Kimberlee S. Knopf, Esquire

SBA lenders frequently extend loans to borrowers that do not own the real property where the borrower's business operates. Instead, such borrowers have or will have an interest in such real property through a lease. The Merriam Webster Dictionary defines a lease, in part, as "a contract by which one conveys real estate, equipment, or facilities for a specified term and for a specified rent."

The SBA requires its lenders to obtain an assignment of the borrower's lease, together with a landlord waiver, when a substantial portion of the loan proceeds are to be used for leasehold improvements, or a substantial portion of the collateral for an SBA loan consists of leasehold improvements, fixtures, machinery, or equipment that is attached to leased real estate. SOP 50 10 5 (E) p. 213.   When a loan funds the startup or renovation of a franchisee borrower's business, the franchisor will often also require an assignment of the franchisee's interest in the lease.

Technically, by leasing the property to the borrower the landlord conveys an interest in the real property that the borrower, as the owner of the leasehold estate, should be free to assign to an SBA lender and/or franchisor, correct? Yes -- and no. While ownership of the leasehold interest generally includes the right to assign it, most landlords contractually restrict any such assignment by including in the lease provisions that either prohibit assignment or require the landlord's prior written consent.     

As most SBA lenders are aware, franchisors typically approve the location of their franchisee's business and may be involved in the negotiation of the lease. Many franchise agreements require an assignment of the franchisee's lease to the franchisor as a condition to the franchise and the lease. Frequently, a franchisor obtains this lease assignment before an SBA lender has approved and documented its loan.

When a franchisor has already received an assignment of the borrower's lease, how does an SBA lender properly comply with the SOP? The SOP does not require the lender to achieve any particular priority with respect to the assignment of borrower's leasehold estate (in contrast, the lender must still obtain the required priority with respect to its collateral). As such, so long as the SBA lender has either obtained its own, albeit "subordinate," collateral assignment meeting the requirements of the SOP, or has documented other arrangements with the franchisor concerning these requirements, including access to the premises and the ability to liquidate the borrower's assets, then the lender should not run afoul of SBA requirements.

Of course, it is critical to properly document the respective rights of the SBA lender and the franchisor. It is recommended that the SBA lender and franchisor enter into an agreement in which (1) each of the lender and franchisor agree to promptly notify the other party in the event that it intends to exercise its rights and remedies under its respective documents; and (2) the franchisor agrees not to impede the lender's entry upon the leased premises (under either the landlord waiver and/or collateral assignment) to remove and/or dispose of the lender's collateral. Some franchisors may also agree to refer to the lender any potential replacement franchisee for the location. Such referral could result in new business for the lender and/or a potential buyer for the lender's collateral.

For more information, please contact Kim at (215) 542-7070 or at KKnopf@StarfieldSmith.com.

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