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February 3, 2016

Best Practices: Landlord Waivers for Leasehold Improvement Loans

by Janet M. Dery

According to Chapter 5, Section V of SOP 50 10 5(H), when substantial loan proceeds from a U.S. Small Business Administration guaranteed loan are to be used for leasehold improvements or a substantial portion of the collateral of an SBA loan consists of leasehold improvements, fixtures, or equipment that will become affixed to real property, the SBA requires a lender to obtain a collateral assignment of lease and a landlord waiver.

A collateral assignment of lease is required to allow the lender to have the ability to find another person or entity who may be willing to assume the loan and the lease for the rest of their respective terms. Since a lender cannot reasonably remove the leasehold improvements it has financed after a default under the loan, this assignment is the best way to realize on the value of the improvements in a liquidation scenario.

On the surface, it sounds like a simple document to obtain. A lender would have the borrower assign its interest in the lease to the lender in an assignment document executed at closing. Unfortunately, the borrower, if it were to take such an action could trigger a default under the terms of its lease. Most leases contain provisions which prevent the tenant from assigning its interest in the lease without the landlord’s prior written consent. Therefore, if borrower does not obtain landlord’s written permission to assign the lease to the lender prior to the execution of the loan documents, the landlord could consider the borrower’s assignment to be a default under the lease.

Additionally, the SBA requires that the landlord provide a 60 day written notice of default to the lender with the option to cure such default. A borrower could not make such a promise for the landlord, so the landlord must consent to provide such notice, on top of consenting to the assignment.

An effective way for the lender to address these needed consents from the landlord is in the landlord waiver form it otherwise provides to the landlord for consideration. Since landlord waivers are required whenever SBA loans are secured with business personal property which is located at a leased location, most lenders have forms that they consistently use which contain the following items required by the SBA. First, the landlord must subordinate or waive its interest in the lender’s collateral. Second, the landlord must notify the lender if there has been a default under the lease by the borrower. Third, the landlord should provide the lender with a reasonable opportunity to cure any default by the borrower. Finally, the landlord must provide the lender with access to the premises to allow the lender to liquidate the collateral. If the notification requirement of the form is revised to require a 60 day notice period, and language whereby the landlord consents to the collateral assignment of the lease to the lender by borrower is added, then the form would be suitable for submission to landlords where leasehold improvements are being financed.

If the leasehold interest of the borrower is a ground lease, the SBA has additional requirements that must be in the ground lease. These requirements include: (i) tenant’s right to encumber the leasehold interest; (ii) no modification or cancellation of the lease without lender’s approval; (iii) lender’s right to: (a) acquire the lease at a foreclosure sale or by assignment and right to reassign the leasehold interest (landlord may not unreasonably withhold consent to reassignment), (b) sublease, (c) hazard insurance proceeds from damage to improvements, and (d) a share in any condemnation proceeds; and (iv) lender’s rights upon default or termination of the lease. If these provisions are not in the lease, then a lender should obtain an amendment to the lease at the time it submits its landlord waiver to the landlord.

As discussed above, the landlord waiver can be a very effective tool for meeting all the SBA’s requirements when substantial leasehold improvements are being financed or are a substantial portion of the collateral. Therefore, a lender should endeavor to include such needed items in its landlord waiver form before providing the form to the borrower and/or landlord. For more information on landlord waivers when loan proceeds will fund leasehold improvements or be substantially secured by improvements and fixtures, contact Janet at jdery@starfieldsmith.com.