Banks and Landlords: Competing Lien Interests

The Landlord's Lien

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 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 obtain the amount of unpaid rent and other liability.

Second, in about half of the states, landlords have been given statutory landlords' 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 commonlaw 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. The statutory landlord's lien, if available, provides additional security for the landlord, but taking advantage of it is 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 (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, which 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.

With this third type of lien, after a tenant default, the landlord may foreclose on the property pursuant to the procedures set forth in the UCC, without requirement of 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 because 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. This 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.

The tenant should verify that a UCC security interest does not violate the terms of its financing agreements. Note also that UCC financing statements are only valid for five years.

The Landlord Waiver Agreement in Favor of the 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, 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. For some lenders, obtaining the waiver is an absolute requirement of moving forward with the loan, such as with loans obtained in connection with the Small Business Administration (SBA). Even so, landlords may push back at a request to a waiver, but will often agree to at least subordinate their lien rights to that of the lender's security interest. 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, so 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.

The form of the landlord waiver or subordination usually is a bank document prepared by the lender's counsel; therefore, the landlord should give close scrutiny to such forms, as they often grant lenders favorable rights with regard to the leased premises ' and place burdensome obligations on the landlord.

Tenants are not typically key parties in the negotiation of landlord waivers, as their main role is to serve as referee between their landlord and lender. However, the sophisticated tenant would be wise to include its lender's required waiver form as an exhibit to its lease agreement, to save time and expense later. Note that the landlord often tries to pass on the legal fees incurred in negotiation of the landlord waiver onto the tenant.

Suggestions for Landlords

Since most landlord waiver/subordination documents start out as one-sided bank forms, the landlord with leverage should look into the following suggested changes.

First, the landlord should try to subordinate its landlord's lien instead of granting 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. The waiver or subordination should be limited to only the landlord's statutory or common law lien rights, and consensual liens such as UCC security interests if applicable; but not to all liens, such as judgment liens. The waiver should not act to terminate the tenant's continued liability under the lease.

Second, the landlord should try to retain control over the process of the lender's removal of 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 should also be asked to indemnify the 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. Lenders often push-back on a blanket indemnification, but will typically agree to repair any damage caused by the removal of the personal property.

Third, the parties need to make clear which 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 make an “end run” around those provisions by including the lease itself as part of the collateral package, consented to by the landlord in the waiver/subordination document. The landlord should try to exclude certain cash accounts from the definition of collateral.

Fourth, the lender will want notice of the 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 which 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. Many lenders will instead accept notices only prior to or in connection with a lease termination.

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 that would otherwise be payable as rent under the lease during such period of occupancy. It is important to define the starting and expiration points to any obligation on the lender's part to pay rent.

Sixth, the lender should agree not to interfere with the landlord's efforts to lease the premises to a replacement tenant, and should keep the premises available for reasonable inspection by the landlord.

Seventh, the lender should be requested to refrain from holding public liquidation sales at the premises without the landlord's prior consent, and then only subject to the landlord's reasonable conditions.

Last, the waiver or subordination document should clearly provide that the agreement terminates, at least with respect to the landlord's obligations under such an agreement, upon the tenant's full repayment and satisfaction of its loan with the lender.

Conclusion

There are different kinds of lien rights available to landlords in the personal property of their tenants, depending on the terms of their lease agreements and applicable state law. Landlords should be very familiar with the lien laws of their respective states and draft the terms of their leases accordingly. The lenders for the tenants will object to 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 the landlord's lien agreement, which, to save time and money, should be attached to the lease as a pre-approved form.

John G. Kelly, a member of this newsletter's Board of Editors, is a shareholder of Arlington, VA-based law firm Bean, Kinney & Korman, P.C. He focuses his practice on all aspects of real property law and finance, representing many national retail tenants and local office landlords. Reach him at [email protected].

'

SPECIAL OFFER: Twitter, LinkedIn, Facebook and Google+ followers can get an online subscription to Commercial Leasing Law & Strategy for only $299. Click here, select Digital Only and use promo code CLOL299 at checkout. This offer is valid for new subscribers only.

'