What should be the rules for the condition of leased premises when “returned” at the end of the lease term? Who should own the real property improvements? What about abandoned or allegedly abandoned personal property?
Ruminations thinks, in its vision of a “proper” world, the answers should be: (a) the tenant should return the premises in good condition and not have to restore it back to “day 1”; (b) in the normal situation, real property improvements should belong to the landlord; and (c) as to tenant’s personal property, it should have a reasonable opportunity to get it out, should repair the effects of the personal property having been there, and if the tenant doesn’t, it should reimburse the landlord for doing what the tenant should have done. Two caveats: (x) every deal is different, so don’t ever throw these “ideals” in our face; and (y) there are caveats and details below.
As to the “return” condition at the end of the lease’s term (or sooner), landlords’ form leases (for use with tenants having little bargaining power) often read like this:
Tenant shall return the Leased Premises at the end of the Term in the same condition they were in at the commencement, subject to reasonable wear and tear, and damage by fire and the elements.
In a tenant’s form of lease (where the tenant has bargaining power), you’re more likely to see:
Tenant agrees to deliver to Landlord physical possession of the Leased Premises upon the termination of the Term in good condition, ordinary wear and tear, damage by fire or other casualty or damages from any other cause (not directly attributable to the negligence of Tenant unless covered by Landlord’s insurance) excepted.
In our view, the only reason for the difference in concept is “bargaining power” because this is a purely economic issue. There is no moral right or wrong. Either the rent “covers” whatever work a landlord might need to do after the tenant leaves or it doesn’t. Given that the rent is really set by the marketplace (what is the rent across the street?), what the marketplace is saying is that the (already higher) rent paid by weak bargaining power-tenants doesn’t cover this expense, but the (lower) rent paid by strong tenants does. That, of course, shows that any other explanation is nonsense. Why should a higher rent-paying tenant have to restore its premises, while a lower rent-paying tenant doesn’t have to do so? With that as background, it seems to us that all the protestations by a landlord to the effect of: “but, I’ll have to do this; I’ll have to do that,” mean little.
A weak bargaining power-tenant is simply at the mercy of its landlord because, if the landlord wants to keep the new(er) restrooms and fire sprinkler system, but not the back manager’s office, it will tell the tenant – “I’ll save you some money; don’t rip out the rest rooms and put the old ones back in; just take down the office you built.” That’s more evidence that the landlord didn’t have the cost of “restoring back to the way it was 20 years ago” already in the lease, because the landlord couldn’t have known at the time of signing whether it wanted 50% of the tenant’s improvements upon surrender. In fact, landlords who fear that their tenants will respond, “I’ll tear out the restrooms and put the old toilets back in [yes, I found old toilets and lighting fixtures at a junkyard], and I’ll give you back the sprinkler-less space I got when I moved in, just like the lease says,” will use a lease provision like:
Tenant shall quit and surrender the Leased Premises in good and orderly condition and repair (reasonable wear and tear, and damage by fire or other casualty excepted) and shall deliver and surrender the Leased Premises to the Landlord peaceably, together with all alterations, additions, and improvements in, to or on the Leased Premises made by Tenant which Landlord elects to retain. Landlord reserves the right to require Tenant, at Tenant’s cost and expense, to remove any alterations or improvements installed by the Tenant and restore the Leased Premises to good condition, which right shall survive the surrender and the delivery of the Leased Premises as provided hereunder.
There are a fair number of general exceptions to the underlying premise behind these thoughts, best explained by pointing out that special purpose improvements are a “whole different thing.” You want examples? – How about bank vaults, sloped or tiered floors or theater seating? Make that deal right up front!
By the way, Ruminations thinks a good formulation is that the tenant must return the leased premises, “broom clean, in good condition, and free of occupants, fair wear and tear … excepted.”
Surrendering the leased premises at the end of the lease’s term or at any other time should not act as a waiver of the tenant’s prior maintenance and repair obligations unless that is the express agreement of the parties. Thus, if the tenant has failed to keep something in the condition the lease required that thing to be kept, the landlord should retain the right to seek damages by reason of the tenant’s particular default. Most often, these ongoing tenant obligations will be subsumed into the general concept of returning the leased premises in good condition, but where there were specific, higher standards required for certain items in the lease, the tenant should be held to its promise to keep those standards. Case law is a little confused over this point, and it might be wise for leases to cover this point explicitly by saying that the obligation to return the leased premises in good condition does not excuse tenant for failing to satisfy its maintenance, repair, and maintenance obligations under the lease. For example, if the lease requires a tenant to replace the HVAC unit every 10 years and it surrenders the leased premises at the end of 15 years without ever having replaced the HVAC unit, it shouldn’t be able to get off the hook by demonstrating that the 15- year old HVAC unit was in good condition and fine working order. That wasn’t the bargain.
When it comes to “who should own” any real property improvements actually put in by a tenant, it seems that all of the important “default” stuff in the world point to their being owned by a landlord. A building’s property insurance doesn’t distinguish between one wall and another or the old sink on the left from the new sink on the right. It doesn’t care who paid for the item or work. You have to do something special to exclude the supplemental HVAC unit from the property owner’s insurance policy. Similarly, the owner’s mortgagee is going to grab all improvements as part of the collateral. If there is a taking by eminent domain, it doesn’t matter who did the work, the owner gets the check.
Then, there are some practical issues, illustrated as follows. Suppose the tenant replaces all of the rest room fixtures (rest room fixtures being items of real property), why would any one think that, at the end of the lease term, the tenant would be taking a toilet with it and leaving a hole in the floor? When a tenant moves a wall between the front of the store and the storage area, wouldn’t the landlord be losing something (the old wall) if it didn’t get to own the new wall.
Why should it matter who did the work or paid the bill? Why would there be a difference between the tenant doing the work itself and the tenant paying its landlord to have the very same work done?
Ruminations concedes that “tax consequences” are often hard to figure out. Our default thinking has always been: “satisfy the business deal first; then, see what the tax effects might be and adjust the business deal, if really desired.” Yes, we think the business deal has primacy and if the tax effect is not central to the business deal, don’t start by crafting to make the taxes “happy.”
When it comes to a tenant leaving its personal property behind, either because the property is obsolete or because it would cost the tenant more to remove the property than the property is worth, Ruminations has a maxim: “Don’t make your problem into my problem.” Landlords should not have to get stuck with junk its tenant doesn’t want. Of course, the parties can make an agreement otherwise, up front, when they sign the lease. And, a landlord might volunteer to take the leftover personal property (think – pizza oven), but those possibilities rhyme with “consensual.” [Well, not really. Apparently, we have to work on our phonemic awareness skills.]
As a default (no, not a tenant’s default), a tenant should have its property “outta there” before the lease’s term expires, but it wouldn’t be unreasonable for a tenant to have an extra ten days (or so) if the lease is terminated before its expected expiration date. Forfeiture is an extremely harsh penalty and even courts should be willing to tell that to a landlord. Of course, the parties can negotiate over whether the tenant can have extra time to remove its personal property.
If a tenant doesn’t get all of its stuff out of the leased premises by the time it should have been removed, a question arises as to whether the property has been abandoned (meaning it has become ownerless and whoever gets to it first gets to keep it. Certainly, given the landlord’s control over the empty premises, that would be the landlord. If that were the end of the story, then we wouldn’t ramble on.
If you call the property “abandoned,” then what right do you have to charge the abandoning tenant to remove the property? What not charge the property’s owner? We guess that couldn’t happen because the property, by definition, is ownerless. So, to Ruminations, if a landlord wants to charge its tenant for removal and disposal costs, it shouldn’t be calling the property “abandoned.” If that is intellectually correct, then if the landlord asserts a right to pick and choose among the various items its tenant left behind, and wants to call the tenant’s failure to remove its property – a “default,” then the landlord has a duty to mitigate damages. Implicit is that mitigation is to make a commercially reasonable effort to “sell” the property and to “pay” the tenant for the fair market value of what it, the landlord, keeps for itself. Yes, we know this is heresy, but on an intellectual basis this makes sense. To further this “rumination,” it would then seem that any lease provision to the contrary should be tested against the criteria used to validate a liquidated damages provision.
Tenants, you can’t leave holes in the floor! Leases typically say that a tenant shall remove its personal property and repair the damage caused by its removal. A better formulation might be that the tenant has to repair damage caused by the property’s “removal, presence, and initial installation.” That would mean that when the tenant removes its exterior store sign and the now uncovered wall behind the sign doesn’t match the rest of the wall, the wall has to be fixed. You can create your own examples.
Lastly, for this rant, don’t forget that certain kinds of property might need some forethought while the lease is being negotiated and the parties are still lovey-dovey. One example should be enough. What do you do with the floor studs when you remove theater seats? Do you cut ‘em “close” or do you drill them out and fill with epoxy? Perhaps, something in the middle. Work those things out before the seats are out and the floor is unusable and expensive to restore.