Liens

A lien is a legal claim or right that a creditor has over someone else's property, serving as collateral until a debt or obligation is fully paid. Think of it as a legal sticky note slapped on an asset—like a building, a piece of equipment, or even an investment account—that says, “I'm owed money, and this item is my guarantee!” This sticky note gives the creditor the legal power to seize and sell the property if the debtor defaults on their payments. For investors, spotting a lien on a company's assets is like finding a potential termite infestation in a house you're about to buy. It's a significant red flag that can signal financial trouble and complicate the true valuation of a company's assets, making it a critical detail to uncover during your research.

Not all liens are created equal. They fall into a few key categories, some of which are far more alarming to an investor than others.

These are the “friendly” liens, voluntarily agreed to by the property owner as part of a deal. The most common example is a mortgage. When a company buys a new headquarters with a loan, it gives the bank a lien on the property. Everyone agrees to this upfront; it’s a standard part of financing a large purchase. Car loans work the same way. While these liens still represent debt, they are a normal and often healthy part of corporate finance and expansion.

These are the uninvited guests. Statutory liens are created automatically by law, without the property owner's consent, usually because a bill has gone unpaid. They are often a sign of trouble.

• Tax Liens: If a company fails to pay its taxes (property, income, etc.), the government can place a tax lien on its assets. This is a major warning sign of severe cash flow problems.
• Mechanic's Liens: If a company hires a contractor to improve a property (e.g., renovate an office) and then fails to pay for the work, the contractor can file a mechanic's lien against that property to secure payment.

These are another type of non-consensual lien, but they arise from a lawsuit. If a company loses a court case and is ordered to pay damages but fails to do so, the winner of the lawsuit (the judgment creditor) can obtain a court order to place a lien on the company's assets. This ensures they can collect what they are owed, by forcing the sale of property if necessary. Like a tax lien, a judgment lien is a clear indicator of financial distress.

Value investors are detectives, searching for clues about a company's true worth and financial health. Liens are one of the most important clues you can find, and they are almost never a good sign.

While some consensual liens are a normal part of business, statutory and judgment liens scream trouble. They suggest a company can't meet its basic obligations, which could be a symptom of deeper operational or financial failures. A company juggling multiple non-consensual liens is likely in a precarious financial position, making its stock a much riskier bet. You can typically find information about liens in the footnotes of a company's financial statements, particularly on its balance sheet.

A core principle of value investing is to buy assets for less than their intrinsic worth. A lien clouds the title to an asset and reduces its value to shareholders. Why? Because the asset's value is first and foremost a guarantee for the creditor. If a company has a factory worth $10 million but there's a $2 million lien on it, shareholders only have a claim on the remaining $8 million of value. During due diligence, savvy investors must identify all liens and subtract their value from the company's assets to arrive at a more accurate asset valuation.

In a worst-case scenario like bankruptcy or liquidation, liens determine who gets paid first. This is governed by the priority of liens.

• First in Line: Creditors with senior, perfected liens (like the government with a tax lien or a bank with a first mortgage) get their money from the sale of the specific asset their lien is attached to.
• Last in the Queue: Common shareholders are at the very back of the line. If a company's assets are covered in liens, there might be nothing left for stockholders after the creditors are paid. Understanding the lien structure is a critical part of assessing your margin of safety.

Let's look at “Global Goods Inc.,” a fictional retail company.

1. The Setup: Global Goods takes out a $5 million loan from Big Bank to buy a new warehouse, giving the bank a consensual lien on the property. This is standard business.
2. The Trouble: A year later, sales plummet. Global Goods can't pay its property taxes, and the county places a $200,000 tax lien on all its properties, including the new warehouse. This statutory lien is a huge red flag.
3. The Investor's View: As a value investor, you discover this tax lien in the company's public filings. You now know that:
   • The company has serious cash flow issues.
   • The county's tax lien likely has priority over Big Bank's mortgage lien, making the bank's position riskier and potentially complicating future financing efforts for Global Goods.
   • The company's total assets are effectively worth at least $5.2 million less to you as a potential shareholder, because that money is owed to creditors with strong claims.

This discovery would drastically lower your estimate of the company's intrinsic value and likely lead you to avoid the stock entirely, saving you from a potential investment disaster.