The Landlord's Lien under the Uniform Commercial Code

UCC Section 9-109(a) states that Article 9 applies to transactions that create “a security interest in personal property or fixtures by contract.” Some confusion has historically arisen from Section 9-109(d), which specifically excludes the applicability of Article 9 to a “landlord's lien.” However, courts have consistently held that this exception excludes statutory and common-law liens only; hence, the priority of non-consensual liens is not governed by the UCC.

Under Article 9, an effective lien upon personal property is created by a written security agreement between the debtor (i.e., the tenant) and the secured party (i.e., the landlord). In this context, the security agreement is customarily
embedded in the lease, and the lien created thereby “attaches” upon execution of the lease. The tenant must have rights in the collateral to be secured (or the power to transfer those rights), and value must be given in exchange for the grant. The collateral secured must be adequately described in the conveyance document, which, as discussed below, may present challenges for the landlord. Finally, the security interest must be perfected, which is accomplished by the landlord's filing of a financing statement in the appropriate public records.

Lease Provision

A lease provision creating a security agreement under Article 9 may be relatively straightforward:

In consideration of the mutual benefits arising under this Lease and to secure the payment of all rent and other sums of money becoming due from Tenant under this Lease, Tenant hereby grants unto Landlord a continuing first-priority lien and security interest in '

While the granting language and statement of consideration are prerequisites to the establishment of the security interest, this portion of the lease provision is largely non-controversial.

The collateral description, however, is a critically important element of the provision, and should be analyzed closely. Landlords should be mindful to describe the collateral as comprehensively as possible:

' in all existing and after-acquired property of Tenant (and any transferees and other occupants of the Premises) placed in or relating to Tenant's business at the Premises, including but not limited to, accounts receivable, insurance proceeds, good will, accounts, contracts, intangibles, furniture, fixtures, equipment, inventory, and personal property, and all proceeds thereof.

The collateral should not be limited to property owned by the tenant; rather, it should include property owned by assignees or other transferees of the lease and other parties occupying the premises. Furthermore, the description should include both property within the premises at the time of the grant and after-acquired property brought into the premises at any time during the term of the lease. It may also describe property not present upon the Premises at all. Finally, the grant should be inclusive of insurance proceeds and proceeds from the sale of the property secured.

Some tenants may want to reserve the right to transfer the secured property and receive and retain the proceeds thereof in the ordinary course of business. Landlords may consent to this right but require that any property so transferred is replaced with property of comparable or better quality, and in any event require that such right be extinguished upon a default by the tenant. Conversely, landlords may wish to include an express provision that prohibits any transfer of property off the premises without the landlord's prior consent, which would not be available until and unless all amounts due and payable under lease are paid in full.

Perfecting the Interest

In order to perfect a security interest given pursuant to the UCC, a landlord must file a financing statement in the proper office. This may be the office of the secretary of state of the state in which the tenant entity is organized or incorporated, or in the case of individuals or entities not formally registered, the state of principal residence or office. To perfect a security interest in fixtures, a fixture filing must be recorded in the real property records of the county where the fixtures are located. Regular continuation statements must also be filed to maintain the priority of a perfected lien. Landlords should also be cognizant that in a tenant bankruptcy, a perfected landlord's lien under Article 9 will render the landlord in the same position as other secured creditors, and relief from the stay may be required prior to enforcement.

The mere perfection of the landlord's lien under Article 9 is not a guarantee that issues will not arise when the landlord seeks to foreclose. The tenant may have granted a lien in the collateral to a purchase-money lender or to secure other debt, or third parties may assert competing liens pursuant to statute or common law. Asset-based lenders often seek waivers from landlords, which customarily grant notice and cure rights to the lender and define procedures for possession and disposition of the collateral subject to the liens. Unfortunately, space limitations preclude an in-depth discussion of issues raised by landlord waivers and associated negotiating strategies, which are worthy of an article of their own.

Relevant Case Law

Relevant case law highlights issues that may arise in the course of creating and foreclosing on landlord's liens under the UCC.

In this context, the importance of including proceeds in the collateral description is illustrated in Perez v. The Bank of Nova Scotia. 1975 U.S. Dist. LEXIS 5584 (D.V.I. Sept. 30, 1975). In Perez, following a default by the tenant, the landlord seized certain of the tenant's inventory in which it had a perfected UCC security interest, and the property was subsequently sold pursuant to a sheriff's sale. Following the sale, a priority dispute arose between the landlord and the tenant's bank, which held a competing security interest in the same property (and importantly, the proceeds thereof) pursuant to a financing statement filed prior to the landlord's financing statement. The court held that the lender's lien had priority because it was perfected first in time, and that the inclusion of proceeds in the collateral description protected the lender's interest notwithstanding the sale of the property.

Ownership of collateral may also be of issue, and prior to taking a UCC security interest in a tenant's property, a landlord should identify the owner of the property and, if that party is not the tenant, the relationship the owner bears to the tenant. In Zurita v. SVH-1 Partners, Ltd., for example, the tenant was an individual, but the owner of the pledged equipment was an entity owned by the tenant. 2011 Tex. App. LEXIS 9670 (Tex. App. Dec. 8, 2011). After the tenant defaulted, the secured landlord seized the secured property and ultimately gained ownership of it through an auction process. The landlord then sued the tenant for the remaining rent deficiency. However, the entity countersued the landlord, claiming that the landlord had converted its property. Because the tenant was the sole owner of the company, the court held that he could legally grant a security interest in the property and denied the claim for conversion. An entity with multiple equity owners would likely have further clouded the issue however, highlighting the relevance of the beneficial owner of the collateral.

Jurisdictions may vary greatly in their common-law and statutory rules of enforcement. In Southwest Bank of St. Louis v. Poulokefalos, the plaintiff bank learned this lesson the hard way. 931 N.E.2d 285 (1st Dist. 2010). Under the common law of Illinois, a landlord may assert a common law lien on a tenant's property for non-payment of rent, if the lien is properly perfected. The landlord in Southwest properly perfected its lien on the tenant's personal property. The tenant's bank, however, filed its UCC financing statement in the tenant's state of incorporation but not the state in which the property was located. Because the landlord's perfected common law lien was perfected first in time, it had priority over the lender's lien. The bank's failure to perfect its lien properly cost it the security for its loan to the tenant in favor of the landlord's overdue and unpaid rent, which was perfected first.

Conclusion

Landlords seeking a UCC lien upon the personalty of their tenants should be mindful of these inherent drafting and procedural details, which, while simple in form, may be tricky in substance.

A property owner may consider a variety of legal and business protections when negotiating a lease with a tenant that is only marginally creditworthy. While used less frequently than security deposits and personal guarantees, granting the landlord a security interest in its personal property can enhance a tenant's credit. This device may be more effective when conferred by certain types of tenants than by others (e.g., a restaurant or industrial tenant with valuable fixtures and/or inventory, as opposed to a conventional office tenant), but nevertheless, it may provide the landlord with a potent default remedy, particularly in a fragile market.

Many states have enacted statutes that prescribe a landlord's lien, and these liens can vary in scope and strength. Other states grant to a landlord the common-law right of distraint, which may enable a landlord to take possession of personal property located within the premises following a default by the tenant. A third, more universal option for landlords is a consensual security interest granted by the tenant under the lease pursuant to Article 9 of the Uniform Commercial Code (UCC).

A 'Landlord's Lien'

UCC Section 9-109(a) states that Article 9 applies to transactions that create “a security interest in personal property or fixtures by contract.” Some confusion has historically arisen from Section 9-109(d), which specifically excludes the applicability of Article 9 to a “landlord's lien.” However, courts have consistently held that this exception excludes statutory and common-law liens only; hence, the priority of non-consensual liens is not governed by the UCC.

Under Article 9, an effective lien upon personal property is created by a written security agreement between the debtor (i.e., the tenant) and the secured party (i.e., the landlord). In this context, the security agreement is customarily
embedded in the lease, and the lien created thereby “attaches” upon execution of the lease. The tenant must have rights in the collateral to be secured (or the power to transfer those rights), and value must be given in exchange for the grant. The collateral secured must be adequately described in the conveyance document, which, as discussed below, may present challenges for the landlord. Finally, the security interest must be perfected, which is accomplished by the landlord's filing of a financing statement in the appropriate public records.

Lease Provision

A lease provision creating a security agreement under Article 9 may be relatively straightforward:

In consideration of the mutual benefits arising under this Lease and to secure the payment of all rent and other sums of money becoming due from Tenant under this Lease, Tenant hereby grants unto Landlord a continuing first-priority lien and security interest in '

While the granting language and statement of consideration are prerequisites to the establishment of the security interest, this portion of the lease provision is largely non-controversial.

The collateral description, however, is a critically important element of the provision, and should be analyzed closely. Landlords should be mindful to describe the collateral as comprehensively as possible:

' in all existing and after-acquired property of Tenant (and any transferees and other occupants of the Premises) placed in or relating to Tenant's business at the Premises, including but not limited to, accounts receivable, insurance proceeds, good will, accounts, contracts, intangibles, furniture, fixtures, equipment, inventory, and personal property, and all proceeds thereof.

The collateral should not be limited to property owned by the tenant; rather, it should include property owned by assignees or other transferees of the lease and other parties occupying the premises. Furthermore, the description should include both property within the premises at the time of the grant and after-acquired property brought into the premises at any time during the term of the lease. It may also describe property not present upon the Premises at all. Finally, the grant should be inclusive of insurance proceeds and proceeds from the sale of the property secured.

Some tenants may want to reserve the right to transfer the secured property and receive and retain the proceeds thereof in the ordinary course of business. Landlords may consent to this right but require that any property so transferred is replaced with property of comparable or better quality, and in any event require that such right be extinguished upon a default by the tenant. Conversely, landlords may wish to include an express provision that prohibits any transfer of property off the premises without the landlord's prior consent, which would not be available until and unless all amounts due and payable under lease are paid in full.

Perfecting the Interest

In order to perfect a security interest given pursuant to the UCC, a landlord must file a financing statement in the proper office. This may be the office of the secretary of state of the state in which the tenant entity is organized or incorporated, or in the case of individuals or entities not formally registered, the state of principal residence or office. To perfect a security interest in fixtures, a fixture filing must be recorded in the real property records of the county where the fixtures are located. Regular continuation statements must also be filed to maintain the priority of a perfected lien. Landlords should also be cognizant that in a tenant bankruptcy, a perfected landlord's lien under Article 9 will render the landlord in the same position as other secured creditors, and relief from the stay may be required prior to enforcement.

The mere perfection of the landlord's lien under Article 9 is not a guarantee that issues will not arise when the landlord seeks to foreclose. The tenant may have granted a lien in the collateral to a purchase-money lender or to secure other debt, or third parties may assert competing liens pursuant to statute or common law. Asset-based lenders often seek waivers from landlords, which customarily grant notice and cure rights to the lender and define procedures for possession and disposition of the collateral subject to the liens. Unfortunately, space limitations preclude an in-depth discussion of issues raised by landlord waivers and associated negotiating strategies, which are worthy of an article of their own.

Relevant Case Law

Relevant case law highlights issues that may arise in the course of creating and foreclosing on landlord's liens under the UCC.

In this context, the importance of including proceeds in the collateral description is illustrated in Perez v. The Bank of Nova Scotia. 1975 U.S. Dist. LEXIS 5584 (D.V.I. Sept. 30, 1975). In Perez, following a default by the tenant, the landlord seized certain of the tenant's inventory in which it had a perfected UCC security interest, and the property was subsequently sold pursuant to a sheriff's sale. Following the sale, a priority dispute arose between the landlord and the tenant's bank, which held a competing security interest in the same property (and importantly, the proceeds thereof) pursuant to a financing statement filed prior to the landlord's financing statement. The court held that the lender's lien had priority because it was perfected first in time, and that the inclusion of proceeds in the collateral description protected the lender's interest notwithstanding the sale of the property.

Ownership of collateral may also be of issue, and prior to taking a UCC security interest in a tenant's property, a landlord should identify the owner of the property and, if that party is not the tenant, the relationship the owner bears to the tenant. In Zurita v. SVH-1 Partners, Ltd., for example, the tenant was an individual, but the owner of the pledged equipment was an entity owned by the tenant. 2011 Tex. App. LEXIS 9670 (Tex. App. Dec. 8, 2011). After the tenant defaulted, the secured landlord seized the secured property and ultimately gained ownership of it through an auction process. The landlord then sued the tenant for the remaining rent deficiency. However, the entity countersued the landlord, claiming that the landlord had converted its property. Because the tenant was the sole owner of the company, the court held that he could legally grant a security interest in the property and denied the claim for conversion. An entity with multiple equity owners would likely have further clouded the issue however, highlighting the relevance of the beneficial owner of the collateral.

Jurisdictions may vary greatly in their common-law and statutory rules of enforcement. In Southwest Bank of St. Louis v. Poulokefalos, the plaintiff bank learned this lesson the hard way. 931 N.E.2d 285 (1st Dist. 2010). Under the common law of Illinois, a landlord may assert a common law lien on a tenant's property for non-payment of rent, if the lien is properly perfected. The landlord in Southwest properly perfected its lien on the tenant's personal property. The tenant's bank, however, filed its UCC financing statement in the tenant's state of incorporation but not the state in which the property was located. Because the landlord's perfected common law lien was perfected first in time, it had priority over the lender's lien. The bank's failure to perfect its lien properly cost it the security for its loan to the tenant in favor of the landlord's overdue and unpaid rent, which was perfected first.

Conclusion

Landlords seeking a UCC lien upon the personalty of their tenants should be mindful of these inherent drafting and procedural details, which, while simple in form, may be tricky in substance.