Assets May Not Be Worth Enough To Settle Leases
By Chiree McGavin
When commercial tenants default, many lease agreements give the landlord the right to hold or liquidate tenant assets to cover the rents owed. With bankruptcy filings on the rise in Ohio, some commercial property owners will be forced to consider exercising that right more often, but the option is not always worthwhile.
Compared to the fiscal year ending June 30, 2000, this year's business bankruptcy filings increased by about 41 percent in Ohio's southern federal court district, according to data provided by the administrative office of the U.S. Courts.
For commercial property owners, a tenant's bankruptcy means default on the lease. In such cases, the lease agreement may address seizure of the tenant's personal property under a section titled Landlord's Lien, Security Interest, Removal of Property, or Landlord's Remedies for Default. Local commercial landlords and property managers say their lease agreements generally include such provisions.
Perfecting and enforcing such a lien is another matter, said Jeff McClelland, a private practice attorney who represents commercial and residential landlords.
"I don't find that's been very common, and I don't think it's very practical or workable in the real world," McClelland said.
Priority Creditors
One reason is that a bank or another third party may have a lien that takes priority over the landlord's.
"Chances are most of the stuff (the tenant) would be giving the landlord a lien on is already collateral for a loan he's taken out to start his business," McClelland said.
To perfect the lien, a landlord would need to file a Uniform Commercial Code filing statement, which establishes the priority of the lien holders.
"Very few landlords take the additional step of describing that property and making that filing at the secretary of state and the county recorder's office," said Jim Havens, an attorney practicing in commercial real estate with Havens Willis Law Firm LLC.
Another consideration is the market value of the property.
"Certain industrial assets, such as merchandise, equipment and machinery may be quite valuable and may be very helpful in covering landlord expenses," said Paul Krimm, assistant vice president in property management services for NAI Welsh Cos., which manages more than 5 million square feet of commercial space in the Columbus area.
On the other hand, Krimm said office equipment and furniture are virtually useless - especially when companies are downsizing and used furniture dealers may already have ample inventory.
During his 12 years in property management, Krimm said he has only once exercised a lien for a commercial landlord. In that case, Krimm said, the tenant in default was a retail operator in a mall's food court, and the seized restaurant equipment was marketed as part of the package when the space was relet.
Havens said personal property in warehouse, retail and industrial applications may be more valuable than the typical office assets.
"If you were concerned about the creditworthiness of a tenant, it might be worth doing, and it's certainly worth looking at," Havens said.
Cashing in on intellectual property
A lien on personal property could cover more than just the physical objects. If the lease includes a provision for intangible personal property, Havens said the term encompasses intellectual property.
"Intellectual property is becoming more and more of a valuable commodity," he said, noting that it could be sold to a competitor.
While some assets may help cover lost rents, Havens acknowledges that many landlords prefer to get the tenant evicted as quickly as possible and find a new, creditworthy tenant.
The process also causes delay, McClelland said exercising the lien places a good faith responsibility on the landlord to maximize the liquidation price - an obligation the landlord does not face during a typical eviction.
Brian Marsh, vice president at ProLogis, said he has not had to enforce lien provisions during the past six years in Columbus. Instead, he said, ProLogis, which owns 7.2 million square feet of commercial space in the Columbus area, tries to work with tenants to avoid the necessity of seizing personal property.
"Our focus is always to relet (the space) as quickly as possible to minimize our loss," Marsh said.
Although Ohio law does not establish a statutory landlord's lien, McClelland said case law does support self-help remedies. Under self-help remedies, the landlord may reenter the premises and remove the property - set it out on the sidewalk, for instance - in the event of default on a nonresidential lease. McClelland said there's just one catch: The removal can't cause a breach of the peace.
Whether a landlord opts to exercise any lien rights or to move on to the next tenant as quickly as possible, the simplest solution for the future is to choose creditworthy tenants. Krimm said defaults and tenant moveouts can be limited by properly investigating the financial status of a potential tenant before signing the lease.