At first blush, from the perspective of a lender, landlord or other party seeking to secure performance of an obligation, the act of acquiring an interest in a third party’s liquor license as part of the secured collateral would appear relatively safe. Michigan law, specifically, the Michigan Liquor Control Code of 1998 (“Code”) and the associated Administrative Rules (“Rules”) provides ample statutory and regulatory authority to protect a lender that is willing to finance a new or an existing restaurant, hotel or retail venture.
Rules 19 and 21, for example, acknowledge the right of a secured creditor to acquire a secured interest in the borrower’s liquor license, and expressly acknowledge that funds derived from a state or federally approved lender may be utilized by the borrower to finance the purchase of the business assets. Moreover, Michigan’s licensing scheme, which generally permits an on-premises licensee to transfer its license to anywhere within the immediate county and not solely within the municipality from which it was originally issued and operated, has caused the value of the licenses – and the value of the collateral – to increase. Thus, the market value that may be commanded for a liquor license is attractive to the lender, and this value may offset the risks sometimes associated with the finance of a new restaurant or similar venture.
The Challenge
The economic climate in the state of Michigan is exposing a problem few lenders, landlords or other third parties who have acquired an interest in a liquor license would have or could have anticipated: an inability to freely liquidate the license as part of the foreclosure process following an event of default. The reality of this problem has unfortunately played itself out on many occasions in the past two years and with the number of defaulting commercial loans increasing, this scenario will be experienced by far more lenders who are compelled to foreclose and attempt to sell the license in order to realize the recovery of the defaulted indebtedness.
In a nutshell, while the Code provides the statutory framework for a lender to acquire a secured interest, and while Michigan’s version of Article 9 of the Uniform Commercial Code provides a mechanism for a secured creditor to obtain relief by exercising one of a number of potential methods of relief against a defaulting debtor, the Code does not afford a creditor any special treatment or consideration when it elects to take title to a liquor license and then attempts to resell the license to recoup its losses. In these instances, where a creditor does not intend to operate a licensed business, but to merely sell the license as part of the recovered collateral, the Code and the Rules require the lender to be investigated by both the Michigan Liquor Control Commission (“MLCC”) and the local investigative body before it can sell the license to a third party. This is generally referred to as a two-step approval process, and if the lender is unable to obtain approval for the transfer of the license into its name, even for no more than the brief time period necessary to transfer title to the ultimate third party for operation, the lender will be denied the right to the liquor license and the value assigned to it as part of the collateral.
One might question, why would a lender be denied approval if it does not intend to ever operate the license, but only intends to liquidate its interest? The answer is addressed in section 501 of the Code, which provides that any party seeking to acquire a license must be approved by the local municipality, and the local community possesses almost carte blanche authority to deny the transfer. If a local community believes that a foreclosing lender will sell the license to a third party in another community, it has no incentive to approve the transfer and suffer the loss of the license and the tax revenue generated by the loss of business. Rather than losing the license to a different community, the municipality can prohibit the relocation simply by denying the bank the right to acquire title. Thus, while the state legislature provides for the right of a licensee to sell the license to a party in a different community and increase the market value of the licenses, the local approval requirement forces the lender to either locate an operator within that community, and thus eliminate the main incentive of the community to veto the transfer, or to negotiate with the local governing body to persuade the community to permit the transfer.
Solutions
Legislative relief to this transfer quandary is unlikely in the foreseeable future. Solutions are available, but they require the lender to plan well in advance of the foreclosure process by drafting voluntary re-acquisition and other agreements in a manner that permits the lender to avoid being classified by the MLCC as a license transferee and thereby escaping transfer requirements of the Code.
Without care and planning, the bank or other institution may find itself in the predicament faced by many other lenders. Given today’s economic climate, this is a problem that lenders should attempt to avoid.
For more information on this or other Hospitality Law and Liquor Control matters, contact Chris Baker at 248/567-7425.