Is this battle you should choose ? – Negotiating Commercial Lease Maintenance and Repair Terms

While negotiating a commercial lease, the inevitable issue of maintenance of the building, premises and building systems may prove to be one of the tougher issues facing landlords and tenants.  Although the LOI negotiations on basic terms such as rent, term , options, square footage and other rights and responsibilities of the parties are often sorted out early, maintenance and repair are often not specifically defined (carve out here for dynamite manufacturers and buildings that have significant deferred maintenance issues).  However, many well intentioned business people leave the issues of who maintains and repairs what in general terms even in the drafting of the lease agreement. In addition, tying in generic terms relating to casualties and indemnity can lead to uncertain results if not examined carefully for each transaction.

Concerns of Landlords and Tenants

For owners, the basic concern is protecting the asset while minimizing  cost. For tenants (except for their specific improvements) the chief concern is minimizing the scope and costs, specifically related to the structure, building systems common areas and even certain improvements which may be deemed fixtures that have to be surrendered at the expiration of the lease.  Costs are the common denominator, but there is often more at stake. Take the tenant who has injected thousands of dollars into upfits and permanent improvements or the landlord who has retrofitted the premises to fit tenant tenant needs. Then the issues get sticky….

 Less Sticky Situations

In  some lease scenarios, these issues may be more easily resolved and defined, such as:

  1. Ground Leases
  2. Build to Suit Transactions
  3. Single Tenant Occupancy
  4. Outparcel Leases
  5. Franchised Tenants
  6. Substantial or Complete Retrofit by Tenant
  7. Tenant with Extensive Renewal Options
  8. Tenant with an Option to Purchase

In these situations either landlord or or tenant will likely want to substantially control the protection of their asset or improvements. Landlords desire to protect the structure, building systems, fixtures and alteration approval. Tenants generally want landlords to pay for the maintenance and repair of as much as possible, except for tenant-specific or custom alterations and personal property.  Many LOIs in these situations come tailor made for the final lease and are  essentially non-negotiable on these issue. But what about the rest?

What’s in the the toolbox  to help?

Great question. But over time, real estate professionals have gathered and honed many methods to deal with the issues of maintenance and repairs. By no means a complete list, the items below can help guide the parties to a final agreement knowing that protections and securities have been built in to deal with the lease, such as:

1. Insurance – ideally both landlord and tenant should maintain separate policies that name the other other as additional insureds where appropriate.

2.  Maintenance Contracts – especially for building systems, a solid and reliable maintenance agreement obtained by one or both of the parties can prevent problems from arising. As for the structure (except in ground leases and other situations where the tenant is constructing and fully controlling the building), most tenants look to landlords to cover.

3. Indemnities – these animals can create a good umbrella to cover negligence,  third party damage and other unforeseen circumstances. Again, the party with more to protect will want want a stronger, tighter and broad scope clause included in the lease. Key to this discussion will be the financial status of the parties.

4. Casualty Responsibilities – Likewise, by dividing the risk, responsibilities and rights if there is unpredictable damage to the building and its contents, the parties should know what the consequences will be for themselves.

5.  Approval for Improvements – This is often a tug of war between landlords and tenants. Many times setting a requirement for approval of improvements costing above a certain dollar amount can allow the landlord to be assured the building is not substantially modified without their blessing, while allowing tenants the right to make routine changes and replacements without having to wait for the landlord to respond to their requests.

6. Guarantors – Often a tool to insure that landlords have additional security for unpaid rent, TICAM etc., personal or corporate guaranties can assuage concerns of how risk may be otherwise allocated in the lease agreement.

 

Takeaway

The touchstone for negotiation of maintenance and repair responsibilities should be what does each party want to protect or control and what are the costs and benefits of the physical items, fixtures or structure to be maintained.

 

 

 

 

 

 

 

 

Tenant Personal Property – CHAPTER 3 – Time’s Up and Cut The Scene!

cut scene 1cut scene 2

SCENE 1:   Whether the Tenant has defaulted or is holding over, Landlord is in the process of taking possession of the premises. Even assuming an amicable termination of the leasehold interest, Landlord and Tenant have to deal with the issues created by a move-out.

In the best of all worlds,  Landlord would employ its trusty pre-Lease checklist and go through the premises with Tenant and check off all items and review any personal property that remains as well as wear and tear, damage to structure, systems and so on and so on.  The happy Tenant contractors are standing by as well, ready to counter check all items and remove all personal property, repair any damage and be out of the space in a  jiffy. Landlord then returns the next day to a broom swept premises free of all blemishes and a final rent check in certified funds from the Tenant who is waving good-bye and giving well wishes to the owner and all neighboring tenants.

Hopefully you have experienced this series of events, but we must now leave Oz to examine what most folks encounter in real life.

CUT to SCENE 2 (MOST REALITIES): The Tenant is nowhere to be found and the Landlord’s Property Manager (“PM”) is forced to have a locksmith create access to the premises.  As the door creaks open, the vermin scatter and garbage, debris and water on the floor are the first thing that greet this brave soul.  As the PM has been advised, the broker for the property has already signed a lease with a new tenant who needs the space in five days in vanilla shell condition and ready for custom upfits.  As the PM walks slowly into the space,  and it becomes apparent there is a large amount of remaining personal property, alterations and improvements (most of which are malfunctioning) still in the premises.  What to do?

 

1. Review and analyze the situation.

The best tool for this situation is a camera/phone/video record of the space and a witness to corroborate the conditions that are encountered.  Despite any pre-Lease list, the current condition of the premises is paramount to analyzing what to do regarding Tenant’s personal property, fixtures and third party property that may be located in the space.  Your witness is important, especially if there is substantial personal property left behind  or major damage to the premises, or BOTH.  Make sure to check for all evidence of property that may be owned, leased or liened by third parties (see below for a further discussion this issue!).  Secure the premises. Return to your office and check for any UCC-1s that have been filed against the tenant and its specific list of collateral.  Also note any obvious third party property (and hopefully) an address and phone number for a leasing or financing company.

 

2. Take A Deep Breath and Review.

If there is any property owned or leased or liened by third parties, contact them ASAP and tell them what is there and that you need it removed quickly.  Once that is done you are hopefully dealing with only tenant owned personal property.  If the third parties do not respond to you, your state law may require you to give certain notice to the owners before selling it, giving it to the new tenant or tossing it in the trash.  If these folks fail to respond to you, give them an ultimatum; i.e.  “take it soon or we will throw it away or sell it.”   Careful though: a perfected secured interest in personal property may restrict your rights in this regard. Those rights (as well as the fee ownership rights of third parties) are protected by law even if the collateral is located beyond the boundaries of the premises.  Here is your best weapon: let them know you have their property and give them a deadline to retrieve it.  If they don’t respond, state clearly you will charge them for storage fees. Depending upon state law this may equal a “reasonable” storage fee or an amount close to the rent owed by the Tenant.

Special Note:  If your Tenant is a franchisee, consult your lease and any related documents. Most franchisors will have protections built into the lease or associated agreements which not only prevent the Landlord from disposing of the personal property, but also give the franchisor the right (after appropriate notice) to step into the shoes of the franchisee, put a substitute franchisee in place in the premises, or otherwise have rights to retrieve the personal property.  There are also likely procedures built into a default scenario that allow the franchisor the ability to analyze the situation before making a decision.

 

3. Come Up With A Plan.

Once the personal property has been inventoried, identified, scrutinized and related third parties given any required notice,  the PM and the Landlord will need to decide what rights and remedies they wish to invoke to deal with the items left behind. These usually fall into a number of categories:

A.  Lien Rights

State law and the Lease Agreement may provide for a security interest in the personal property that the Landlord can enforce by means of public or private sale or both. Certainly when the Landlord holds a first priority UCC this will be a north star to guide your decision making.  Time to call the broker who so quickly promised the leftovers to the new tenant he has signed up to take possession of the premises!  Most states recognize both statutory and common law lien rights for Landlords in the collateral.  In NC, Landlords have the ability under many cases of enforcing a mechanic’s lien (see N.C. Gen. Stat. Section 44A) or even a post eviction lien (see N.C. Gen. Stat. 42-36.1 et. seq.).   Wherever you may be located though, this should be your first avenue of inquiry !

B. What Can You Use Or Sell Or Trade Out

Assuming the there are no third party rights in the personal property,  the PM and his or her Owner should evaluate what is a fixture (as a result of  alterations or improvements) and what is not. Fixtures under most state laws and the terms of most commercial leases become the “property” of the landlord upon installation and/or abandonment.  Some are obvious (new walls, brick oven, plumbing systems), some are on the border (hoods, shelving, cabling, lighting) and some are obviously not (carts, furniture, pallets, TVs, rugs, inventory and movable equipment) – For more on this topic See REAL ESTATE DRILL DOWN Post entitled  “Fixtures – A Group Arrangement Or Entanglement.”

C. What Should You Just Throw Away

Garbage, useless inventory, broken equipment and debris. The biggest issue here is the cost of removal and cleaning. Demand should be made upon the Tenant to pay for this cost. However, many times the tenant is absent or not willing to cooperate or insolvent.  Result then = cost of doing business. Just don’t try to pass it along in your CAM expenses !

D. What Should You Require Others To Retrieve

Third Party Property, Government Records and Hazardous Waste (“HW”). The first item is discussed above. The second is something the Tenant should be notified of and required to retrieve.  The latter is a situation one hopes to never be involved with.  However, if a PM encounters HW at the premises, due care should be given to determine the contractual and legal requirements that the Landlord and the Tenant have with regard to remediation.  Depending on the type of HW, this can be a nuisance (oil cans, ink buckets) or a very serious problem (PCB s, toxic chemicals, sludge).  A whole article could be written about how to deal with the problem items/waste, but the key point is always, document, analyze (with experts) and act expeditiously to resolve the situation. A final note: take care to observe the rules and regulations regarding tax and medical documents. Even a Landlord may have independent responsibilities to take steps to get these items into the hands of the appropriate agency(s).

At the end of the day whether you lease retail, industrial or office space, you will encounter these issues again and again. The hope is that you work your way through them more like Scene 1, than Scene 2.  However, keep these words in mind:

 

“You Just Can’t Lose What You Never Had….”

– Muddy Waters

 

Tenant Personal Property – CHAPTER 2 – Close Eye

watching eye 2So, the Lease is underway. As Landlord, you are gliding along with the Tenant paying rent and not causing trouble. Here are a few reasons to keep an eye on things:

1.  Alterations – Tenants, especially successful tenants, will want to amplify their space with additional changes. This also is a natural result of a sublease or assignment.  Make sure as a landlord you know exactly what is contemplated and when (and who) will make the upfits. Your lease could be the best in the world at creating hoops for tenants to jump through to report and properly construct alterations before construction begins. However, in practice, due diligence is still the key. The worst of all worlds is to approve alterations to the premises and not follow-up on their progress, especially when it may alter the structure or cause problems with other tenants. A two-way dialogue is best throughout the process, may be three ways if a franchisor and contractor are involved.

2.  Improvements – This is a good sign that the Tenant is doing well and wants to solidify or expand its presence in the Center, Park or Building.  However, the key issue is whether the requested improvements will (or might) become fixtures that are attached to the Premises and may be property of the Landlord, depending on how the Lease is worded.  Hopefully the Lease calls for the Tenant to disclose the plan for the improvements the same as the alterations to the Premises. If not, trouble.  If so, Landlord do not fall asleep  on these modifications to the Premises.  Many tenants will also reserve the right to remove the “improvements” upon termination or earlier vacating of the space.  If so, landlords need to make sure they agree as such before the improvements are constructed to avoid a showdown upon vacating (and thereafter). A true tenant fixture (tables, chairs, shelving etc.) should be distinguished from  a fixture (hood, walk in cooler, new doorway etc.). This is never easy, but getting ahead of it is key to later disputes.

3.   Assignment – So the Landlord and the Tenant have agreed to assign the lease to a separate entity/business. Among the many issues should be who takes what, why,  and  what is the status of what is left behind.  Beyond the agreement between the tenant/assignor and the new tenant/assignee, the Landlord should be concerned about several things. First, what is taken out of the premises in the transition. Any fixtures? Any damage? Second, what will the assignee add to the premises (or take away). This is important.  Third, is this a true assignment or just a sublease in disguise (see below)?  Fourth, is the assignor still liable for personal property issues?

4.   Subletting – A true sublease will require the Tenant to be required to watch over and be responsible for the Sublessee.  As landlords, be sure this is the case. In may jurisdictions, it is easy to allow the sublease to become an assignment by the language of the lease.  Aside from that issue, the Sulessee should be required to follow and abide by the terms of the Lease. Consent Requirements are key here. As Landlord, the owner will want to make sure they are made aware of the Sublesse’s activities in the Premises. Not only the use, but also any additional activities of the Sublesee, despite the language of the Lease and the Sublease.

5.   Maintenance and Financial Status – Sure. This is essential to any agreement to sublease or assignment of the Premises to another entity or even to monitor the Tenant. Most landlords protect themselves well with the language of the Lease.  But that is only the foundation.  Follow-up  and supervision through property management is the key here. Does the Tenant have the financial wherewithal to run its business and pay vendors including the Landlord.  And, is the HVAC maintenance contract still in force. Is the Tenant or its Sublessee/Assignee following the plan and requirements for maintaining the Premises?

Keep a close eye on the occupant and the premises!

 

 

Tenant Personal Property – CHAPTER 1 – The Project May be The Lion, but the List is your North Star*

making list 1

So you’ve got your lease signed and are ready to go with your new tenant. Everything is in place – or is it?

Getting the deal done is paramount, but the demon is is in the details for a lot of lease issues including tenant personal property and trade fixtures.  This is the first in several articles about what the tenant brings to the premises and how that plays out during the lease term.

Understanding what the tenant is bringing (or may add later) to the premises is key to getting ahead of the situations that may result from what is installed, stored, used, rented, financed or otherwise placed in the premises by the lessee.

Here are some due diligence items:

1.  Initial Inventory of Items – Ask your tenant what they plan to do with space and what they will be stocking and installing in the premises.  Sounds simple but sometimes it is only inquired of in the general sense. In addition, sometimes the response is vague or “to be determined.” If there is significant TI involved, this may appear more difficult, but should not be if the tenant quizzes their contractor and equipment/inventory vendor(s).  Is this too much to ask the tenant?  I would say no, especially if they are going to be in a long-term relationship with the landlord. Better to get off on a fresh and straight start than not.

2. Lists and Photographs – Another task that will pay dividends at the end of the lease (or sometimes before). Hopefully the tenant will provide its FF&E list upon request. Video or pictures of the finished space are crucial too. Although sometimes not a usual item on most DD lists, this can be essential when the doo doo hits the fan.

3.  Initial Walk Through and Inspection of the Premises – absolutely key to the process. Tenant approval in writing should be a premium.  Delivery of this document can be coupled with the tenant’s requirement to execute and return the estoppel and/or the Commencement Date Agreement.  Note as much as can be viewed and analyzed and if it cannot be determined (age of roof, walls, foundation, structural issues etc.) then note that as well.  The more detail the better the result later if there is a dispute. In other words, you can put disputes to bed up front and hopefully not have to revisit them later in the tenancy.

4. What Is Owned By The Tenant And what is not? – Require the tenant to provide documentation of all personal property they own, any encumbrances on that property, and any lease contracts or finance agreements that cover any items or trade fixtures in the premises. As we will see later, this step will often prevent a investigatory nightmare if the tenant leaves property in the space and is not around (or willing) to aid the landlord in identifying the proper owners or lien holders of the items.

4.  Contractual Lien In Lease – In NC and most other states, the landlord can create a security interest in all property owned by the tenant by inserting the proper language in the lease. This step should also be accompanied by a UCC-1 filing to perfect the landlord’s interest. Some tenants may resist allowing this term in the lease because it will put them in default of a business or vendor loan agreement. Even so, landlords should discuss this issue with the tenant and also complete an independent UCC lien search to determine the rights of any third parties in the property.

 

NEXT TIME: During the lease term….
*Quote by Adam Savage

My Tenant’s Subcontractor Just Liened My Whole Property ! What Do I Do?

scared businessman 2

The last REDD Post discussed some of the dangers of speeding through a commercial closing without reviewing key documents. Let’s switch gears this week and discuss the situation of the landlord who has done thorough due diligence, reviewed all of its tenants’ leases and is carefully managing the asset and the activities at the shopping center, office building or business park….

SITUATION:  As Landlord, you have made absolutely sure that all leases have strict alteration/modification provisions that prohibit your lessees from making any more than small repairs to their premises without written approval AFTER advance written notice. In addition, your form lease has an absolute prohibition against a tenant, sublessee or assignee allowing a lien to be placed on the space for any reason. This provision also includes strict penalties if a claim of lien is filed including indemnification and automatic default.

Tenant Q (who has always been a model corporate citizen) provided proper notice of a request to upfit a portion of his premises and attached specific documentation about what, who, where and how the work is to be done.  The contractor and subs appear to be solid folks who have a good reputation in the community. You approve the work and your property manager visits the premises regularly to check on the progress of the project. All appears fine, from the comments of the tenant and contractor and visual inspection of the work.

Three days later though, you receive a claim of lien from Subcontractor X (who was not on the list of companies who would be working on the project). Close examination reveals that Sub X has not only placed a lien for $25,000 on the premises, but has in fact liened the  entire fee by using the legal description copied from the deed found on-line.

Trying to calm down, you contact Tenant Q and ask about the lien claim.  Q has just received his copy of the same lien and is bewildered because they have paid the Contractor in full and on time as progress payments were received. A quick call to Sub X gets you nothing but a direct referral to the attorney who filed the lien.  He is indignant and “offended” that you question what he has done for his client. He refuses to modify or remove the lien until sub X is paid the $25K plus all his attorneys and costs.  As you are taking all of this in, your partner hands you your loan documents from Special Servicer Z (who bought the loan for a 40% discount).   The documents state that any lien placed on the property is an automatic incurable default of your loan agreement.

What Do You Do Now?

No doubt the initial reaction of most landlords would be to seek recovery from Tenant Q and have the lien bonded off immediately or removed by receipt of full payment from Tenant Q to the contractor or subcontractor combined with a signed lien waiver.  But what happens if the Tenant claims that some of the upfit is actually composed of fixtures that improve the value of the real estate?

SOME THOUGHTS ON SOLUTIONS:

1.  If contacted by its lender, landlord should be proactive in letting them know the matter will be dealt with right away and keep a dialogue going on progress in that regard.  Although the special servicer may be less likely than the original lender to be willing work through this matter to resolution without defaulting the landlord, the key is to keep the dialogue going while the lien is being removed.

2.  If the sub refuses to amend or re-file their lien to remove the fee interest and insert only the “leasehold interest” (which in most states is all that contractors can lien if their agreement is with the tenant), landlord may need to consider an aggressive response, including asking a court of appropriate jurisdiction for injunctive relief ASAP. That will also help with the issue in #1 above.

3.  Any lawsuit that is filed or even a discussion of claims and defenses will likely include Sub X claiming that Landlord has been unjustly enriched and therefore they are entitled to seek recovery from the owner.  The question of whether the improvements are “fixtures” or “trade fixtures” could be a whole article/debate in itself. Perhaps a better way for a landlord to attack this claim is to show there was no agreement between it and the contractor or the sub; and thus there is not a reasonable expectation of payment by sub under the circumstances.

4.  Cooperation by Tenant Q in this scenario is key. If there are problems between their contractor and the subs, the quicker they at least bond off the lien the better for all involved.  The rub here may be that they don’t have the financial ability or desire to get into a contractor/subcontractor battle.  That again may trigger the need for the landlord to act aggressively to begin the process of resolving the situation.

Fixtures – A Group Arrangement or Entanglement ?

flow chart     Is there is widespread agreement by Landlords, Tenants, Lenders, Vendors and the Courts as to the meaning of Fixtures (structures or improvements that are the property of the Landlord) and Trade Fixtures (personal property owned by the Tenant) ?

Experience in leasing transactions – and perhaps protracted litigation arising therefrom – has tended to show that the answer is more likely NO than YES. Whether you examine the intent of the contracting parties, the institutions that fund the purchase or even the companies that install these items, there is often disagreement at a fundamental level. This is complicated by the Courts who have their own ways of interpreting both the common law definitions and the meaning intended by the parties.

Hence, when an issue arises concerning ownership, lien rights, repair and removal responsibilities, insurance coverage, taxes or the effect on the value of the real property, the result often resembles this:

entanglement 2    The  key to determining which items or improvements to a structure fall in to which category is complex and likely deserves a series of separate articles to  “untangle” these issues. This post will not attempt to reach that answer, but instead provide some drafting and procedural tips to help avoid becoming embroiled in the cost and chaos of a dispute over Fixtures in, on, under or otherwise attached to a structure.

CAVEAT:  There is no silver bullet here. However, careful analysis, communication between the parties and other points described below can significantly reduce the chances of a food fight over that oven hood, walk in freezer, conduit trail, tank, shelving, drop ceiling, and so on and so on….

 

NEGOTIATION and DRAFTING TIPS:

1. Who are the parties involved?

Landlord and Tenant are the easy answers here; but if Lenders or Vendors are involved on both sides, what happens?  Especially if UCCs are filed, this can be crucial. Take the time to find out who is in the room.

2.  What is in the building already that Landlord owns and/or controls?

Not always an easy answer especially when Landlord is a new owner or has inherited the Lease through assignment. But, never a bad idea to make sure Landlord’s Lender has provided the most up to date information on the structure and any Improvements already installed or to be completed by Tenant.

3.  How is Tenant going to alter the building and what are they bringing into the Premises to operate their business?

This is essential.  Most of these details usually get worked out during the Tenant Upfit discussion, but Lenders and Vendors should also be identified.  Again, if the Landlord is acquiring the property through purchase, the examination of the assignment of leases should not be left to a cursory review of rent rolls and ledgers.  Due diligence often offers an adequate time to determine these issues.

 

PROCEDURAL TIPS during the Lease Term:

1.  As a Landlord, do you know what is being installed in the Premises during Tenant Upfit?

This is often where things may go awry as far as communication between owner and Tenant and associated contractors, Lenders and Vendors.  Many leases create a delivery date and a lease commencement date without also establishing a communication conduit between Landlord and Tenant as to what is being placed inside the Premises, installed onto the structure, etc.   Language that requires Tenant to report all installations that may constitute more than a movable Trade Fixture is a good way to monitor this process and know the players involved.  Property Management can also be invaluable at this time and later in the lease term as the Tenant may continue to alter the Premises during the Term.

 

2. Does Your Lease Create A Duty for Tenant to Report All Modifications to the Premises and Collateral Obligations to Business Lenders and Vendors?

This portion of the Lease term is where all parties tend to not notice anything unless there is a monetary default or a major event of damage at the Premises.  It is understandable as both Landlord and Tenant are concerned with the operations of the business and the profits/payments associated with the same.  However, periodic review and discussion of any planned improvements can pay dividends to all parties.

 

3.  Is There a Mechanism in the Lease that Requires Tenant to Be Responsible for the Maintenance and Repairs to Fixtures and Improvements?

Hopefully so, but the Landlord also needs to check periodically to see what is going on in the Premises. Prevention is truly the best medicine.

 

4.  When Tenants are exiting the Premises, is there a means to determine who may have an interest in the Improvements?

Again, this admonition is key to getting ahead of many end of Lease issues. Surely there is no certain means to determine which items installed or placed in the premises are Fixtures or Trade Fixtures before the end of the Lease term or termination. However, an inventory and improvement list can be a tremendous help in resolving these issues before they become contentious.  Rarely are matters more maddening than a Landlord taking inventory of an upfitted Premises with a list of companies demanding payment for financing or installing items in the Premises.  Here a pinch of prevention will reap great rewards.  Who wants to fight with Lendors and Vendors when the Tenant has left or thrown up their arms and given up working with the Landlord?

 

As stated previously, there is no fullproof means to avoid these matters and disputes relating to Fxtures of all types.  Hopefully though implementing lease terms and procedural practices of the type described above can be of great use in reducing the problems that ensue during or after the Lease is terminated.