Don’t You Just Get Burned Up When Someone Wants To Misuse A Lease Provision As A Pretext To Get Out Of Their Lease?

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A couple of odd phone calls came to me over the past few weeks, both dealing with “damage and destruction” of leased space. One dealt with water damage following Hurricane Sandy. The other about a common provision dealing with “killing” a lease if there is damage in the last two years of the term. So, we thought we’d ramble about those two situations and also about the relationship between a landlord receiving adequate insurance proceeds and the obligation to restore the premises. Today, however, in the holiday spirit, we’ll stick to the Hurricane Sandy question. 

First, here is a prototypical damage/destruction provision commonly found in leases:

In the event that more than [pick your favorite fraction of 1/2 or more] of the gross leasable area of the Leased Premises shall be damaged or destroyed by fire or other cause, [Landlord or Tenant or either] shall have the right, to be exercised by notice in writing delivered to [the other] within sixty (60) days after such occurrence, to terminate this Lease.

Here’s the gist of the phone call: “What do you think? We have a shopping center with about 15 tenants. It has a 60,000 square foot supermarket and one other large space of about 15,000 square feet. Hurricane Sandy caused flooding of the both large stores and three or four of the small ones. Essentially, the water was four to six inches high. The supermarket cleaned-up, did essential replacements of wallboard and the like, and reopened after five days. The small stores have either reopened or will reopen in a few days. The 15,000 square foot tenant, a chain store that has been struggling at this location and to whom we had given a rent reduction waiver less than a year ago, has given notice that it is terminating its lease because its entire premises was damaged by an “other cause,” to wit: “flooding.”

We said, not very helpfully, “that language has always troubled us.” And, it has.

Basically, the amount of space affected test is wrong, though a vast number of leases use it. What has puzzled us is that those same leases “kind of, sort of, maybe,” understand this to be a problem, but think it is only a problem when the damage is to less than the “magic fraction” they’ve chosen for “total destruction.” What do we mean?

When the damage affects only a small part of the leased space, a lease typically aims to stay in force and to give the landlord “time” to restore the premises. The parties, recognizing that they only expect a temporary interruption, worry only that the restoration period will, for whatever reason, stretch out too long. So, they agree to a circuit breaker like, “but, if repair or restoration takes more than [say, 6] months, tenant may terminate the lease.” Funny, if the water floods 100% of the space’s floor area, the lease can be terminated even if the interruption is five days, but if 10% of the non-sales area is unusable for 182 days, the lease can be cancelled.

So, maybe there shouldn’t be a distinction based on how much of the leased space or of the rest of the property is made unusable by whatever “cause” you like. Perhaps, the test should always be based on some ratio of how long the work will take and how much it will cost to do. For the purpose of this “exercise,” we’ll suggest only that a party’s right to terminate a lease be based on how long the leased space will be out of service. That “outage” period would vary by the peculiar needs of a particular tenant and a particular property (or landlord). We assume that the landlord would have to begin promptly and diligently continue. As to the concept of using the cost of repair as a metric for resolving this problem, we’ll leave that until next week when we ruminate over the last two (or so) years in the term of a lease.

For those readers who are still troubled by the “or other cause” concept following “fire,” toss all of us Ruminations readers your comments by click the “comment” link just below this piece’s headline.

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  1. Randall Gunn says:

    I understand the frustration but, this has become almost common place in Florida and other traditional hurricane areas. Tenants are not changing, landlords in the Northeast are being impacted and thus will get more attention. Weather events become the excuse. Advise landlord clients to be proactive. so the tenant is not looking for a loophole. Landlord s have a need to meet financial returns. Ultimately you need to work with the tenants.

    By the way, not all tenants are saints. There will always be some bad actors who just look for angles. The “never let a crisis go to waste” crowd. Know your tenants. They will give indications for how they will act based on representation and reputation.

  2. Michael Bivens says:

    Nice points. Slightly off-course, another piece of insurance would be to add a claw-back on the “rent reduction waiver” granted to the tenant. Landlords should condition rent workouts so that if the tenant terminates for any reason (short of LL’s default), tenant would owe all waived/reduced rent. Tenants seeking lower rent might find this a fair gamble.

  3. Ira, a legitimate comment from the landlord’s side. Buy it cuts both ways. Why do landlord lease forms give the landlord a right to cancel the lease when there is more than 2 years left on the term and the damage may be 30% or even 50% of the replacement cost to restore (I agree that cost is better than area affected)? When I ask landlords this question, their response is “Well, who knows how we might want to reconfigure the shopping center after a destruction?”. I call that the “wheel and deal” response. The policy of a casualty clause should be to promote reconstruction following an insurable casualty and getting back to business. The exceptions should be (i) uninsurable casualties in excess of a certain amount of replacement cost, e.g. 10% or 20%, (ii) damage occurring during the last two years with 10-20% damage cost or would leave less than one year of the term remaining after restoration, (iii) damage occurring earlier than that but where restoration would spill over into the last two years and would leave less than one year of the term remaining, (iv) where restoration would otherwise take an unreasonably long period, e.g. 180 days. If you cannot achieve this goal, then the backstop protection would be a non-discriminatory cancellation clause where the landlord must cancel the leases of a certain number of tenants in the neighborhood of the Premises identified on the site plan, regardless of whether (x) their premises is affected by the casualty, or (y) their leases permit the landlord to cancel.

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