Lien Rights of Lenders and Landlords - Part I

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, while the tenant’s lender 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.  Part I will discuss the varied interests of the landlord and the tenant's lender in the tenant’s personal property are discussed in this article, and Part II will discuss suggested compromise solutions and a typical landlord waiver.  Note that the article that is the basis for this post first appeared in the December, 2012 issue of Commercial Leasing Law & Strategy. 

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.   In Virginia, the landlord must file a sworn petition with the court which demonstrates the justifications for the attachment of the levy as  set forth in the Code of Virginia, but the landlord 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.  

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. 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 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 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.

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.

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