Enough with the “self-help” already, but not before we address every reader’s favorite commodity – “money.” When a tenant does what a landlord is required to do, but didn’t (or a landlord does what the tenant should have done, but didn’t), the motive isn’t charity. Whatever was “self-helped” has to be at the expense of the non-performing party.
Just because repayment is expected and deserved, no one should be expected to write a blank check, even if that signatory brought about the situation itself. The work that was done should be necessary and the cost of doing it should be reasonable under the circumstances. That’s a two-part test that needs to “passed” before the non-performing party should be obligated to pay up. One the test taker (the self-help exercising party) gets a passing grade, the non-performing party should make its payment within a short period of time. The amount owed should be treated as if it were an “extension” of credit; and the time for payment should be based on reasonable administrative needs. Ten to twenty days should be appropriate in all but the most unusual of circumstances.
Ruminations will now take a slight detour to point out something that many lease drafters overlook. This point is important for more than just where a party has incurred an expense that properly should have been incurred by the other party. We’re talking about the difference between: (a) “will pay”; and (b) “will reimburse.” When a lease or other agreement requires one party to pay the other party for the expenses incurred by that other party, there is no requirement that the recipient have first paid its bills. When the provision calls for “reimbursement,” the party being reimbursed will first have to have to pay the underlying expense.
Let’s give an example. Suppose a tenant, exercising its self-help rights, incurs a $100,000 expense to replace a roof section and has 60 days to pay the bill. If its landlord is obligated to pay it for the incurred expense and the payment is due 20 days after the landlord gets a copy of the roofer’s bill, the tenant will have the landlord’s money before it has to advance its own. [That assumes that a non-performing landlord will actually pay within 20 days.] If the landlord’s obligation is to reimburse the tenant within 20 days, the tenant will need to pay the roofer before demanding money from its landlord. For small expenditures, it isn’t material which word is used; for large amounts, it is.
A self-help exercising party should not have to go “out-of-pocket” for doing something that the allegedly non-performing party was obligated to do in the first place. To be made whole means recovering not only actual out-of-pocket costs, but also being compensated for “lost” costs.
In order for the party exercising self-help to be fully compensated, it should receive interest on the amount the non-performing party is obligated to pay. If the performing party has paid before getting reimbursed, interest should run from when the bill or bills are paid. When choosing to call for “payment” or “reimbursement,” that concept needs to be considered in the document drafting process.
[As we proceed, for simplicity, we’ll use “reimbursement,” but that’s not our endorsement of that approach.]
Although rarely (i.e., close to never) seen, if a tenant does what its landlord should have done, it should be compensated for administrative (internal) costs. After all, if the landlord had done what it was supposed to do, the landlord, not its tenant, would have had those expenses itself. Of course, what’s good for the goose should also be good for the gander. Though drafting a “perfect” provision is impossible, one shouldn’t ignore this economic reality. A deemed percentage-style administrative fee would be appropriate. Beggars can’t be choosers.
Let’s return to a point made above: just because a non-performing party has “caused” the other to step in and spend money doesn’t mean that it’s “open checkbook” time. First, the self-help performing party is only asserting that the other has breached some obligation. If that threshold test isn’t met (i.e., there really wasn’t a breach) there is no reason to allow for reimbursement. That’s probably obvious. So, there needs to be some mechanism to adjudicate that question if it arises.
Assuming that there really was a breach of the kind that the self-help provision was designed to address, will every expenditure by the self-helping party be reimbursable? Ruminations thinks not. We think that only those that are both reasonable and necessary are appropriate. Most readers are familiar with the “reasonableness” criterion, but how many use “necessary” as a criterion? There may have been a breach that needs rectification, and the cost incurred by the curing party might be reasonable, but was the cost necessary? Did the self-helping party need to engage a food truck to feed the workers? Yes, the food truck’s pricing may have been more than reasonable, but was the expenditure necessary?
At this point in today’s blog posting, we’re looking at a provision that includes text like: “Landlord (or Tenant) must reimburse (pay) Tenant (or Landlord) for: (a) Tenant’s (Landlord’s) reasonable and necessary out-of pocket cost to cure Landlord’s (Tenant’s) breach; and (b) an amount equal to 15% of (a).” If the party doing the work intends to perform it with its own labor (and that’s probably not a good idea), then the lease should contemplate this and the concept of “out-of-pocket” will need to be changed.
These reimbursements are not self-executing. If the alleged breaching party agrees that the cure effectuated by the other party was appropriate and agrees with the “bill,” then there is no issue. If not, a means to resolve the conflict will be needed.
To begin with, if a party wants to be reimbursed, it should certainly let the other party know what it wants and why it wants it. The request should be accompanied by reasonable back-up material: third-party bills, proof that the work was done, proof that preliminary notices had been properly sent (or received), etc. It would probably be a good idea to require the party upon whom the demand has been made to object (by notice) before payment would otherwise be due or lose that right.
Assuming that a notice of objection has been sent, either party should be able to initiate a “dispute resolution” process. In most cases, the dispute will be a narrow one and arbitration would seem appropriate. Ruminations has not yet perambulated on the “great debate,” whether it is better to arbitrate or (suffer the slings) not to arbitrate, but readers should know that this isn’t an all or nothing choice in our mind.
So far, advocates for landlords and advocates for tenants probably are on the same page. After all, who could argue that, at the end of the day, if there is a dispute over necessity or reasonableness, use of a third-party is an appropriate means to resolve it. BUT, what about the money? One party or the other has spent money it now thinks is owed to it by the other. Here, a landlord would seem to have the upper hand in that they have a special weapon: they can get a tenant evicted for not paying rent, and money owed to a landlord beyond the basic or minimum rent is still a form of “rent.” Eviction is a draconian remedy for a tenant. If the disagreement was a good faith one as to whether the tenant really was in default or whether its landlord had the right to exercise self-help under the circumstances or whether the landlord’s expenditures were reasonable and necessary, why should a tenant be punished with loss of its lease just because it loses those arguments 49 to 51? Let the disputes be resolved first (by arbitration, for example) and then if the tenant doesn’t pay, throw the bum out.
On the other side of the mirror, if the landlord turns out to legitimately owe its tenant “self-help” money, why should the tenant have to keep sending money (e.g., the rent) to the landlord when it, the tenant is owed money by is landlord? A tenant should have the right to “offset” its expenditures against rent otherwise due. That’s especially true when the root reason why a landlord has not “performed” is that it didn’t have the money to do so. The rent is supposed to cover the cost for a landlord to perform its obligations. That means the bargained-for landlord’s work was already “paid for.”
Landlords commonly (actually, nearly always) cry that their tenants shouldn’t be able to unilaterally withhold rent. Ruminations appreciates such a concern, but the case we’re talking about is where the tenant has actually spent money. To us, that’s a pretty good indication that the desire to “offset” is in good faith. If ultimately be adjudged to be unjustified, it’s not like the tenant had just decided not to pay its rent. After all, it is out-of-pocket. If the tenant just doesn’t have the money to pay rent AND was mistaken about its self-help right, then it will be evicted. And, the landlord, whether the roof needed repair at that time or not, can both evict the tenant (granted, with some delay) and have a moderately better roof as well.
There is no right or wrong here. For that reason, it wouldn’t be inappropriate for the tenant seeking reimbursement to post the amount it seeks to offset with a third party, akin to an escrow agent. That way, the landlord will have a ready source of funds against which to collect if the claimed offset is unjustified, and the tenant will be able to get its money back (and thus be reimbursed) if it turns out to be right.
To avoid having the sword of Damocles (not, not Judas Priest’s) fall on a tenant, a lease should provide that the landlord can’t seek eviction in the disputed self-help situation until an arbitrator has ruled against the offset-claiming tenant and the tenant has not paid what the arbitrator ordered to be paid.
There are some complications. For one, it doesn’t help a tenant to hold back so much money that the property’s mortgage can’t be paid. That’s the basis of a nearly universal cry from a landlord: “My lender won’t allow offset.” In our experience, that’s not true in most cases. Lenders don’t say that. What a lender wants is for the mortgage payments to be made. Nonetheless, it is common for a limit to be imposed on offset amounts, often no more than 30% to 50% of what the rent payment should have been. Why these limits are commonly measured only against basic rent has always been a puzzle to us, and remains so. The other puzzle is why setting a limit should be “universal” practice. Ruminations understands that a single tenant property could not bear having the rent flow cut by even 30% because, commonly, that would reduce the received rent to below what is needed to service the property’s mortgage. But, why should a tenant accounting for one percent of a property’s rent be limited in the amount it can offset. In fact, those tenants are often the ones least able to both pay the rent and pay for what their landlords were supposed to do.
Tenants need to concern themselves with what needs to be done if, with or without a limit on the amount of the monthly offsets, there won’t be enough lease term left to recoup their expenditure. To address that possibility, a lease might (should) give the tenant an option to extend the lease’s term until all of the expenditure has been recouped.
Well, we’re left with one other important concern – “What about the lender?” Will a lender allow offset? Of course, tenants should read all of the documents that trump their lease, such as mortgages and assignments of leases. Our experience however, is that these do not bar a tenant from legitimately withholding or offsetting against rent. That, however, is not the end of the story. After all, if the landlord isn’t performing its duties under the lease, there is a reason for it. That reason is usually lack of funds. That means there is a good risk that the landlord is not paying its mortgage and its lender (and the lender’s successor) will be the next landlord. All tenants should have a non-disturbance agreement with their landlord’s lender; many, but far from all do. For a discussion of such agreements, click HERE and HERE and HERE.
A common point of contention in negotiating a non-disturbance agreement with a lender is whether the lender (and the successor landlord becoming such through the lender) will honor any remaining, untaken offset. Ruminations strongly feels it is appropriate, in most cases, for the lender to bear this cost. That’s because most of a tenant’s self-help expenditures also benefit the lender. If work needed to be done, such as a roof repair, the lender would need to do the work to protect its collateral. If not the lender, then the successor landlord would need to do so. If the tenant paid the taxes, the lender didn’t have to. The ins and outs of this issue are amply discussed in the three previous postings accessible by clicking the links at the end of the preceding paragraph.
This is not the time to get into a discussion about “personal” obligations of a landlord to a tenant, such as indemnification obligations (e.g., for a personal injury damages paid by the tenant where the landlord should have paid them). Such “personal” obligations are probably something about which a lender legitimately could object as far as allowing a rent offset to continue after the lender steps into its borrower’s shoes. That’s a topic for a later posting revisiting the very fine points of a non-disturbance agreement.
For those who are exhausted with this topic – LASTLY – way back (two weeks ago), we suggested that a tenant be given the right to pay such items as property taxes if its landlord didn’t and the lease could be lost. Of course, if the lender pays the taxes (as would be very, very wise to do), the tenant won’t have the need to do so. But if the lender can’t get its act together (a not so uncommon lender malady), the tenant might have to step in. What the tenant wants to guard against is paying the taxes and then having the lender foreclose on its borrower (i.e., the landlord) because the landlord failed to pay property taxes (maintain the property, get rid of liens, and who knows what else). If the tenant doesn’t have an effective non-disturbance agreement, it could find the taxes fully paid (because it, the tenant, paid them) and still be out on the street because its landlord defaulted on its mortgage obligations. So, the lesson is that tenants need non-disturbance agreements or, at a minimum, some agreement with the property’s lender that will avoid the horror just described.
Yes, we’re sure there was more that could have been said. We’ll leave that for loyal readers to say. Join the discussion by adding your comments below.