Everything Is Money In A Lease, But We Argue Mostly About Allocation Of Risk

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Money, that’s the only reason a landlord and its tenant do business with each other. There are some items that, by something that approaches natural law, are firmly in the court of one or the other. For example, landlords are expected to pay their own mortgages. Tenants are expected to pay their own employees. There may not be a lot of other examples. For instance, at first blush, one might think that the tenant gets to keep its sales revenue. That’s often true, but what about percentage rent clauses?

Brother Ali, in his “Say Amen,” might claim that the “last thing I do is overstate the obvious,” but Ruminations isn’t a rap performer. So, we’ll tell readers that a lease has four basic kinds of provisions: (a) rent and rent-like provisions that require the tenant to pay money to the landlord (and sometimes the reverse – landlords paying money to tenants in the form of allowances and the like); (b) ones that require one party or the other to perform duties, either to actually do things or to buy outside services, such as insurance; (c) ones that make one party or the other pay for the consequences of its own acts (or omissions where it had a duty to act); and (d) ones that allocate the risk of bad stuff happening.

We’re going to Ruminate about item (d), allocation of risk. Basically, what’s involved when negotiating, as between a landlord and tenant, is the question of who should take the risk of bad things that happen when those bad things were in no way caused or aggravated by either one of them. The example we will use this week comes from Hurricane Sandy, but it could have arisen from last week’s incomprehensible events in Boston or in West, Texas.

Today’s topic had been on our “list” for quite some time, but it wasn’t until we saw this (http://tinyurl.com/c28df5o) unpublished “Informal Opinion and Decision” in a humdrum (no, not the animated short) residential eviction case, that we knew the “time was ripe.”

Basically, a landlord went to a New Jersey landlord-tenant court to get an order of eviction against a residential tenant for non-payment of rent, specifically for half of November, 2012. The tenant, represented by counsel, raised a number of defenses, all associated with Hurricane Sandy. You could sum them up as saying that the landlord should have borne the risk that Hurricane Sandy knocked out the power for two weeks, thereby making the apartment “uninhabitable.” Phrased more “legally,” the argument was that the landlord, because of this hurricane-caused loss of power, had breached the (residential only) “implied covenant of habitability.” Simply put, the tenant argued he “shouldn’t have to pay for something he did not receive.”

In New Jersey, a breach of that covenant, where the facts don’t support a valid “constructive eviction” claim, gives a residential tenant the right to “repair and deduct” As more commonly applied, it allows a residential tenant to take a partial rent abatement based on the degree of impairment.

That’s the background. What intrigued us was: (a) the judge, a jurist we know (by reason of his prominence), is very smart and also very wise; (b) New Jersey courts lean over backwards to help residential tenants, but this one didn’t; and (c) here, a landlord-tenant judge actually cited law (beyond the same old formulistic pronouncements) in a residential matter.

So, why is this relevant to commercial real property leases? Our take is that if a very talented and experienced landlord-tenant court judge is going to tell us why a residential landlord isn’t going to assume the risk of an event over which it had no control to stop or (reasonably) to mitigate, no judge would do so when the combatants are a commercial landlord and its commercial tenant.

The court began by citing from New Jersey’s seminal “remedies for breach of a residential implied covenant of habitability” case, known as Marini. Since not all of Ruminations’ readers have the same understanding as to what this implied covenant means, we’ll start with the quoted explanation. It is:

a covenant that, at the inception of the lease, there are no latent defects in facilities vital to the use of the premises for residential purposes because of faulty original construction or deterioration from age or normal usage. And further it is a covenant that these facilities will remain in usable condition during the entire term of the lease. In performance of this covenant the landlord is required to maintain those facilities in a condition which renders the property livable.

This actual covenant doesn’t apply to commercial tenancies in New Jersey or, to our understanding, anywhere in the United States. We are reproducing it as an example of an entire class of possible “implied covenants.” [By the way, a bare bones equivalent of “covenant” is, “promise.” Thus, an “implied promise.”]

At this point, most readers could reasonably ask – where is Ruminations going? Well, this was exactly the point in our rambling where we were going to tell you. Basically, parties to a contract are bound by what they promise to each other (“express covenants”) and the promises that the law implies as having been made by them (“implied covenants”). So, if the parties don’t say “who is responsible for what” in their contract (and, a lease is a type of contract), the law might answer the question for them. By way of example, if the lease doesn’t say who has what duties when the electric company’s power lines are cut down the street, they law might say: “the landlord has to pay this and do this; and the tenant might have to do this and pay this.” How would the court know? It would see what the situation and the relationship “implied.”

How does a lease covenant get “implied”? Here is what the New Jersey court said:

A covenant in a lease can arise only by necessary implication from specific language of the lease or because it is indispensable to carry into effect the purpose of the lease. In determining, under contract law, what covenants are implied, the object which the parties had in view and intended to be accomplished is of primary importance. The subject matter and circumstances of the letting give at least as clear a clue to the natural intentions of the parties as do the written words. … Terms are to be implied not because ‘they are just or reasonable, but rather for the reason that the parties must have intended them and have only failed to express them * * * or because they are necessary to give business efficacy to the contract as written, or to give the contract the effect which the parties, as fair and reasonable men, presumably would have agreed on if, having in mind the possibility of the situation which has arisen, they contracted expressly in reference thereto. [Emphasis ours.]

Pay attention to the bold, underlined text above. Basically, it says that if you don’t write the rules down for yourself in a lease (or other contract – which could be a mortgage, purchase agreement or one of a lot of other kinds of agreements), then the courts will GUESS what you had in mind or, more often, what it thinks you would have had in mind had you taken the time to think about it.

In the case as hand, the court ruled that the landlord had done nothing, affirmatively or by omission, that would have entitled its tenant to rent relief. Basically, it felt that had the parties thought about it, they wouldn’t have negotiated any rent relief for the tenant, thereby placing the risk of a hurricane-caused power loss on the tenant. That’s not to say that this New Jersey court would absolve a landlord in every situation where the landlord was not the cause of the problem. This particular court understood that there are circumstances where it would be implied that a landlord has a duty to ameliorate the situation – call that, act to mitigate its tenant’s damages – just not here. In that regard, the court said:

I can easily conceive of conditions that would justify an abatement because the conditions would substantially and negatively affect the reasonable use and enjoyment of an apartment and because elimination of those conditions would be within the reasonable control of the landlord. Examples would be a consistent foul odor or unreasonable, excessive and continued noise from another apartment (when the landlord might be able to have the tenant creating the consistent foul odor or noise evicted based on disorderly conduct) or an animal in the attic.

So, what is the point of today’s message. It is a simple one: if you don’t want a court guessing what you would have agreed-to, had you thought about a potential “neither party caused the problem” situation, put your own agreement in the lease (or other kind of contract).

We’ve overstayed our visit this week. So, if you return to Ruminations next week, you’ll see what we think the appropriate resolutions for common “nobody’s fault” risks might be.

If you’ve gotten this far in today’s Ruminations, you are probably a loyal enough Ruminator to be interested in the following. Howard Kline, host of CRERadio, has invited us to join him and David Ezra in a discussion of insurance issues in commercial leases. The show, about an hour or a little more, will be broadcast in real time on Friday, April 26 starting at 3 pm EST (which is noon PST, and you can figure out the rest yourself). It is at www.CRERadio.com and podcasts will be available shortly after the show’s conclusion. David Ezra is a California attorney with enormous experience in insurance issues. Join us, if you can.

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