By Devin Lawton Palmer, Esq., Partner, Boylan Code LLP
The rights of a secured creditor to secure and dispose of its collateral is fairly well established under New York’s Uniform Commercial Code (the “UCC”). Section 9-609 of the UCC allows a secured creditor to take possession and dispose of its collateral on the debtor’s premises after default. “The secured party’s right to possession of the collateral upon default may be asserted against a third party in possession, which may not properly refuse upon the secured party’s request for delivery.” Bank of India v. Weg and Myers, P.C., 257 A.D.2d 183 (1st Dept. 1999). The failure of either the debtor or the third-party landlord to release a secured creditor’s collateral can constitute a conversion of the property, allowing for an award of damages. See e.g., Bank of India, supra (holding “to establish a conversion claim it need only be shown that a plaintiff had…an immediate superior right of possession to the identifiable fund and the exercise by defendants of unauthorized dominion over the money in question to the exclusion of plaintiff’s rights”).
Similarly, a landlord’s right to remove a tenant’s personal property has been addressed at length in New York case law. See Bergh v. Herring-Hall-Marvin Safe Co., 136 F. 368 (2nd Cir. 1902) (“a dispossessed tenant is entitled to a reasonable time in which to remove his chattels”); Surks v. Kenmare Storage & Moving Co., 38 A.D.2d 944, (2nd Dep’t 1972) (“it is the duty of the landlord to notify the tenant to remove them, and in case he does not, to himself cause their removal”); Reich v. Cochran, 114 A.D. 141 (1st Dept. 1906) (“the doctrine of abandonment applies only to fixtures. As to ordinary chattels left upon the premises on removal or after eviction, it is the duty of the landlord to notify the tenant to remove them, and in case he does not, to himself cause their removal”).
Little guidance, however, appears to be offered regarding the differing goals of a secured creditor and landlord when wed by a defaulting borrower/tenant. The landlord obviously has a pressing interest to quickly empty and re-rent the commercial space. In contrast, the secured creditor must dispose of the collateral in a commercially reasonable manner under UCC § 9-610, which when dealing with heavy equipment may require holding the collateral on the landlord’s premises for a period of time. In many instances it is in the best interest of both parties to cooperate in this collective endeavor. A subsequent tenant may desire to operate a similar business with the secured creditor’s equipment in place. Moreover, a landlord would rather have the secured creditor bear the cost of removing heavy equipment that is unnecessary for reletting the premises.
Overriding questions remain, however, in instances where cooperation is impractical. Does the landlord have a statutory, common law, or contractual right to rent payments from the secured creditor while the lender negotiates the sale of the equipment? Can the landlord attempt to collect back rent owed by the tenant from the secured creditor? How does the landlord protect itself from potential damage resulting in the removal of the equipment?
Section 9-604 of the UCC, entitled Procedure if Security Agreement Covers Real Property, Fixtures , or Cooperative Interests, seems the logical starting point for the discussion. Specifically UCC § 9-604, reads:
(c) Removal of fixtures. Subject to the other provisions of this part, if a secured party holding a security interest in fixtures has priority over all owners and encumbrances of the real property, the secured party, after default, may remove the collateral from the real property.
(d) Injury caused by removal. A secured party that removes collateral shall promptly reimburse any encumbrancer or owner of the real property, other than the debtor, for the cost of repair of any physical injury caused by the removal. The secured party need not reimburse the encumbrancer or owner for any diminution in value of the real property caused by the absence of the goods removed or by any necessity of replacing them. A person entitled to reimbursement may refuse permission to remove until the secured party gives adequate assurance for the performance of the obligation to reimburse.
While the title of section 9-604 is specific to fixtures, courts appear to have broadly interpret subsection (d). For example, citing N.Y.U.C.C. § 9-313(8) the court in Berger v. Alexopoulus, held that “when a debtor has defaulted on an obligation for which fixtures or goods, located on real property owned by a third-party, have been given as collateral, the secured party may remove the collateral from the property.” 280 A.D.2d 505 (2nd Dept. 2001) (emphasis added). See also, Cla-Mil East Holding Corp. v. Medallion Funding Corp., 6 N.Y.3d 375 (2006) (applying section 9-604(d) to a secured creditor’s removal of Laundromat equipment from the landlord’s premises).
In the pointed case of Leban Store Fixture Co., Inc. v. August Properties, the collateral in question was “certain equipment and other personal property” that remained on the landlord’s commercial property. 117 A.D.2d 782 (2nd Dept. 1986). As a prerequisite to its removal and disposition, the landlord requested the secured lender: (1) pay all rent arrears owing on the tenant’s underlying lease; (2) provide confirmation of workers compensation, property damage and personal injury insurance; and (3) provide a cash bond as security for removal of the equipment. Absent the foregoing, the landlord refused the release of the collateral. The Leban Court found the landlord could not require anything more than what was allowed under UCC § 9-313(8) as a prerequisite for the lender’s removal of the equipment. 117 A.D.2d 782. It held that “although the owner of the real estate is granted the right to reimbursement for the costs of removal and proof of the secured party’s interest in the collateral where, as here, the default is committed by a lessee, a landlord is not entitled to refuse permission to remove the collateral if the secured party complies with the requirements of UCC 9-313(8).” Thus, a requested bond covering potential damage from the collateral’s removal was allowed under section 9-604. However, the landlord’s additional conditions, including the payment of back rent constituted an “unreasonable interference” with the secured creditor’s right to possession. As such, the Court found the landlord liable for conversion. Leban Store Fixture Co., Inc., 117 A.D.2d 782. See also, Bozzuto v. Vinci, 205 A.D.2d 570 (2d Dept. 1994) (holding the landlord liable for conversion of the secured creditor’s collateral when it moved the inventory to the basement and refused to release it to the creditor).
The decision in Leban is in accordance with the common law rules of contract. The landlord’s lease agreement is with the tenant, not the secured creditor. While it may be able to argue damages against the tenant as a holdover for the months the pledged equipment remains on site , it has no contractual relationship with the secured creditor and thus no right to contractual damages.
It should also be noted that New York does not include a statutory landlord lien on fixtures. Thus, a landlord’s claim of a priority right to the secured lender’s collaterized equipment must flow from the lease terms and a prior, perfected UCC-filing .
In Berger v. Alexopoulus, the landlord did not require that the secured creditor post a bond, but instead demanded that the creditor pay future rent and obtain liability insurance as a condition for the removal of collateral. 280 A.D.2d 505 (2nd Dept. 2001). The Court found these demands too were “in contravention of the requirements of the Uniform Commercial Code [9-313(8)].” Id. As a result, the Court in Berger similarly held the landlord liable for conversion of the secured lender’s equipment.
These cases, however, do not deal directly with a landlord who seeks rent or storage costs, but does not make their payment a condition of the equipment’s release to the secured creditor (i.e., “you can have your equipment, but I still want to be paid for storing your collateral these past months”). Without a legal right to withhold the creditor’s equipment, this threat appears hollow and of little consequence to the lender. The landlord’s only recourse would be to file a time-consuming and costly civil suit for its storage costs under an equitable argument of a constructive lease/agreement or unjust enrichment (assuming the lender never actually signs a written agreement as to these storage costs).
The landlord in the non-binding Massachusetts decision of First Republic Corp. of America v. Baybank, did just that; seeking damages for unjust enrichment in the amount of monthly rent payments flowing from a secured creditor’s delay in liquidating its collateral. 677 N.E.2d 1146 (Sup. Ct. Mass. 1997). The Court found the deciding factor was whether the creditor took actual possession of the collateral (first finding that the UCC imposes no duty on a creditor to take possession of the collateral used to secure the loan). While the secured creditor inspected the equipment and negotiated its sale, it never actually took possession of the equipment. See also, McDonald v. Rockland Trust Co., 798 N.E.2d 323 (Appeals Ct. Mass. 2003) (noting an event of default does not automatically transfer possession of collateral to the secured creditor for purposes of § 9-609, and a creditor can only be held liable for storage/occupancy charges if it takes actual possession of the collateral); compare with, Elliot v. Villa Park Trust & Sav. Bank., 380 N.E.2d 507 (1978) (finding actual possession where the creditor removed parts of the collateral to a safer location on the same premises and intentionally left it there to be cared for by the landlord). The Banbank court dismissed the landlord’s complaint, holding in conclusion:
Effective public policy supports our decision. The risk of a tenant’s default should be borne by the landlord, not a creditor bank. If our decision today made the use of heavy machinery and equipment impractical as collateral, then companies such as Watham Clock (the eventual purchaser of the equipment) might be unable to raise capital from financial institutions because of a lack of commercially attractive mobile collateral.
677 N.E. 2d 1146.
Therefore, in instances where the landlord does not condition the release of the collateral on the payment of rent/storage, it must still prove the lender took actual possession of the collateral to state a colorable claim for relief.
These cases/statutes do not however, require a landlord to hold a lender’s collateral indefinitely. Citing to case law such as Reich v. Cochran, a landlord who gives a secured creditor notice of its intention to physically remove the equipment would appear to have fulfilled its obligations under the UCC. While it may not be able to recover storage charges if it moves the equipment to a secure location, it would likely be absolved of any liability if it removes the collateral on notice to the secured creditor. As long as that notice was undertaken in a commercially reasonable manner, a lender who fails to repossess that equipment would have difficulty claiming the landlord’s actions of emptying its premises constituted a conversion of that collateral.
This scenario gives more support to execution of a “landlord waiver” at the outset of the loan. The waiver should provide an acknowledgement from the landlord that the lender has a first priority position to the pledged collateral located on the landlord’s premises. It should also specify that the lender’s collateral shall remain personal property and will not become a fixture and deemed part of the realty; thus removing any claim of ownership by the landlord. A typical waiver also grants the lender a license to enter upon and have possession of the premises for the purpose of doing everything necessary to dispose of the pledged equipment including conducting the sale on the premises, and removal of the collateral following that sale. It is here that the parties may want to specify the time allowed a lender to perform these tasks, and the per diem storage/rent costs associated with its continued possession. To that end, the parties should also agree at the outset when this clock starts running (i.e., upon the debtor’s default to the landlord, notice to the lender, the borrower’s default to the lender, notice to the landlord, etc). This per diem may include continued utilities, taxes, and insurance previously incorporated in the landlord’s lease with the tenant. The lender could also clarify within the waiver that it is not assuming the lease, curing past rentals, or other monetary defaults of the borrower/tenant. Again, laying the groundwork in a landlord waiver may help avoid the costs, uncertainties, difficulties, and delay associated with removing the collateral following the tenant/borrower’s default.
