Wave The White Flag – “I Give Up” Agreements For Landlords and Tenants

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Surrender really does mean, “I give up.” And, that’s the case in war and also with respect to leasing. Draw any other connections you’d like, but do so on your own.

At the end of a lease’s term, the tenant is required to “surrender” the leased premises. Yes, “give it up” to the landlord. Though leases may say that directly, there really isn’t any need to do so. That’s just the way it works. All we are going to say about this case of an ordinary, implied surrender is that wise people write down, in the lease, just what the tenant’s return obligations will be – “what condition the leased premises must to be in at the end of the lease’s term.”

Today, we’re going to ramble about early lease terminations and how that relates to the concept of “surrender.” There are basically two ways an early surrender comes about: inadvertently; and by negotiated agreement.

Before Ruminations elaborates on each of those possibilities, we’re going to cut some reader’s thoughts off at the pass and lay the foundation for our later discussion of written surrender agreements. [BTW, Hedley Lamarr just hates that cliché!!] Here’s what we had in mind. If a landlord and tenant agree that the lease will end before its originally contemplated expiration date and it is agreed that the tenant can just “surrender” its space, all they have to do is agree that, for some consideration (in jurisdictions that still look for “real” consideration), the last day of the lease term will be changed from what the lease said it would be to a different, agreed-upon earlier date. Then, all of the party’s respective rights and obligation would be exactly the same as if that had been the original expiration date in the lease.

“But it could be so simple, (you were thinking); Life should be that simple, (Who would have thought it); I wish it were just so simple, (don’t know what you were thinking); But the point’s been missed, You’ve made a mess; Who would have guessed. That it’s as simple as it seems.” [Katy Perry – “Simple”]

The hallmark of a lease is that it gives the tenant the right to exclusive possession of the leased space. If a landlord takes back that possessory right without reserving its rights, either in the lease or by a later agreement or pursuant to a governing law, it might find that it has allowed its tenant to get off the hook [not as in “Them shoes are off the hook dog”] from and after the day that happens. One common way for this to happen is by the tenant vacating the space, offering the keys back to its landlord, having the landlord just take them, and then having the landlord proceed as if it now could do with the space as it pleases. In effect, such a tenant has “surrendered,” and the landlord has accepted, the leased premises, with the result being that the lease term has ended as effectively as if the lease had set that date as the last day of the term.

The outcome of such a scenario is that the landlord appears to have willingly agreed to end its relationship with its tenant. Though a “voluntary surrender” by reason of how the parties act toward each other requires a showing that it was the party’s intent to effect a surrender, when a landlord takes the keys and acts as if the tenant is no longer in possession, there’s a pretty good inference that the landlord was finished, even economically, with that tenant – hence, a “surrender.” So, if a tenant “forces” the keys on its landlord, that landlord, if it wants to avoid an implied “surrender” and still keep its tenant on the hook, had better make it pretty clear that it isn’t accepting return of the leased space and is only taking the keys to protect the property while the tenant is “missing” and is going to re-let the space for the tenant’s account. The physical act of transferring the keys is pretty symbolic of an intent on the part of both landlord and tenant to sever their relationship.

Wise landlords expressly utilize a lease provision that says acceptance of the keys does not work a “surrender,” much like saying that acceptance of less than all that is owed does not constitute an “accord and satisfaction.” [If that term makes no sense to you, look it up.]

There are other ways to work an inadvertent surrender, such as a landlord retaking leased premises that have seemingly been abandoned and treating those premises as if the landlord has the right to occupy them and then letting others do the same.

That’s the general principle. Differing states laws will create different results. What we have written is good, old common law.

Now, to the real task at hand, dealing with the voluntary surrender and what such agreements might cover.

It wouldn’t be very smart to jump right into a list of concerns to be covered in a “surrender agreement” before noting that such agreements reflect the relative bargaining power of the landlord and its tenant. That balance is not as nearly related to the financial strength of the parties as to what each party seeks to get out of an early end to a lease. In some cases, a landlord is buying its tenant out, such as when the landlord wants the tenant’s space to make room for an expanding next-door tenant or for a new tenant who wants a large space. In some cases, a tenant has offered up an assignee or a subtenant and the landlord, for a variety of good reasons, just wants to do a direct deal with that prospective transferee. Sometimes, a tenant will be paying its landlord for the “surrender,” and, in other cases, the landlord will be opening its wallet. Readers can make their own lists.

Basically, the reason for having a surrender agreement that says anything more than one party might be paying the other to end the lease and then amending the lease to change its expiration date, is that the parties want to change their respective end-of-lease obligations. The most common reason for one party or the other to want to change those post-term obligations is get some level of certainty and allow itself to “move on,” to eliminate contingent liabilities. Most often, however, the fear of contingent liabilities lies with the tenant.

Some changes are pretty innocent. Those include a final resolution of the payment of basic rent: “Tenant will pay landlord $X in full and final consideration of Tenant’s obligation to pay Basic Rent pursuant to the Lease.” Another example might be: “Landlord waives any and all rights it may have to require Tenant to remove any real property improvements Tenant may ever have made to the Leased Premises and Tenant no longer will have the right to remove or alter any of the Leased Premises’ real property improvements.” Each, of course would arise out of the “business deal” that had been struck.

Everything is part of a business deal, some items more clearly than others. The easiest category to address is that of outright financial obligations. Ruminations has already covered the primary financial obligation in a lease – basic rent. What about pass-through items such as a tenant’s obligation to pay taxes or operating expenses or the landlord’s insurance premiums (if not included in operating expenses)? Basically, there are two subcategories – the liquidated portions and the unliquidated portions. Where the amount of a pass-through item is fully known, the surrender agreement needs to say something like: “Tenant will pay landlord $X in full and final consideration of Tenant’s obligation to pay Tenant’s Pro Rata share of Taxes pursuant to the Lease.” But, what about the common situation where the taxes for a given period are not fully known, such as in the early months of a tax fiscal year taxing jurisdiction where the tax bills are still based on estimates based upon the prior year’s taxes? Everyone knows the taxes will be greater once the taxing authority gets its act together. Simply speaking, as a business matter, the parties could agree to do a post-surrender reconciliation, but, as simple a solution as that would be, it is inconsistent with what the parties wanted in the first place – closure. So, in most cases, a landlord and its tenant will negotiate and “pick a number.” The same could be said for similar items, so we won’t say it.

The parties will want to deal with whether a tenant should be paying back part of a tenant allowance the landlord may have paid at the outset of the lease with the expectation that the landlord intended to amortize or absorb the entire amount over the intended lease term. Or, it might deal with allocating the brokerage commission paid by the landlord with the expectation that the lease would have played out until its intended expiration date.

There are other financial or financially-related item that are characterized by  reasonable certainty. The tenant’s restoration obligations are one example. The disposition of a security deposit (and dealing with interest on the deposit if the lease called for it) is another. In some cases, the parties might agree that certain fixtures, such as a pizza oven or walk-in box might remain behind even though the lease would have demanded otherwise. That could be in return for a payment, or not. Wiring might be another area that needs (or wants) to be addressed. Basically, it would be wise, now that “the end is near,” for the surrender agreement to re-write the restoration-surrender provisions of the lease. After all, whereas at the outset of a lease there were a lot of “if, ands, or buts” when it comes to what the leased space might look like ten years down the road, that isn’t the case at the time of a surrender agreement. Then, much of the uncertainty is gone. Basically, if the parties care, the surrender agreement might only need to leave, as uncertain, the specific obligations the tenant would have as to post-agreement date damage: latent, reasonably undiscoverable damage or that caused by the initial installation, presence of or removal of the tenant’s property, including signage.

In some cases a landlord and its tenant may be in the middle of a lease dispute, such as  a claim that one party has harmed the other. That could be a claim that the landlord has allowed another tenant to violate the now-departing tenant’s exclusive use rights, or it might be a dispute over whether the tenant had caused damage to the property or to another tenant’s business. Presumably, if the surrender arises out of a resolution of such a dispute, the surrender agreement would say so and end the claims. That, however is only the tip of the iceberg. What each party, perhaps the tenant to a larger degree, wants is to cut off all of those known claims and also yet unknown claims. For that reason, surrender agreements almost always include a mutual release of known and unknown claims as of the date of the agreement itself (not as of a future date, such as the actual surrender date).

That leads us to the last primary category: the yet unknown. The two major items in this category are unmade claims by third parties (think “tort” claims such as those arising from an accident at the property) and potential environmental damage done by the tenant (though it would be wise to think about what the landlord or another user of the property might have done that could drag the departing tenant into a lawsuit or into an administrative proceeding).

Where one party or the other is unwilling to be the sole risk-taker as to potential third party claims, the surrender agreement needs to re-write or “save or reserve” the lease’s indemnity and insurance provisions as to these potential, but yet-unknown claims. That Ruminations isn’t a big fan of such a solution because that each party should always carry its own insurance for such claims, won’t persuade some business people or, more likely, their overly conservative (we would argue) legal counselors. That’s why they play the game. Whatever one’s philosophy might be, the question has to be answered: “Are the landlord and the tenant going to waive these claims and release each other or are they not?” You can’t ignore this when crafting a surrender agreement.

A similar question arises as to possible environmental contamination. Though a remote possibility, even a 900 square foot dress shop could be a “violator” if it had been pouring bad stuff into its restroom drain. Most, however, would discount that possibility is such a situation and not carve out environmental claims from a surrender agreement’s general release. On the other hand, in the release of an industrial tenant or, more likely for the majority of Ruminations readers, release of a dry cleaner with an in-store plant, you can’t ignore the issue or blithely subsume the environmental risk issue in a general release. The smartest, but most expensive, approach to reduce uncertainty would be to have an environmental assessment done before a surrender agreement is executed. When the parties are concerned about the issue, but for one reason or another aren’t concerned enough to spend money on such an assessment, they MUST deal with the risk in the surrender agreement. Again, that needs to be done by rewriting the related lease provision, this time with hindsight instead of foresight.

Fear not, the end (of today’s posting) is near.

A surrender agreement has to deal with a tenant holdover. The treatment will differ depending on whether the landlord or its tenant is the one who asked for the lease to end. If the tenant is “buying out” of the lease, some form of: “if you don’t leave, we’ll just act as if the surrender agreement was never executed and you’ll have to stay” approach is warranted. If the landlord initiated the surrender, its remedies might be not having to pay the “surrender price” or some part of that price. The potential damages to the landlord will be better known at the point of the surrender than they would have been at the outset of the lease. So, the damage formula or a negotiated liquidated damages amount is more tenable (or, less theoretical) than it was when the lease was first signed. The tenant should be less uncertain as to whether it can get out on time, and the landlord knows better what the immediate future will hold. So, the surrender agreement should “rewrite” the lease’s holdover provision.

Just like there might have been claims from one or more brokers related to the origination of the lease, there could be claims related to the end of the lease. Therefore, unless not factually correct, the surrender agreement should have a mutual “no brokers were involved” provision and a related indemnification provision. If there was or were brokers, the surrender agreement should properly reflect the party’s respective payment obligations.

Another possible post-termination problem might arise out of one party or the other failing to obtain approval from lenders or others whose consent to the lease termination might be required. A surrender agreement needs to address that possibility unless the parties are sure there are no such pre-conditions or that they have been satisfied.

We’re going to sign off now, but not before tossing out a hand grenade. And, we’re not going to call the bomb squad either. Readers will need to take on that responsibility for themselves. So, Ruminations is leaving its interested readers with a homework assignment. Your surrender agreement might not survive a bankruptcy filing. The surrender might be valid, but one party or the other (almost always the landlord) might find itself obligated to give the money back. It could be possible to characterize payments in a way that would avoid that result, but recent cases have made the problem into a large camel and the escape route into a size 12 hand sewing needle. The homework assignment? Research the bankruptcy issue for yourself. You might start by looking at  Midwest Holding & 7, LLC v. Anderson, 387 B.R. 892 (N.D. Ga. 2008), which can be found by clicking HERE.

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