The last REDD Post discussed some of the dangers of speeding through a commercial closing without reviewing key documents. Let’s switch gears this week and discuss the situation of the landlord who has done thorough due diligence, reviewed all of its tenants’ leases and is carefully managing the asset and the activities at the shopping center, office building or business park….
SITUATION: As Landlord, you have made absolutely sure that all leases have strict alteration/modification provisions that prohibit your lessees from making any more than small repairs to their premises without written approval AFTER advance written notice. In addition, your form lease has an absolute prohibition against a tenant, sublessee or assignee allowing a lien to be placed on the space for any reason. This provision also includes strict penalties if a claim of lien is filed including indemnification and automatic default.
Tenant Q (who has always been a model corporate citizen) provided proper notice of a request to upfit a portion of his premises and attached specific documentation about what, who, where and how the work is to be done. The contractor and subs appear to be solid folks who have a good reputation in the community. You approve the work and your property manager visits the premises regularly to check on the progress of the project. All appears fine, from the comments of the tenant and contractor and visual inspection of the work.
Three days later though, you receive a claim of lien from Subcontractor X (who was not on the list of companies who would be working on the project). Close examination reveals that Sub X has not only placed a lien for $25,000 on the premises, but has in fact liened the entire fee by using the legal description copied from the deed found on-line.
Trying to calm down, you contact Tenant Q and ask about the lien claim. Q has just received his copy of the same lien and is bewildered because they have paid the Contractor in full and on time as progress payments were received. A quick call to Sub X gets you nothing but a direct referral to the attorney who filed the lien. He is indignant and “offended” that you question what he has done for his client. He refuses to modify or remove the lien until sub X is paid the $25K plus all his attorneys and costs. As you are taking all of this in, your partner hands you your loan documents from Special Servicer Z (who bought the loan for a 40% discount). The documents state that any lien placed on the property is an automatic incurable default of your loan agreement.
What Do You Do Now?
No doubt the initial reaction of most landlords would be to seek recovery from Tenant Q and have the lien bonded off immediately or removed by receipt of full payment from Tenant Q to the contractor or subcontractor combined with a signed lien waiver. But what happens if the Tenant claims that some of the upfit is actually composed of fixtures that improve the value of the real estate?
SOME THOUGHTS ON SOLUTIONS:
1. If contacted by its lender, landlord should be proactive in letting them know the matter will be dealt with right away and keep a dialogue going on progress in that regard. Although the special servicer may be less likely than the original lender to be willing work through this matter to resolution without defaulting the landlord, the key is to keep the dialogue going while the lien is being removed.
2. If the sub refuses to amend or re-file their lien to remove the fee interest and insert only the “leasehold interest” (which in most states is all that contractors can lien if their agreement is with the tenant), landlord may need to consider an aggressive response, including asking a court of appropriate jurisdiction for injunctive relief ASAP. That will also help with the issue in #1 above.
3. Any lawsuit that is filed or even a discussion of claims and defenses will likely include Sub X claiming that Landlord has been unjustly enriched and therefore they are entitled to seek recovery from the owner. The question of whether the improvements are “fixtures” or “trade fixtures” could be a whole article/debate in itself. Perhaps a better way for a landlord to attack this claim is to show there was no agreement between it and the contractor or the sub; and thus there is not a reasonable expectation of payment by sub under the circumstances.
4. Cooperation by Tenant Q in this scenario is key. If there are problems between their contractor and the subs, the quicker they at least bond off the lien the better for all involved. The rub here may be that they don’t have the financial ability or desire to get into a contractor/subcontractor battle. That again may trigger the need for the landlord to act aggressively to begin the process of resolving the situation.