this request, but will often agree at least to subordinate their landlord's lien rights to that of the lender's security interest.

The landlords recognize that financing is a critical need for their tenants, without which the tenant would not be able to operate its business and generate the revenues needed to pay the rent. Consequently, they typically agree to the waiver or the subordination of their lien rights for larger, creditworthy tenants.

The landlord would obviously prefer the subordination over the waiver, as a secondary secured position could at least provide some limited recovery in a default situation. In any event, landlords would be wise to pay close attention to the form landlord waiver presented by the lender, as such forms often grant lenders favorable rights with regard to the leased premises and place burdensome obligations on the landlord. The tenant is not typically a key party in the negotiation of the landlord waiver, as their main role is to serve as referee between their landlord and lender. However, the sophisticated tenant would be wise to include the form of their lender's required waiver form as an exhibit to their lease agreement, to save time and expense later. Note that the landlord could likely pass its legal fees incurred in negotiating the landlord waiver onto its tenant. Five key landlord-friendly points that should be addressed in the landlord waiver/subordination document are set forth here:

• First, the landlord should try to subordinate its landlord's lien instead of an outright waiver. The true value of a secondary position may be questionable, but there could be some recovery and it is better for the landlord to be a secured creditor in the event of a bankruptcy.
• Second, the landlord should try to retain control over the process of the lender removing the collateral. For example, the lender should only remove the collateral after business hours and from designated loading areas. The lender should also agree to pay for any damage caused by the removal, and indemnify landlord in case of third party claims resulting from the lender's entry into the premises for such purposes. The landlord could also insist that the lender furnish evidence of insurance before entering onto the premises to remove the collateral.
• Third, the parties need to make clear what equipment is part of the collateral. The landlord should agree that personal property remains personalty (and not part of the real estate) in exchange for the lender agreeing not to pursue its security interest against building systems such as plumbing and HVAC or other fixtures. The landlord could violate the terms of its own mortgage were it to waive its interest in these items. Further, the landlord will want to make sure that the tenant's leasehold interest in the premises is not part of the collateral. Lease provisions dealing with the assignment of the lease by the tenant are typically very landlord-friendly and the landlord does not want the tenant to do an “end run” around those provisions by including the lease itself as part of the collateral package to which the landlord has consented in the waiver/subordination document.
• Fourth, the lender will want notice of tenant's default under the lease and an opportunity to cure on behalf of the tenant. This presents an administrative burden for the landlord, so the number and cause of notices should be limited, if possible, to notices that may result in a termination of the lease. With respect to giving the lender an opportunity to cure the tenant's default, the time period should be short and limited only to monetary defaults.
• Fifth, the lender will request a period of time following the termination of the lease (perhaps up to 60 or 90 days) to take inventory and remove the collateral. Such a request by the lender may not be unreasonable, but the landlord should insist that the lender pay the amount which would otherwise be payable as rent under the lease during such period.

Conclusion

Subject to the terms of their lease agreements and the applicable state law, there are many kinds of lien rights available to landlords in the personal property of their tenants. Landlords would be wise to learn the lien laws of their respective states and draft their leases accordingly. At the same time, lenders for the tenants will object to these broad landlord's liens as they will look to secure their loans against the same personal property. The resulting conflict is best resolved through a fair subordination of landlord's lien agreement, which should be attached to the lease as a pre-approved form to save time, expense and aggravation later.

John G. Kelly, a member of this newsletter's Board of Editors, is a partner with Bean Kinney & Korman in Arlington, VA. He represents national retailers and regional landlords, and can be reached at [email protected].