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Renting space for your business and planning to apply for an SBA loan? It’d be a good idea to familiarize yourself with the notion of a Landlord Subordination Agreement. These agreements are common requirements of SBA loan applications, but getting one signed by your landlord might prove challenging. It could delay or even completely stall your loan approval if your landlord refuses to sign.
Understanding the basics of a landlord subordination agreement will help you explain it better, and might improve the chances of getting the lessor’s signature.
According to Starfield & Smith, P.C., “If a Landlord’s Waiver is required, it must include provisions whereby the landlord agrees to subordinate to the lender its interest in the subject collateral located on the leased property; notify the lender of the borrower’s default; and permit the lender to enter onto the leased property and to remove and dispose of the collateral.”
In plain English: the landlord is “subordinating” their rights to your collateral in case you default. In other words, the lender gets first dibs. However, your landlord isn’t waiving his rights entirely.
This benefits the lender because they can use your property as collateral without worrying about landlord interference… But it doesn’t appear to be in the best interest of the landlord, which is why many don’t want to sign it.
Signing this document means a landlord agrees to give a lender access to the property, and priority to taking collateral in the event of default. This means that if you stop paying your lender, they have the right to collateral in your rented or leased premises—ahead of the landlord.
Landlord Subordination Agreements or Landlord Waivers can be a real thorn in the side of small business owners trying to qualify for SBA loans. Landlords might be reluctant to sign one of these agreements because they don’t want to lose their potential claim on collateral in the event that you default on your lease.
Small business owners trying to move through a loan application that requires a Landlord Subordination Agreement might find that the process takes longer than expected if their landlord refuses to sign. In these cases, your bank could apply to the SBA or to their own commercial underwriting departments in order to waive the requirements for a signed Landlord Subordination Agreement, but that adds further delays to obtaining financing. And ultimately, the loan might be refused outright without the signed Landlord Subordination Agreement.
While Landlord Subordination Agreements may seem shorter and simpler than many of the legal documents you’ll come across when pursuing funding, pay particular attention to these three key sections that must be included in Landlord Subordination Agreements used for SBA loans.
Pay close attention to the subsection titled “Subordinate to Lender Lessor’s Interest.” These sentences set out exactly what your landlord is agreeing to in terms of giving up their position to your lender. Point out that subordination is not waiving their rights, but simply agreeing that your lender has priority to your property in the event of a default.
In signing the Landlord Subordination Agreement, your landlord agrees to provide written notice to your lender if you default on your payment. In addition, they agree to give the lender the opportunity to “cure” the default, or take care of making your delinquent payments—a benefit to your landlord, actually, since it gives them the chance to get their rent payments after all.
Note that inclusion of the opportunity to “cure” the default is not always included in the lender’s Landlord Subordination.
The third key element of a Landlord Subordination Agreement is letting the lender enter the premises of your business. They can then proceed to remove any property used as collateral for your loan to begin liquidating it in order to try to recover some of their losses.
Lenders use Landlord Subordination Agreement for a variety of loans, including situations where the purpose of the loan is to make leasehold improvements so the borrower may carry on business in the leased premises. They’re also commonly requested when the lender offers SBA loans using the borrower’s personal property as collateral for the loan.
Try to encourage your landlord to sign the Landlord Subordination Agreement by reminding them that you need this financing to expand your business, which will improve your cash flow and keep you paying rent to the landlord for the remainder of your lease agreement. Also, you’ll bring foot traffic to other businesses in the area—possibly their other tenants. Reassure them that this agreement isn’t a requirement because you have a poor credit score or bad credit history. Rather, it’s standard practice of many small business lending agreements. Most importantly, make sure they understand they aren’t waiving their claim to your collateral. They’re just getting in line behind your lender.