How liens affect your small business

By ,
Ask a Lender
September 26, 2017


Key Points

Understanding the impact of liens

  • Liens are legal filings with the state or county that give a lender a claim to one or more of a borrower’s assets.
  • Having too many liens or a blanket lien on your business discourage additional lenders or increase interest rates on future loans.
  • Read the small print on all business loans and routinely check for liens filed against your company.

Liens are an important part of every secured U.S. Small Business Administration-backed and conventional small business loan, but are often overshadowed by concerns over interest rates, terms and collateral.

In fact, liens are a form of a collateral and can have a significant impact on your business, both in terms of existing loans and future credit prospects.

Types of liens

A lien is a legal filing that grants a lender a claim to one or more of a business’ assets. A variety of lien types exist, including those filed by government taxing entities (tax liens), building contractors (mechanics leans) and lenders (trust deeds and UCC-1 liens). Lender liens filed against a business place a claim on real estate or other assets, such as equipment.

Lenders are obligated to file liens on assets secured in their name in order to create a public record of their claim. If a small business obtains an equipment loan, for example, the lender will file a lien on that piece of equipment asserting its right to seize the asset in case the borrower defaults on the loan. Such a claim is referred to as a UCC-1 lien — named for the Uniform Commercial Code that standardizes business and legal transactions across U.S. states. UCC liens are typically filed through the secretary of state’s office in the state where the business is located, while most real estate liens that involve claims against property, such as trust deeds, are recorded at the county level.

Liens can be statutory or consensual. Statutory or nonconsensual liens are claims on assets that have not been agreed to previously by the parties involved and are filed with county recording offices or the courts to recoup funds owed. They consist of tax liens, contractor’s or mechanic’s liens, and judgment liens.

The most common liens a small business will encounter are consensual security interests. The terms of such liens are usually outlined within the fine print of a business loan and agreed on by both parties. Consensual liens can be on an individual asset — such as a piece of property or equipment — on a group of assets, or on all business assets via a blanket lien. A blanket lien grants the lender a right to seize any of a business’ capital or current assets in order to satisfy an outstanding debt. This is the most comprehensive form of collateral for a lender and the riskiest for a borrower.

Multiple lenders can hold lien positions, or claims, against a business’ assets. The first to file a lien against an asset holds the first-lien loan position, meaning subsequent liens are subordinate to it. In the event an asset is liquidated, or sold, as the result of a loan default, the primary lienholder is paid first, with any remaining proceeds going to the subordinate lienholders.

Business impact

The potential negative consequences of not paying attention to the types and number of liens filed against your company are many. Consequently, it’s good business to stay on top of those filings. Among the problems that can arise if you fail to remain vigilant are the following:

  • Potentially higher interest rates. Lien positions can affect a business’ loan eligibility and interest rates. Lenders are less likely to want to take a second or third lien position because it is higher risk. A subordinate lienholder has no guarantee that, in the event of default, it will recover the full amount owed because the first-position lienholder gets paid first. This can result in a business receiving less favorable loan terms and higher interest rates on a second loan. If a lender has a blanket lien on a business, obtaining a loan from another lender becomes even more challenging because that blanket lienholder already has a claim against the bulk of the company’s assets.
  • Expansive lien filings. While liens are usually filed in line with the specific collateral being pledged as part of a loan agreement, sometimes lenders can obtain broader liens than a borrower realizes. The most common scenario is a borrower failing to read the small print on a business loan and inadvertently agreeing to a more onerous lien — for example, a blanket lien to secure a small equipment loan.
  • Loan eligibility. Having one or more liens against your business assets can discourage lenders from extending a loan to your company. Lenders are not obligated to disclose lien filings to the borrower, so your business may have liens filed against it without your knowledge or outdated liens that have not been removed from public record. The borrower is responsible for asking lenders to close liens that are no longer in effect.

With the capacity to affect a business’ assets, loan eligibility and interest rates, the power of liens cannot be overstated. Make sure to read the fine print of every business loan for lien requirements and periodically search state and county records to detect liens filed against your business and ensure they are accurate and up to date.

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