Legal insight and perspective from the Steinbergs Team
Published: April 29, 2024
Category: Real Estate
While the tenant does not own the subject property, the leasehold interest giving it the right to occupy the premises can be a valuable asset. As a result, tenants may be able to borrow by using their leasehold interests as security for the loan. Such agreements are typically registered on title (a topic of a recent blog post) and provide tenants with the ability to finance their renovations and operations. Such agreements, however, present several unique considerations not only for tenants and lenders, but landlords as well.
Ultimately, the lender’s objective in such an arrangement will be to minimize risk and protect its capital. As a result, for example, a lender may seek to protect itself by including the tenant’s assets, such as inventory or improvements made to the premises, as collateral for the loan. This may, however, conflict with the landlord’s claim should the tenant breach its lease. In such cases, the lender and landlord will both have claims against the tenant, and a lender will want to prevent its interests from being subordinated to those of the landlord.
Further, a lender will want to ensure that the lease does not terminate prior to the loan being repaid. As such, a lender will want the duration of the lease term to exceed the loan’s repayment schedule, and will further seek to limit the landlord’s ability to terminate the lease prematurely. Lenders will thus want to be able to cure any defaults by the tenant and preserve the existence of the lease.
Meanwhile, if the tenant defaults on the loan, the lender will likely seek to take over the premises and find a new tenant. A lease that limits the uses of the premises, or that otherwise limits the lender’s ability to find new tenants, will thus provide the lender with a less valuable asset. Other lease provisions that will affect whether a leasehold interest provides suitable security to a lender include those that: (i) specify the conditions under which the tenant is permitted to enter into financing agreements; (ii) set out the circumstances for renewing the lease, as a lender will presumably want the flexibility to maximize the length of the lease’s term; and (iii) limit the ability of the tenant to assign the lease to another party (lease assignment were the topic of an earlier post).
Ultimately, a lender’s objective will be to minimize risk and protect its capital. Meanwhile, a tenant will want to ensure that the provisions of the lease maximize the value of its leasehold interest. A landlord, on the other hand, will focus on protecting its interests in the event the tenant breaches the provisions of the lease.
As a result, issues regarding leasehold financing need to be carefully considered by all parties, not only when a tenant seeks financing, but when a commercial lease is first negotiated.
