Banks that provide financing for commercial tenants and the real estate landlords for those same tenants both want additional security in the tenant’s personal property located at the premises. The interests of the landlord and the lender are in conflict. 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 certain retail, restaurant or industrial tenants . At the same time, the tenant’s lender providing tenant improvement and/or working capital financing desires a security interest in the same property. A landlord’s lien may be created, depending on the state, under statutory lien rights, the common law, or by contract under the terms of the lease, and gives the landlord the right to levy the property located at the demised premises of a defaulting tenant.
The typical smaller retail or office tenant does not heavily resist their lender’s request for a security interest in its personal property or resist the landlord’s request for a landlord lien, but instead attempts to facilitate the competing interests of both the landlord and the lender at the time of lease negotiation. However, some national retailers with stronger credit may have the leverage to obtain a waiver or subordination of their landlord’s lien rights. The varied interests of the landlord and the tenant’s lender in the tenant’s personal property are discussed in this article, along with suggested compromise solutions.
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 reimburse the landlord for the amount of unpaid rent and other liability.
Second, in about half of the states, 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. The statutory landlord’s lien, if available, provides additional security for the landlord, but it is also a cumbersome progress 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, 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. 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, and 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.
This article first appeared in Commercial Leasing Law & Strategy , and is republished with their permission. John serves a contributor and a member of their Board of Editors.