Many small businesses that seek financing under the SBA 7(a) Loan Program operate from buildings that are leased from a third-party landlord, which can take the form of stand-alone buildings, shopping centers or commercial office parks. These loans are generally underwritten on a cash-flow basis and the primary (or oftentimes the only) collateral is the tangible, business personal property (e.g., equipment, furniture, and inventory) of the borrower located at the leased property.
Whenever a SBA loan includes the borrower’s tangible personal property as collateral, the SBA requires lenders to obtain a lien subordination agreement prior to closing from landlords and sub-landlords, as applicable, giving the lender, at a minimum, in addition to lien subordination provisions: (i) notice of the borrower’s default under the lease, (ii) an opportunity to cure the default, and (iii) access to the leased premises in order to remove collateral. Further, “[w]hen a substantial portion of the loan proceeds are to be used for leasehold improvements or [ii] a substantial portion of the collateral consists of leasehold improvements, fixtures, machinery, or equipment that is attached to leased real estate,” the SBA also requires lenders to obtain a collateral assignment of the lease.
Ideally, lenders should provide the borrower and landlord with a copy of the lender’s form landlord subordination agreement early on in the closing process to provide adequate time for negotiations prior to closing. Commonly negotiated provisions include (i) notice, (ii) time of lender’s possession, (iii) payment of rent, and (iv) assignment of lease.
Most SBA landlord subordination forms require landlord to provide notice to the lender of the borrower’s default under the lease. This notice is important as borrowers often default under the lease prior to defaulting under the subject SBA loan. While the lender’s loan documents may provide that a lease default constitutes a default under the loan, that does not protect the lender if it does not know of the lease default. As such, the landlord subordination agreement should provide that the landlord may not terminate the lease or remove, sell or otherwise dispose of the borrower’s personal property without first providing the lender notice of the borrower’s default and an opportunity to cure or exercise lender’s rights under the landlord subordination agreement.
Time of Possession
Another frequently negotiated section of any landlord subordination agreement is lender’s right to access and occupy the premises in order to inspect and/or remove collateral. Lenders generally request 60-90 days to enter and remove the collateral but, in some cases, landlords want the property removed in as little as five days. Lenders should carefully consider the minimum amount of time needed based on the location of the property and type of property to be removed.
While a lender is occupying the property, it is usually requested that the lender pay rent to the landlord. However, it is important for lenders to review the language used by the landlord in reference to the amount of rent owed. In some instances, landlords will request that the lender pay rent due and owing under the lease, which appears reasonable on its face. However, a review of the lease may reveal various types and amount of rent. Additionally, lenders should ensure that they are only obligated to pay rent for the time that the lender is actually in possession of the premises. The lender should ensure it is agreeable to what rent is being paid and limit, if necessary.
Collateral Assignment of Lease
A collateral assignment of lease provision allows the lender to collaterally assign the lease over to a new borrower who is willing to assume the loan and business operation of an original borrower. Landlords are generally hesitant to agree to allow the lender to choose a new tenant. A landlord may be agreeable to allowing an assignment with the landlord’s prior written approval, which approval is generally subject to a review of the creditworthiness of the new tenant. Ultimately, the collateral assignment means that the lender is assisting the landlord with finding a new tenant to rent the property, which is to the benefit of both the landlord and the lender, assuming that the new tenant also assumes part or all of the loan.
Although landlord subordination agreements are generally one to two pages documents, these documents can be challenging to finalize and often result in lengthy negotiations. It is important that lenders are familiar with the terms of the landlord subordination agreement and understand both the lender’s internal policies and SBA requirements when negotiating with landlords.
For more information on negotiating landlord waivers, please contact the attorneys at Starfield & Smith, P.C. at 215.542.7070 or email us at firstname.lastname@example.org.