Exculpation Clauses – Why?

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This is only going to work if we all agree not to get emotional or react by reaching to our knees and jerking them.

Landlord exculpations clauses are a given. They are ingrained in our tradition. They aren’t going away. But, do they add anything to a lease any longer? Are they fairly drafted once the parties agree or concede that a lease will have one?

What are “exculpation clauses”? Well, they aren’t really clauses “exculpating” anyone, because they don’t really absolve, pardon or excuse a mistake or breach. If they did, then there really wouldn’t be a monetary claim to pursue. They just limit the source of funds that can be reached if the landlord owes money to the tenant. What they weren’t called “damage limitation” clauses, I don’t know. Maybe, that would have been too clear.

A lease is going to have an exculpation clause. In what must be more than a thousand leases covering well over 15,000,000 square feet of space, I have only seen one lease without a landlord exculpation clause, and the landlord wouldn’t sign that lease. A state liquor agency, negotiating in-house for a retail location, would not accept the concept. The landlord was an old-fashioned general partnership, and wouldn’t take the risk of a tenant reaching into a partner’s personal assets.

That wouldn’t happen today. The landlord would have been organized as a single purpose limited liability company. Why is that important? That’s important because a lease’s exculpation provision says that the tenant can’t look to other than the landlord’s interest in the property when seeking to recover damages. A single purpose limited liability company has no assets other than its interest in the property and perhaps some meager bank accounts.

What about the nitty-gritty however? What’s “fair” and “not fair” in a landlord exculpation lease provision? For one, why do landlords think that it is appropriate to limit a tenant’s recourse to only the landlord’s interest in the “demised premises,” and not the entire project? Doesn’t that mean that the tenant can only look to whatever it would still have to pay the landlord under its own lease? Maybe it would reach as far as rents from the tenants in the same space. Is that any kind of remedy? I’m not sure I’m even going to read anyone’s comments supporting such a limitation.

But, what makes up a landlord’s “interest in the project”? Shouldn’t the lease provision make that clear? Try these items: (a) landlord’s reversionary estate; (b) the rents and profits from the project; (c) the proceeds from any sale or financing or refinancing of landlord’s interest in any portion or interest in the project; or (d) the proceeds realized from insurance or upon a taking.

Now, here comes the perplexing part. What about money or assets the landlord has distributed to its owners? Let’s set up the “bad boy” scenario. Landlord, faced with a potential claim or planning to take a risky step (a hypothetical I raise so that no one shouts – “fraudulent transfer claim”), refinances its project and strips out most of its equity by distributing the proceeds to its owners. Absent a pending tenant claim or a reasonably possible future claim, there is nothing nefarious about making such a distribution. That’s why landlords are in the business of owning real estate – to live a better life for themselves and their families.

But, where does that leave a deserving tenant with a valid monetary claim? Should a lease’s exculpation clause include a “claw-back” provision, requiring the owners of a landlord entity to kick back any money they’ve taken out if it was taken out within the prior “X” number of years?

If the distribution were a fraudulent transfer (or, in retrograde states, a fraudulent conveyance), that period could be four years. A smaller number would be a compromise.

Now this raises a particular question – will a lease’s exculpation clause override a state’s fraudulent transfer (conveyance) law? Even with a standard landlord exculpation provision in a lease, could a tenant successfully evade its consequences and pursue such a claim against the persons who received a distribution? What if the exculpation clause said, as is common, “Tenant shall not, under any theory, seek any recovery against Landlord’s parent or affiliates or its or their officers, directors, stockholders, partners or members except pursuant to a written agreement executed by the party against whom such recovery is sought”? Look at Finch v. Southside Lincoln-Mercury, Inc., 274 Wis.2d 719, 685 N.W.2d 154 (Wisc. 2004) and you decide.

My quick read is that a fraudulent transfer or breach of fiduciary duty claim is not one that arises “out of the lease itself,” and is therefore not governed by the language of the lease. If that is true, then why don’t the parties draft their lease’s landlord exculpation clause to concede that point and avoid the future cost of litigating it? (See the August 1 blog posting.)

We haven’t spoken about limiting claims against a tenant. Tenants with bargaining power and a strong interest in the subject might offer: “Landlord agrees to look solely to Tenant for the fulfillment of Tenant’s obligations hereunder and shall not, under any theory, seek any recovery against Tenant’s parent or affiliates or its or their officers, directors, stockholders, partners or members except pursuant to a written agreement executed by the party against whom such recovery is sought.” This isn’t exactly a parallel to the standard landlord exculpation clause unless the tenant is a single location entity, but the provision seems to be one that many landlords will accept in a lease, especially if they want to fill a vacant space.

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Comments

  1. When the Landlord is a single asset LLC (or other entity) is seems like all these clauses do is shift the risk of the LLC not filing its annual report to the tenant (or other formalities – which are mostly minimal- which keep its limited liability in place.) In my opinion that’s the Landlord’s responsibility. However, the Landlord may argue it needs to protect future transferees who may chose to forego the corporate shield to save on state income taxes only assessed on limited liability entities. In that case, if the tax savings enable the owner to keep the tenant’s rent down then maybe the tenant has bargained for the exculpatory clause. Regardless of clauses that say you can’t pass through those taxes as CAM/RE taxes, they get passed through in higher base rent or the owner wouldn’t invest in real estate.
    But I agree, these clauses have become boilerplate without any grounding in the actual transaction these days.

  2. A strong tenant should simply ask for it to be mutual and that the dollar limit is the amount avaiable if it was the Landlord at fault. This would require the LL to show the ‘equity’ available in the project if they were suing a tenant.

  3. Ira, I share your unemotional reaction to these exculpation clauses (I call them “judgment recovery sources”) whose origins were in connection with tax issues involving REIT’s but have now morphed into sacred cows that all landlords “have to have” and have become a fixture in the leasing landscape. I also share your rumination about whether they are really necessary. But we deal with them. Like you, I expand the “pool” to include the entire property owned by my landlord, not just the landlord’s interest in the premises. And in addition to the carve-outs you recommended, I include any rent offset right that I managed to secure in the lease, with direct access to that offset without having to first obtain a judgment. Also, in extremely risky situations – e.g. where the landlord does not want to approach an existing exclusive holder for a waiver – I draft an indemnification clause which is exempt from the exculpation clause. I also exclude (i) equitable remedies, and (ii) damages resulting from fraud, and (iii) attorneys fees (good luck). I’m interested in your “clawback” comment and ask if you have a sample clause. With respect to the tenant entity, I also like your reciprocal concept. Have you been at all successful with this?

    • 1. The tenant exculpation clause is in many leases we have negotiated for regional and national tenants.where a tenant client has no bargaining power, we often focus on more important issues and don’t seek to get tenant exculpation. For many lesser credit tenants, often a family owned business, there will be a personal guaranty anyway.

      2. As to the claw back, our experience has been less successful, but when we have been successful, we generally get a 2 year claw back, signed by the principal owner. One difficulty is that the lease is with the entity and, if it were needed to be enforced, one would have to look through the entity.

      3. One additional observation – we’ve never been involved in a situation where a tenant had a claim for which assets would have been available but for the landlord exculpation clause.

  4. I would agree that the exculpation should be mutual if you can get it; however, for a Tenant there is a hidden gem with these clauses. By limiting recovery to the Landlord’s “interest in the shopping center” the Landlord has unwittingly created an additional encumbrance on the shopping center that the Tenant would not otherwise have had. This can be incredibly advantageous in litigation or threatened litigation. There is now the ability for the Tenant to file a lis pendens as a part of any action prosecuted against the Landlord that would involve payment of money.

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