Truth be told, the question Ruminations will really address is: “how much SHOULD a landlord be able to collect from an evicted tenant?” While our answer will be founded on legal principles, it will be based on the law of a fictional 51st state – Ruminamia. Its laws are those of modern states ruled upon by modern courts.
At the outset, we need get some language straight – we need to correct a very common misperception. After a lease has been terminated, if there would have been more time in its term but for the termination (think “eviction” or a lease termination by reason of the tenant’s default), the landlord DOES NOT COLLECT THE RENT OR ADDITIONAL RENT that would first have been due after the date of termination. It can collect rent and additional rent that should have been paid before the termination, but not any that was first due after the termination.
What the landlord collects are in the form of DAMAGES. The landlord is entitled to an award for the loss of its expectancy. It no longer gets the rent; it gets damages to compensate it for what it expected to receive. The two are not the same. Now, we’ll explain why (and then we’ll do a mathematical example).
Now, let us tell you something about our fictional jurisdiction – Ruminamia. It is a modern jurisdiction. In leasing parlance, that means it leans to the contract theory of leases and away from the conveyance theory of leases. Our good colleague Mark Senn touched on this topic in a recent article in the ABA-RPTE magazine -Probate and Property. Here, we’ll only scratch the surface (and barely at that).
A lease is an interest in real property in which a landlord conveys a leasehold estate to its tenant in return for a rent payment – think lords, knights, serfs, etc. Think back to when a leasehold was a non-freehold estate to which no seisin attached. According to our research, the word “lease” comes from Middle English les < Anglo-French (equivalent to Old French lais, French legs legacy), the noun derivative of lesser to lease, literally, let go (equivalent to Old French laissier ) < Latin laxāre to release, let go.
More importantly for us, in merry old England, landlords and tenants had very few obligations one to the other. The tenant had the obligation to pay rent and, in return, the landlord had two obligations: (a) to give its tenant exclusive possession of the premises; and (b) to promise quiet enjoyment [http://tinyurl.com/24zf2yt]. In fact, these were independent covenants, meaning, by way of example, if the improvements on the land burned down, the rent was still due and owing. You see, in merry old England, you didn’t have 84 page leases replete with covenants and conditions. The relationship wasn’t contractual – it was a deed of conveyance – essentially, the tenant owned the land for a given period of years.
Another important difference is that rent was paid in a lump sum, often at the beginning of the term. That’s important to remember – the rent was often payable up front. Monthly payments were a privilege. So, if a tenant abused that privilege, it was revoked and all the rent that wasn’t paid at the outset became due and payable.
Today, we have a much more complex society. Real property leases have become contracts. No one could challenge that statement, or so you would think. We’ve long forgotten that a tenant’s right to make monthly payments was only a privilege, or so you would think. OK, why does Ruminations emphasize “or so you would think”? That’s the key to the next couple of paragraphs.
This is the fourth and final (for now) exposition about “damages.” In earlier installments, we’ve pointed out that the primary remedy one has for a party’s breach of a contract is for the non-breaching party to be placed in the same position it expected to be in, had the contract not been breached. We’re talking “expectancy” damages, i.e., money to paid to the non-breaching party as compensation to make up that difference – to get it what it expected in the first place. So, if a landlord expected to collect, throughout a ten- year lease term, $1,000,000 above and beyond its costs, and its tenants “bails out” early (at the end of the seventh year) after paying only $700,000, the landlord would be $300,000 short of its rightful expectancy. That would be the measure of its damages. (Later, we’ll talk about incidental damages, being the out of pocket expenses the landlord will incur that it wouldn’t have incurred had the tenant not breached its lease by bailing out early.)
Here’s the rub and here’s what we meant by, “or so you would think.” Although at least 23 states fully recognize real property leases as contracts when it comes to calculating damage awards (and it isn’t clear where a bunch of other states stand), there are still some states with emotional and legal ties to merry old England. Those states, such as New York, measure these kinds of damages as if the lease was purely a conveyance and that the privilege to pay rent monthly had been revoked. Thus, in a conveyance theory state, landlord, in our example, would be entitled to the sum of $300,000. State after state are (slowly, we grant) moving from the conveyance theory to the contract theory, but the flow is only in that direction. That’s what makes “contract theory” into the “modern trend.”
Whoa, you say – so what’s the difference? Doesn’t the landlord get $300,000 under either approach – conveyance or contract? No. Here’s why.
Under the contract theory, a landlord, like any other contracting party, has a duty to mitigate its tenant’s damages. The non-breaching, contracting party (in our case, a landlord), cannot sit back and do nothing. In “contract theory – modern trend” states, such a landlord has to look for a replacement tenant or be treated as if it were looking for such a replacement. When its original tenant was evicted or the lease was otherwise terminated before the end of the lease term, the landlord got back an asset. In modern jurisdictions, such as Ruminamia, The landlord can’t let this asset sit idle and think its former tenant will have to keep paying the old rent.
Put in numerical terms, if, in the marketplace, the premises would rent for $300,000 for what would have been the remaining three years of the original tenant’s terms, then, by adding the $700,000 already paid to the $300,000 of rent from a replacement tenant, the landlord would receive its original expectancy of $1,000,000. If a landlord could collect $300,000 from the old tenant and then lease the premises for those same three years and get another $300,000, it would be collecting a total of $1,300,000 for the ten years instead of the $1,000,000 it had been expecting. Later down, we’ll do an example where the new rent is less than the old rent, so hang on. We’ve got to talk about present value first.
What is this thing called “present value”? Basically, it is the amount of money that, if paid today, would yield the same benefit as if it were paid in the future, installment after installment after installment. Assuming inflation, a dollar paid five years from now won’t buy the same amount of goods five years from now as a dollar paid today would buy. So, if someone owed you a dollar to be paid on September 16, 2017 and you got it today, you’d be ahead of the game. You could invest that dollar for five years and on September 16, 2017 you’d have (say) $1.10. That’s ten cents more than had you waited until 2017. Another way of saying this is that if you got (say) $0.91 today, by September 16, 2017, you’d have the dollar you were owed and nothing more. Mathematicians have a complicated formula (equation) to do this calculation, but you can go to http://tinyurl.com/2e5o73v and bypass the formula. If you try it out (remembering to put in a monthly interest rate), you’ll see that the result is always less that just adding up all the remaining rent payments.
Now, we’re ready for an example. Our example (and what we’ve said above) assumes that the lease in question doesn’t have an enforceable damages provision of its own – essentially, that the damages payable to the landlord are what the law of Ruminamia would otherwise provide.
Here’s our hypothetical:
- 10 year lease
- Rent is $1,000 per month (“all-in” after adding in taxes, operating expenses, etc.).
- Late charge is 5% of each unpaid rent installment.
- Tenant stops paying rent at the end of 6 years.
- Tenant is evicted at the end of the 7th lease year.
- The cost to repair what the tenant should have repaired, like a broken sink, is $500.
- Landlord either starts collecting rent 3 months later or gets a judgment 3 months later (that’s to simplify the example)*** [see below].
- The “new lease” is for 5 years, at $900 a month, and it cost the landlord $5,000 to get the new lease (attorneys fees, brokerage commission, leasehold improvements, etc.).
Here goes – here’s what the landlord gets in the modern state of Ruminamia:
A. One year’s old rent (to cover the 6th lease year) at $1,000 a month, or $12,000.
B. Late charges of $50 per month, being a reasonable liquidated damage amount to cover certain, but not precisely calculable, administrative costs, or $600.
C. The three months’ rent it lost before getting the new tenant or getting the judgment at $1,000 a month, or $3,000, and probably another $150 in late charges.
D. The present value of the remaining 27 months of lost rent ($100 a month because the landlord is now getting $900 a month instead of $1,000 a month), or (using the calculator with a 4% a year interest rate for the 27 monthly payments of $100 that would have been paid at the beginning of each month) $2,586.55 (not $2,700).
E. The “incidental” expense of $5,000 for reletting expenses, prorated monthly for 27 months ($5,000 divided by 60 months times the 27 months that were left), or $2,250.
F. Plus attorneys fees for the eviction, but only if the lease called for this type of damage award.
G. So, what’s the total? – $20,586.55. [Had it been a conveyance state, the lost rent alone would have been 4 years’ worth at $1,000 a month, or $48,000 plus incidental and other costs AND the landlord would be getting 27 months’ of new rent at $900 a month as well. So, there is a big difference.]
That’s what a landlord should be able to collect. Actually collecting it? Well, that’s an entirely different matter.
*** [This is what is to be seen "below"]. In our example, the reason it doesn’t matter whether the landlord found a new tenant at $900 a month or didn’t find a tenant by the time it goes for a judgment is because we are assuming that “had it found a tenant,” the rent would have been $900 a month (call that Fair Market Rental Value), and the landlord is going to be treated as if its defaulting tenant had already paid it back with an asset worth $900 a month.
Ruminations has run long, again and as usual. So, we’ll leave the questions of: (a) “what exactly is a landlord’s duty to mitigate” and “what if it breaches that duty”; (b) “what interest rate should be used to calculate present value”; and (c) “why prorate the re-letting expenses” for later postings.
In the meantime, if anyone wants to get a jump on answering those questions or taking issue with us on anything we’ve written, just jump away at: http://www.retailrealestatelaw.com/.