How to Draft Owner-Friendly Lien Subordination Agreement

Tenants often seek financing to help them run their businesses, so you have probably gotten numerous requests from tenants for a “landlord’s lien waiver.” Without the lien waiver, a tenant’s lender may refuse to go through with the loan, or an equipment lessor may refuse to lease expensive equipment to the tenant. A lien waiver typically states that you agree to waive a valuable right—that is, the right to take possession of the tenant’s personal property if it doesn’t pay its rent. If you agree to a lien waiver and the tenant defaults on its loan or under its equipment lease, the lender or equipment lessor can take over the tenant’s personal property without fear that you’ll stop it from doing so or that you’ll claim that you have superior rights to that property.

Typically, a tenant will give you its lender’s or equipment lessor’s form of lien waiver to sign. But you should reject that form because it will probably give you few, if any, protections and could take away important rights that you’ll want to keep. Consider the following strategy instead.

Prepare Your Own Form if Tenant Requests Lien Waiver

If you agree to sign a lien waiver (or your lease requires that you do so), it’s better to prepare your own form so that you can protect your interests. Consider the following checklist of 15 protections, which are included in our Model Agreement: Get Key Protections if Tenant Requests Landlord’s Lien Waiver, that you can adapt for your lien subordination agreement. (Note that many of these protections will be missing from a lender’s or equipment lessor’s form of lien waiver.)

Don’t waive your lien; subordinate it. Don’t agree to waive your lien on the tenant’s personal property. Instead, agree only that you’ll “subordinate”—that is, make secondary—your lien to that of the tenant’s lender or equipment lessor [Agr., par. 1]. This way, you’ll still have the right to go after the tenant’s personal property if it doesn’t pay its rent. You’ll just have to wait in line behind the tenant’s lender or equipment lessor.

Define ‘personal property’ narrowly. Define the tenant’s “personal property” within narrow limits. That is, have the term cover only easily removed personal property (or, in the case of an equipment lessor, the leased equipment)—not fixtures or improvements affixed to the space [Agr., intro.]. Otherwise, if the tenant defaults under its loan agreement, the tenant’s lender or equipment lessor could end up ripping out those fixtures, causing severe damage to the space.

Don’t waive or subordinate your enforcement rights. Don’t waive or subordinate your legal right to enforce a judgment against the tenant [Agr., par. 1]. For instance, if you sue the tenant and win, you should have primary access to the tenant’s personal property if it doesn’t pay you the awarded damages.

Give lender limited access to tenant’s space to remove personal property. If the tenant defaults on its loan agreement or equipment lease, you wouldn’t want the lender or equipment lessor entering the tenant’s space after business hours, unannounced and unsupervised. Give the lender or equipment lessor the right to enter the tenant’s space, but only if:

• The entry occurs during business hours;
• The lender or equipment lessor gives you advance written notice; and
• The lender or equipment lessor is accompanied by one of your representatives [Agr., par. 2].

Make lender responsible for repairing damage. If the lender or equipment lessor damages the tenant’s space while removing the personal property, make it responsible for repairing the damage. You shouldn’t have to pay for those repairs. If the lender or equipment lessor doesn’t make the repairs, do them yourself, at its expense [Agr., par. 2].

Condition subordination on personal property’s proper placement. Agree to subordinate your lien only if the tenant places its personal property in the space in a manner that won’t cause any structural or other damage to the space and the building or center [Agr., par. 3]. That should help reduce the risk that the lender or equipment lessor will damage the tenant’s space during the property removal process.

Require lender to indemnify you. Require the lender or equipment lessor to indemnify you against any claims arising directly or indirectly from the removal of the tenant’s personal property from the space [Agr., par. 4]. That way, the lender or equipment lessor will defend and reimburse you if, for example, a third party is injured during the property removal process and sues you for damages.

Require financing statements’ termination at lease end. When the lease ends, have the lender or equipment lessor terminate the financing documents it recorded to notify third parties of its lien on the tenant’s property [Agr., par. 5].

Don’t let lender record lien subordination agreement. Don’t let the lender or equipment lessor publicly record the lien subordination agreement [Agr., par. 5]. Once an agreement is recorded, third parties can find out that you’ve subordinated your lien, and that could cause you problems if you later apply for a loan. Worse yet, when the lease or the tenant’s loan ends, the tenant’s lender may drag its feet in removing the lien subordination agreement from the public record.

Make lender pay if personal property isn’t removed by lease end. If the tenant defaults on its loan, you’ll want the lender or equipment lessor to remove the tenant’s personal property before the lease ends. If it doesn’t finish removing that property in time, make it pay a “use and occupancy” fee. The fee should be equal to the amount of holdover rent then due [Agr., par. 6].

Make tenant responsible for holdover rent, despite lender fee. Even if the lender or equipment lessor ends up paying a fee for not removing the personal property before the lease ends, keep the tenant on the hook for holdover rent, too [Agr., par. 7].

Get right to keep, discard, or store remaining property. You don’t want the tenant’s personal property remaining in the space after its lease ends because you may have a new tenant waiting to move into the space. So, if the lender or equipment lessor hasn’t removed the tenant’s personal property within, for example, five days after the lease ends, have the lender or equipment lessor agree that you may: (1) deem the property abandoned and keep it without paying for it; (2) throw out the remaining property at the lender’s or equipment lessor’s cost; or (3) store the remaining property at the lender’s or equipment lessor’s sole risk and cost [Agr., par. 8].

Make tenant pay for lien subordination agreement. Require the tenant to pay your attorney’s fees for drafting and negotiating the lien subordination agreement [Agr., par. 9]. You’re doing the tenant a favor by subordinating your lien so that it can get financing. You shouldn’t also have to foot the bill for the agreement.

Get tenant and lender to sign lien subordination agreement. Because the lien subordination agreement sets out certain requirements for the tenant and the lender or equipment lessor, you’ll want both of them to sign the agreement [Agr., signature page]. Without their signatures, they’re not obligated to carry out those requirements.

Get guarantor to confirm its obligations. You don’t want the tenant’s guarantor claiming that by subordinating your lien on the tenant’s personal property, you’re also reducing the guarantor’s liability to you under the guaranty. Instead, require the guarantor to confirm that its obligations under the guaranty will continue and that the lien subordination agreement won’t limit or end your protections under the guaranty. Then have the guarantor sign the lien subordination agreement [Agr., end].

Practical Pointer: Attach a form of the lien subordination agreement to your lease, as an exhibit. This way, the tenant will know that it has to use your form if it needs a lien waiver.

Come Up with Compromise If Lender Balks

In some instances, institutional lenders may balk strenuously at using a landlord’s form of lien subordination agreement. If the institutional lender threatens to refuse extending a loan to the tenant unless you first sign the lender’s form of lien subordination agreement, you have two obvious options:

• Agree to the lender’s demands, which disadvantages you in many ways, but helps the tenant obtain the loan and strengthens the tenant’s financial ability to pay the rent on time; or
• Resist the lender’s demands, which preserves your existing rights, but prevents the tenant from obtaining the loan and weakens its financial ability to pay the rent on time.

There is, however, a third alternative that benefits all parties—the lender, the tenant, and you. You could agree to sign the lender’s form of lien subordination agreement in exchange for the tenant’s agreement to substantially increase its security deposit by, say, three months’ rent. This compromise satisfies the lender, helps the tenant obtain the loan, and gives you substitute security to replace the security that you lost by subordinating your lien.