Leases frequently provide that either party can terminate them if damage is caused by a casualty in the last two years of the lease term. This could serve as an incentive for such a “casualty” to take place, and hence the question we ask. Yes, a cheap trick.
Last week, we opened this topic by ruminating about the “measure” to be used when figuring out just “how badly” a building or the leased space had been “damaged” in the context of whether either a landlord or its tenant can “bail out” of a lease. We suggested that the measure should be based on how long it would take to repair, not how much of the property or the leased space was affected (or even how much it might cost). While one reader asked, legitimately we might add, “why should a landlord be able to terminate the lease at all,” no one asked whether there was some threshold of physical damage, such as 50%, that would “change the game” such that it would be reasonable to relieve a landlord from the obligation to rebuild for the tenant. Other than what we’ll cover as today’s specific issue, we’ll try to cover those questions next time, pausing now only to say that we aren’t unaware of the impact of zoning or building code changes that might have taken place after a building was first put up.
Today, we’re going to look at only one facet of the “should a landlord ever be able to terminate the lease” question. It deals with the last “two” years of the lease term. That could be the last year or the last three years or whatever time period you’d like. In fact, the suggestion we’ll be making takes that selected period into account.
A good way to illustrate the reason why Ruminations thinks a landlord should be able to terminate a lease based on serious fire or similar damage toward the end of the lease term is the following. Suppose a building and the leased space within it are damaged by fire with only six months left in the lease term and it will take five months to restore them. At that point, the tenant will have but one month to go and it might take a month or more for the tenant to get ready to reopen, even if needing to do nothing more than re-fixture and restock. Does it make sense to rush the rebuilding to get it done in five months? Does it make sense to be locked into the “old” configuration for the building and leased space with only a month to go? Of course not – it would be an economic waste.
On the other hand, if the fire happened with two years to go, and it took a month to restore, there would still be 23 months of usable space. Even if the fire happened at the six month mark, if it would only take two weeks to restore the space, it seems pretty logical that the lease should continue.
Commonly used “lease language” doesn’t really handle these scenarios very well. What we usually see is something like this: “Either party can terminate this Lease if either the Demised Premises or the Building is damaged by fire or other cause within the last two years of the Term and the damage is to more than 40% of either the Building or the Demised Premises.” As we pointed out last week, you can flood 100% of the leased space and get back in business in five days. At the other end of the possible hypothetical situations, you can have damage to 35% of the leased space (assuming you can figure out what that really means) happening six months before the end of the lease term where it takes five months to restore the space. That’s what we described two paragraphs above.
So, what does Ruminations suggest? Try the following:
X. If, within the last two (2) years of this Lease: (a) the Building (including the Demised Premises) is damaged by fire or through any other cause; and (b) in the written opinion of a [Name of State] licensed architect who has at least fifteen (15) years’ experience in the design and architectural supervision of retail [or industrial, if applicable] buildings it would take more than twenty five percent (25%) of the number of days remaining in the Term (measured from the date of damage) to repair or restore the Building when acting diligently, then at the option of either Landlord or Tenant, which shall be exercised by notice in writing given to the other within thirty (30) days after occurrence of such damage or destruction, this Lease shall terminate and no rent shall be paid by Tenant for the period subsequent to the date of such damage or destruction; provided, however, that if at the time Tenant receives Landlord’s notice of termination pursuant to the preceding sentence Tenant shall have an option to extend the current Term for a period of at least five (5) years and if Tenant so exercises its option to extend within sixty (60) days after receipt of Landlord’s notice of termination, this Lease shall not terminate and Landlord shall be obligated to repair or restore as aforesaid (but subject to the provisions of [possible other limitations in the Lease – not any that say the tenant can’t exercise its option “too soon”]). If this Lease shall terminate as aforesaid and any rent shall have been paid in advance, Landlord agrees to refund to Tenant all rent so paid applicable to the period subsequent to such damage or destruction. Upon any such termination, Tenant and Landlord each shall be released from any further liability under this Lease for anything accruing or first occurring after the event of damage or destruction. In the event Landlord terminates this Lease as hereinabove provided and thereafter restores the Building within one (1) year from the termination of this Lease, Landlord hereby grants to Tenant the right to lease the Demised Premises for the balance of the remaining Term of this Lease, plus any unexercised extension rights set forth in this Lease, on the same terms and conditions as set forth in this Lease. Landlord shall notify Tenant when the Building is substantially restored and Tenant shall have thirty (30) days to notify Landlord of its election to lease the Demised Premises.
We are well aware that elements of our sample lease provision raise important business issues, such as the right to reoccupy some later constructed or restored leased space if the landlord terminates the lease (as a pretext to shed two years of less than market rent). Readers can “play with those.”
Astute followers of Ruminations will note that while the language suggested above is informed by last week’s suggestion that the obligation to restore be measured by the time it takes to do so, using a test measured by the number of days that would be left in the lease term incorporates an economic rent-based concept. We think that using this formula to determine how many “days” to use impliedly takes into account how much rent will be payable once the premises are restored. Factoring in the “economic” burden makes sense to us. Where there is a lot of time to go in the lease term, we believe the tenant has the greater economic interest in the space – it has built a business and had bargained to use this particular location until a given date. The value to the tenant of being able to stay in the space diminishes as the “end” of the term approaches. After all, the tenant’s amortization of improvements and locational good will are diminishing. If there isn’t a lot of time left in the lease term, it will have to move anyway. On the other hand, the landlord is being asked to restore the leased space as it was. If that costs a lot to do, its “economic” interest in when the lease ends increases as the expiration date looms. Basically, we see it as a balancing test of the two parties’ respective interests.
So, that’s why we have “switched” to “hybrid” test. We think there is a point in time in the critical analysis when “money” starts to play a meaningful role. Our approach today also respects the “time” element by using “time” as the trigger for the “switch.” It doesn’t have to be at the two year point. Though that is a common “trigger,” there are properties and situations where a shorter or longer “switch” point would make sense.
As always, Ruminations invites, yea urges, readers to pipe in by clicking where it says “comments” just below the headline to today’s posting.