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.