Best Practices: Landlord’s Agreements – Waiver or Subordination?

A large number of business owners who seek financing under the SBA 7(a) Loan Program operate from leased locations, be it stand-alone buildings, shopping centers or commercial office parks. In these transactions, underwritten on a cash-flow basis, the collateral typically consists of tangible, business personal property located on leased premises such as equipment, furniture, trade fixtures[1] and inventory. In order to facilitate the liquidation of collateral in these type of loans, the SBA requires lenders to obtain an agreement from landlords, and sub-landlords, giving the lender access to the leased premises. But, should this agreement for access provide for a waiver or a subordination of the landlord’s interest in the collateral? The answer is not clear.

Waiver v. Subordination

Part of the challenge comes from the terminology used by the SBA and the use of the terms “waiver” and “subordination” interchangeably. For example, for 7(a) loans, the SOP defines a Landlord Waiver as one where the landlord “gives the Lender access to the leased premises and facilitates the liquidation of the collateral on the borrower’s premises[.]” SOP 50 10 5 (J), with technical corrections, page 193. No further guidance is provided. On the other hand, the Landlord Waiver provision in the National 7(a) Authorization Boilerplate states:

“Lender must obtain a written agreement from all Lessors (including sublessors) agreeing to: (1) Subordinate to Lender the Lessor’s interest, if any, in this property; (2) Provide Lender written notice of default and reasonable opportunity to cure the default; and (3) Allow Lender the right to take possession and dispose of or remove the collateral.” National 7(a) Authorization Boilerplate, Appendix A (emphasis added).

Conversely, for loans under the 504 program, the SOP provides specifically:

“The Landlord’s Waiver must: a) Waive the lessor’s right to the collateral; b) Provide for written notice of default and a reasonable opportunity to cure; and c) Grant the CDC reasonable access to the leased premises to facilitate the liquidation of the collateral.” SOP 50 10 5 (J), with technical corrections, page 331(emphasis added).

Different from a “subordination,” a “waiver” is a complete relinquishment and abandonment of a claim or right. On the contrary, subordination consists of the acknowledgement by one party that its interest or claim is inferior to that of another party. Black’s Law Dictionary. This is not a distinction without a difference and it can have tremendous implications when negotiating the terms of the agreement with a landlord. For instance, while a landlord may be willing to subordinate its rights to a specific lender, it may be unwilling to relinquish all of its rights to the collateral. By agreeing to subordinate its lien to a particular lender, the landlord’s lien remains intact and it would continue to be a secured creditor in the event of a bankruptcy, with a superior lien position vis a vis unsecured creditors. A waiver, in contrast, can cause the landlord to become not only an unsecured creditor; it may have further implications for the landlord as a judgment creditor with limited ability to enforce a judgment, including, for instance, the inability to attach bank accounts even with a judgment. Sophisticated landlords are hard-pressed to agree to such sweeping waivers.

Negotiations with landlords can become protracted and obtaining an equitable, balanced agreement can be challenging due to the parties’ competing interests. The current SOP is somewhat inconsistent in its use of the terms waiver and subordination for 7(a) and 504 loans. Although the language suggested in the National Boilerplate fails to clarify the ambiguity, Lenders should adhere to the terms set forth in the SBA Loan Authorization and obtain, at a minimum, a subordination of the landlord’s interest in Lender’s collateral. For more information on landlord waiver and subordination issues, please contact Victor at 407.667.8111 or at vdiaz@starfieldsmith.com.