Negotiate Lease Clause for UCC Liens
First-time commercial real estate tenants—especially small ones or those who don’t have a proven record of success—might face an uphill battle before they can succeed. Financing and leasing issues are the most problematic. Seasoned landlords are aware that taking on smaller tenants—many of which have limited or nonexistent financial track records—carries a substantial amount of risk. So you might encounter a landlord that will try to protect its interests by asking for the right to file a contractual lien against your property. This contractual lien, which is called a “UCC lien” because it’s subject to the Uniform Commercial Code, is in addition to the statutory lien that an owner has anyway. If you agree to give the owner this right when negotiating your lease, the owner can come after whatever property is defined as “collateral” if you fail to pay rent.
Here’s where the concept gets tricky and you can get burned: This contractual lien may jeopardize your ability to get future financing—or may violate the terms of an existing loan. To protect yourself, avoid using a standard lien provision. During lease negotiations, the tenant’s and owner’s interests and needs aren’t the only ones. The bank is also jockeying to protect itself. Generally, financing is essential to the ability of a business to operate, so you need to make sure that your lease doesn’t conflict with your existing loan documents, or effectively prevent you from obtaining financing in the future. For many tenants, this is a core issue—the tenant simply cannot sign a lease that would cause a default under current financing, or impair the ability to obtain future financing.
Typically, among a loan document’s covenants is the borrower’s pledge not to create any liens superior to the lender’s liens on the bank’s collateral. In some cases, it may even say that you agree not to create any liens (superior or subordinate) on the collateral. But if your loan documents contain such a covenant and you sign a lease that includes a UCC lien, you’ve violated the terms of your loan. If that’s brought to the attention of the bank (for example, when the owner records the UCC financing statement, it will become a public record that will show up whenever anyone does a lien search), the bank could claim that you’ve defaulted, and call your loan—that is, require you to pay off the entire amount in full immediately.
But a lease clause can save the day if it specifies certain things, such as that a UCC lien will be subordinate to a bank lien. Your clause should state that any UCC liens the owner files on your property will be subordinate to any secured creditor’s liens—whether the creditor is a bank or is any lender that has a “purchase money security interest.” Make it crystal clear that if there are any disputes between the loan documents and the lease, the loan documents prevail. Also, require the owner to sign a subordination agreement that satisfies your lender’s requirements. For four more specifications to include in your lease clause, and a Model Lease Clause you can adapt, see, “How to Amend Contractual Lien to Preserve Financing Opportunities,” available to subscribers here.