Learning From the Past: Drafting to Avoid Issues We Saw During the Recession By: John J. Wiles
Published in Probate & Property, Volume 28, Number 6, (November/December 2014).
Now that times are getting better, the inclination is to forget the problems of the last several years. As a lawyer who really wanted to be a history professor, the author is always inclined to remind readers that history has a way of repeating itself. This article is a simple, straightforward review of a few of the problems that came to light during the recession, with some helpful hints on how to draft and negotiate leases going forward to avoid problematic situations.
Failure to Maintain Premises or the Shopping Center
The standard shopping center lease contains a definition of “common areas” and a provision setting forth the landlord’s maintenance and repair duties for those common areas. In addition, the lease will address the landlord’s maintenance and repair of the premises, and a separate provision will address the tenant’s duty for maintenance and repairs of the premises. For example:
1. The landlord will covenant to maintain all common areas in “reasonably good condition and repair as determined by Landlord, subject to reimbursement by Tenant pursuant to a Common Area Maintenance Charge.” The common area will include, without limitation, parking areas, customer loading zones, entrances, exits, sidewalks, ingress/egress locations, and, depending on the nature of the shopping center, interior mall areas, restrooms, escalators, and elevators.
2. The landlord’s duty for maintenance and repair of the premises themselves is much more limited, usually including only the roof, the exterior walls, the foundation, structural parts of the floors, any load bearing interior walls, and gutters and downspouts (subject to notice from the tenant of the need for repairs, and with costs assessed against the tenant if repairs are required because of a negligent action of the tenant).
3. The tenant’s responsibility for repairs to the premises usually includes all repair duties not mandated to the landlord. The lease usually further provides that the tenant will make any and all repairs to the premises that are necessary or desirable to keep, repair, and maintain the premises in good condition and repair, and in a safe and habitable condition, and should be very specific for the HVAC, plumbing, lighting, floor covers, ceiling covers, and wall covers, to avoid confusion.
If the tenant moves in, is successful in the premises, and begins paying rent, and the parties move forward in keeping their respective repairs up to an acceptable standard, the relationship remains good. When the economy weakened, however, many landlords and tenants did not have sufficient funds to maintain the shopping center or premises, respectively, in the manner the other party deemed acceptable. A wellnegotiated lease will specify the meaning of “good, first class condition” or “reasonably good condition and repair,” but vague definitions can leave these terms subjective. In addition, a well-drafted lease will clearly divide maintenance duties between the parties.
Tenant Fails to Maintain Premises
A failure by the tenant to comply with any term of the lease is a default under the lease, subject to any notice and cure periods. The lawyer for the landlord should carefully review the default provision, because a nonmonetary default usually has a written notice requirement and a period of 20 to 30 days in which to cure or commence to cure. Importantly, the landlord’s first step is to send out a default letter in compliance with the lease’s notice provision that indicates in sufficient detail the nature of the necessary repair.
Leases generally provide that if the tenant has failed to make necessary repairs after notice, the landlord can make the repairs and invoice the tenant for reimbursement. Many repairs require access to the premises, and the landlord must exercise this right in a manner so as not to incur liability for claims of damage to inventory or property in the premises, or for theft. In addition, most tenants do not want their business operation interrupted while the landlord makes the repair. In many cases, in fact, there may be privacy issues because of the nature of the business. A tenant with a medical practice or other business containing confidential records needs to remain in compliance with applicable laws, and the tenant does not want to suffer a violation of such as a result of a landlord entry. Accordingly, when anticipating a landlord’s need to access the premises to make repairs, both parties should address the landlord’s ability to timely access and repair the premises given the nature of the situation, the desire to minimize costs, the tenant’s ability to continue to operate during the repairs, and the protection of the tenant’s confidential information and the privacy of its clients. The lease can be specific to the point of requiring repairs before or after normal business hours and specifying that the tenant must have, at its expense, a representative present at all times.
Practice Pointer: Check the lease to assure that the duties of the tenant are clear on maintenance and that a specific time period is provided to make the repair. Inserting “a reasonable time” for completion of repairs leaves room for controversy and misunderstanding.
If a repair is of a nature that requires more than 10 to 20 days to complete, the lease should be drafted so that the tenant has additional time, provided the tenant commences the repairs in a timely manner and diligently proceeds to completion. It is strongly recommended that the parties draft an outside time period of 30 to 60 days for the tenant to complete the repairs so there is incentive to finish the repairs.
It is also important to address the nature of the repair default in the lease to protect the landlord in the event of an emergency or a potential violation of a government-required repair. If a repair of an immediate nature is necessary to avoid damage to the property or injury to persons, the notice requirement can be as minimal as a telephone call or an e-mail. The tenant can request that, when only a short period of notice is given, the landlord be limited to taking only the action necessary to contain the situation and then allow the tenant time to finish the repair. For example, the plumbing, which is the tenant’s responsibility to repair, starts to leak after hours. The lease may allow the landlord to make only an emergency repair to stop the water leak but permit the tenant to investigate the nature of the repair necessary and to choose its manner of permanent repair. If the repairs are required by a government agency, the notice period for the tenant to cure should be shorter than the notice period provided by the law or ordinance, so that, if the tenant fails to make the repair, the landlord can make the repair before the ordinance is violated.
A carefully drafted lease will provide that if the landlord makes the repairs the landlord can invoice the tenant. Unfortunately, a tenant may refuse to pay for the repairs or may not have adequate funds for reimbursement.
Practice Pointer: A properly drafted lease should provide that any amounts expended by a landlord for repairs are within the definition of “Additional Rent,” because most default clauses and state laws provide expedited procedures, such as an eviction action, to collect “Rent.”
In addition, tenants may be concerned about the landlord spending the tenant’s money arbitrarily. Although people often suggest modifying the repair duty by using the term “commercially reasonable,” in most states, unfortunately, what is commercially reasonable is ultimately for a jury to decide. In the author’s opinion, all lease drafting should avoid an interpretation by a jury to avoid the costs of litigation. To address a tenant’s concern that the landlord would spend unwarranted funds to complete a tenant repair, the lease can specify a threshold amount for the repairs so that any repairs exceeding that amount require the landlord to provide a supplemental notice of default or to obtain two or more bids before commencing the repair.
Landlord Fails to Maintain Shopping Center or the Premises
If the landlord does not maintain the shopping center or make required repairs to the premises, the tenant may suffer severe consequences. The tenant should review the lease and make sure there is a landlord default provision. The tenant needs to have a mechanism in the lease that specifies how notices are to be sent and includes a specific timeline for response by the landlord. If the landlord fails to cure the default after notice, the tenant should insist it have a remedy. Even a small tenant in a changing economy can benefit from the negotiation of limited repair rights to have the ability to stop a leak or remedy a hazardous situation that could cause tripping and falling.
Practice Pointer: It is prudent to review state law on whether a landlord’s failure to make repairs can result in a constructive eviction rendering the lease terminable by the tenant (watch landlord-lender requirements, because allowing a constructive eviction remedy may be a default under the loan documents).
Obviously, the landlord benefits from receiving notice that there is a repair it needs to make. An unattended repair can escalate to a more costly repair, and if the repair is a landlord-required repair in the premises, the landlord may have no way of knowing the repair is needed. If a tenant discovers moisture in the premises, for example, it is better that the leak be fixed before there is damage to personal property in the premises or to the structure of the premises and before the onset of mold. Importantly, the lease should require that the tenant immediately notify the landlord if a repair is needed.
As with any repair, the time provided to cure a repair default may fluctuate depending on the nature of the repair needed, but there should be an outside time period for the repair completion. If there is a repair issue, the tenant should review the lease and ascertain if the lender is also entitled to notice. Lenders have a vested interest in maintaining the premises. In addition, emergency repair situations should be addressed separately because the tenant may be the most efficient party to commence emergency repairs.
If the landlord fails to make the repair after the notice and cure period has expired, the tenant should request a self-help right to make the repair in the name of the landlord and to invoice the landlord. Most landlords are reluctant to provide a self-help right to a tenant to make repairs because they do not want a tenant making structural repairs to the shopping center that could affect the building, building systems, or common areas and potentially result in more problems with other tenants or in damage to the roof, foundation, or building systems. If, however, a tenant has enough bargaining power, or the landlord does not have the finances to complete a repair, the landlord may allow the tenant to provide a second (supplemental) written notice in the event of a landlord repair default and require that the notice include the nature of default, the proposed repair to be made, and the exact cost of the repair the tenant proposes to make. A landlord with little cash flow may actually need the tenant to make the repair.
If the landlord fails to make the repair and the tenant is permitted to make a landlord repair, the lease should provide a duty for the landlord to reimburse the tenant; arguably, however, the reason the tenant has to make the repair is because of the landlord’s inability to pay for the repair. The lease should address how the tenant gets paid for the repairs. Most tenants want a complete offset against rent and additional rent. Obviously, such an offset could dramatically affect the landlord’s income stream, which could result in yet more issues for the landlord and the shopping center. In addition, most lenders would refuse to approve such an agreement. The fairest provision may be that a percentage of base rent be offset each month until the amount is reimbursed, thereby keeping the shopping center pass-throughs, together with a portion of revenue flow, in place.
The recession affected both landlords and tenants as each party commenced projects, and at the end of the day the landlord’s money was not necessarily available to be disbursed or the tenant extended its improvements past the allowance amount.
From the landlord’s perspective, when a landlord provides the tenant an allowance to build out its premises, it is reasonable to expect the money actually will be spent to improve the premises. Prudent landlords will limit the money to what is considered a hard build-out, such as walls, ceilings, floor coverings, lighting, and plumbing fixtures, which will remain the property of the landlord at the end of the lease term.
One way to protect the landlord is to provide for any payment to the tenant for the build-out to be done in a draw fashion. When a certain portion of the build-out is completed, the landlord, after receiving lien waivers from the general contractor, is required to distribute a portion of the allowance funds attributable to the work performed. Although the tenant may object to this course of action, it is prudent for the landlord to protect its property.
Importantly, the final draw should be at least 15% of the total cost of the build-out. Before disbursing the final draw, the landlord should require a final lien waiver and affidavit from the general contractor. Liens result when a tenant or contractor does not pay for its materials and labor. For a tenant to allow liens to be placed on the premises is a default under the lease, and the cure specified in a lease requires the tenant to either pay or bond off the liens. Notwithstanding the lease requirements, the best protection is for the landlord to hold part of the build-out allowance pending receipt of lien waivers.
What can a tenant do to protect itself if the landlord does not have the funds necessary to construct the build-out provided in the lease or lease amendment? A tenant may request that the landlord contract directly to complete the build-out. For a large project, the landlord’s lender may be convinced to guarantee the build-out if the landlord fails to construct the improvements. A tenant also can request that the landlord provide a letter of credit. As a final line of protection, a tenant may require the right to complete the build-out and deduct the costs from rent.
The relationship has been great between the landlord and the tenant, and then the tenant receives a notice that the landlord is exercising its right to relocate the tenant. This could be caused by the landlord’s needing to move tenants to accommodate a creditworthy addition to the shopping center or by the landlord’s selling the shopping center and the new landlord’s undertaking to re-develop the shopping center. The first reaction may be “how can you treat me this way?” But a full blown dispute with threats of, or the actual realization of, litigation can be avoided by a better review and negotiation of the relocation clause in the lease. Because they have chosen the original location and expended funds, tenants will be reluctant to allow a relocation clause. As a practical matter, however, to maximize a shopping center’s potential, to improve a center that has become run down, or to accommodate the expansion of other tenants, it is prudent for the landlord to keep a viable relocation right available, even if the landlord must make concessions to get the tenant to agree.
Practice Pointer: The basics of a landlord’s relocation clause are: “Landlord reserves the right, at any time, to relocate Tenant at Landlord’s sole expense to any other Premises within the building or within the Shopping Center/ Complex as selected by Landlord.”
Relocation Costs/How to Document
In assessing the costs of a relocation, the lease must be specific about whether the alternative premises provided must replicate the original premises exactly, either as of lease commencement or as of the date of the relocation, or if a “comparable alternative premises” requirement would allow a change of floor plan, a deviation in square footage, and so on. Such elements will determine the landlord’s costs for the scope of the build-out and allow the landlord to better estimate the costs going into the relocation. If the landlord provided a tenant improvement allowance for the initial premises for a specialized build-out, this amount may be too low, because of inflation, to provide a replication of the premises. So the tenant should avoid being limited to a specific cost figure for preparation of the alternative premises. Accordingly, although the landlord is safer specifying the amount of a tenant improvement allowance, the tenant should require that an increase in costs and labor be included.
The costs of moving should be defined to address how quickly the move must be completed, including whether a premium will be paid to move the tenant “after business hours” or over weekends to avoid down time, and who selects the mover. The landlord may want the right to select the mover; however, the landlord does not want any liability for damages as a result of the move. Accordingly, it may be advisable to allow the tenant to make that choice and contract directly with the movers, with the landlord paying an allowance to be applied to the cost based on bids from the movers.
The cost to modify the tenant’s office supplies (to reflect the new premises address, together with changing the signage if the address is indicated) can be included in the costs of relocation assessed to the landlord. The landlord should clarify, however, that replacement of office supplies and signage is limited to those items actually in the tenant’s possession as of the date of the relocation.
The tenant will undoubtedly have down time when the premises are closed, with employee costs notwithstanding the closure, and assessing actual profit/loss or revenue loss for any given day is extremely difficult, given the nature of the business, seasonal fluctuations, weather, and day of the week, among other factors. Accordingly, if it is necessary to address a payment for down time, the amount should be specified with a cap on the amount per day after a specific number of days. Storage expenses should also be addressed (the landlord may have space to provide storage at no cost or offer an allowance). This will help ensure that both parties complete the move timely.
Practice Pointer: If the landlord provides storage, the lease should require the tenant to maintain insurance on its property during the storage with waivers of subrogation.
Tenant May Desire Approval for Alternative Premises Location
This issue tests the bargaining power of the tenant and the nature of the shopping center over whether there is a need to provide alternative locations that would be deemed acceptable by the tenant. The tenant may request that alternative relocation premises be limited to specific locations the tenant has approved for visibility and access, which would be deemed “prior approved” and can be marked as an exhibit to the relocation clause. The landlord should keep as much flexibility as possible.
Proposing pre-approved areas that the tenant may deem acceptable facilitates the landlord’s maintaining the lease in full force and effect and accomplishing the relocation. As a fallback position, to allow the landlord the right to use any other area of the shopping center for an alternative relocation premises, instead the parties may agree to a termination right for the tenant, strictly exercisable during a short window period following the notice of the proposed alternative relocation premises.
If Relocation Right Is Validly Exercised, Tenant Must Perform
The relocation clause should state that, if the landlord has the right to relocate the tenant, a failure by the tenant to respond appropriately under the terms of the clause is a material breach under the lease, and that all remedies under the lease and at law are available to the landlord. With this in place, provided the landlord has properly exercised the relocation right, the landlord may proceed with its remedies, including, without limitation, eviction or termination of the lease, together with a suit for damages resulting from the tenant’s failure to timely relocate. As additional incentive, a right to per diem liquidated damages in addition to all other rights may be of value.
Notice and Timing
Timing issues for relocation are important because a landlord often exercises the relocation when attempting to facilitate an expansion of an existing tenant (often an anchor or restaurant/national tenant), or to provide premises under a new lease needing a corner/drive-through or specific access. A prolonged dispute regarding the relocation can result in a lost lease (or a default under a new lease assuming the landlord did not put the contingency of availability of the premises in the new lease). With this in mind, to whom and how notice should be given should be specified in the relocation clause, with a specific number of days to respond and to approve the relocation premises.
Will a court issue an injunction—a court order mandating compliance with the terms of the lease—to move the tenant? This brings new meaning to expensive litigation. If the parties are at the point of litigation, the relationship may have deteriorated to such a state that a terminated lease may be more cost-efficient, and that option should be available to the landlord. In summary, although almost all form leases contain a relocation clause, to avoid future issues each party should carefully review and understand the mechanism before execution of the lease.
Every clause of a lease may become an issue because of the economic issues of one or both of the parties. By carefully drafting and reviewing each clause with a “what if” mentality, even the most generic clauses can be structured to prevent expensive use of the judicial system. In drafting, providing specifics and avoiding vague generalities will allow the parties to understand the potential ramifications of their actions and know their rights. Importantly then, if litigation cannot be avoided, the lease may be effectively enforced.