How To Cap The Very Wrong Lease Payment Obligation

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Here’s a question for commercial leasing mavens (that’s informal for: an expert or connoisseur). Have you ever seen (or contemplated) where a tenant wants to have a cap on its monthly estimated payments for its share of operating expenses, but doesn’t want a cap on its actual annual share of those expenses? If the question isn’t clear, it soon will become so.

Normally, we would give some background before presenting any lease clauses but, today, the clauses in question are the background. They come from a January 4, 2018 Court of Appeal of Louisiana decision, one that can be read by clicking: HERE

These are from a multi-tenant retail lease and deal with “Additional Rent”:

The Additional Rent provision is found in Article XXII of the lease, which begins as follows:

Section 22.01. Commencing on the first day of the Lease Term and continuing for the balance of the Lease Term, in addition to and separate from the Minimum Rent and Percentage Rent, Tenant shall pay to Landlord as additional rent the Tenant’s Share of Common Area Operating Costs, Taxes and Insurance Premiums (as such terms are hereinafter defined).

The lease then provides

A. The phrase “Common Area Operating Costs” shall mean, for each calendar year (or portion thereof) during the term of this Lease, the aggregate of all costs, expenses and liabilities of every kind or nature paid or incurred by the Landlord (to the extent that Landlord, in its good faith judgment, regards it as appropriate to provide . . .[).]

. . . .

D. The phrase “Tenant’s Share” as applied to Common Area Operating Costs, Taxes and Insurance Premiums shall refer to a sum calculated by multiplying the Common Area Operating Costs, Taxes and Insurance Premiums (as the case may be) by a fraction, the numerator of which is the floor area (in square feet) of the Leased Premises, . . . and the denominator of which is the aggregate leasable floor area (in square feet) of all buildings in the Shopping Center. . . .

E. Tenant shall pay to Landlord one-twelfth (1/12) of Tenant’s Share of Common Area Operating Costs, Taxes and Insurance Premiums (hereinafter collectively referred to as “CATI”), monthly in advance, for each and every month during the term of this Lease every month during the term of this Lease. . . . Notwithstanding the foregoing, in calendar years 2003 and 2004, respectively Tenant’s Share of CATI shall not exceed $5,416.67 per month (the “CATI Payment”). . . . After the expiration of calendar year 2004, the CATI Payment may increase by no more than four percent (4%) per calendar year (compounded annually); provided however, that the CATI Payment may never exceed one-twelfth (1/12) of Tenant’s Share of CATI during the applicable calendar year.

So, mavens: what is “capped”? At the first level, it is something called: “CATI Payment.” It can’t be more than 1/12 of something called: “CATI.” So, what does CATI mean? For that, we need to examine the following excerpt from (E) above. It says: “…one-twelfth (1/12) of Tenant’s Share of Common Area Operating Costs, Taxes and Insurance Premiums (hereinafter collectively referred to as “CATI”).” Does CATI mean all of those words? Does it mean: “Tenant’s Share of Common Area Operating Costs, Taxes and Insurance Premiums”? Does it mean: “Common Area Operating Costs, Taxes and Insurance Premiums”?

Wouldn’t it be clearer if (E) read something like the following: “…one-twelfth (1/12) of Tenant’s Share of CATI. ‘CATI’ means: the sum of Common Area Operating Costs, Taxes and Insurance Premiums”?

But, if that were all we had to write, we wouldn’t have set “pen to paper” (or is it “finger to keypad”) today. The real issue is that the people who worked on this particular lease either never read these provisions or never understood them. It isn’t that they read them and were sure that the provisions reflected the deal.

The CATI Payment is a monthly amount. But, the tenant has a second obligation, one that first arises after each annual reconciliation is made. It needs to pay any deficiency between what it paid in any given year in the way of those monthly (capped) payments and its share of the actual Common Area Operating Costs, Taxes and Insurance Premiums. And that’s reinforced by these words from the first of the lease provisions we’ve reproduced above, the one that says: “Tenant shall pay to Landlord as additional rent the Tenant’s Share of Common Area Operating Costs, Taxes and Insurance Premiums.”

[By the way, that’s what the court ruled when it decided that the lease unambiguously capped the monthly estimated payments and not the ultimate amount the tenant was required to pay. It said that the eventual obligation was to pay the uncapped, annual obligation.]

One doesn’t have to be a commercial leasing maven to know that’s not what the parties intended, but why are we sure that’s true? That’s because we assume that “everyone knows” tenants who want a cap on their pass-through payments want it to apply to their total obligation. That’s fair enough when it comes to determining the “intent of the parties.” The problem is that courts don’t interpret agreements to line up with what one party or the other would have liked. And, they don’t try to divine “intent” when the words used are unambiguous. Another way of saying this is that if “everyone knows an annual cap is the norm,” then when parties write something else, they must have wanted to deviate from the norm.

From a global vantage, what does Ruminations think went wrong? Basically, we’ve said it already. The parties knew what they wanted the lease to say, so that’s what they saw when they read what they wrote. What they should have done is to “blank out” their minds and actually read the words AND take out paper and pencil and see how those words actually work. Yes, that’s hard, but isn’t it harder to have a court do it for you? After all, though not drafted with this in mind, these lease provisions were intended to create a formula, one that the people who actually administer a lease need to follow. In this case, those administrators, not “being there” when the parties were memorializing their intent, only get to read the words.

That’s the take-away. Those who write the documents aren’t the ones who administer the provisions in those documents. So, if our job is to set forth the rules for administrators (or the parties) to follow, then we need to read our work from the point of view of those administrators.

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Comments

  1. Another one the courts got wrong…

  2. Since the lease states “in calendar years 2003 and 2004 . . . “, if I were the court I would have at least found an ambiguity and turned to the intent of the parties and common understanding in the industry.

  3. This is a NNN lease with a cap. NNN = TAxes, Maintenance and Insurance where the tenant pays their proportional share of the common area expenses as well as taxes and insurance. Tenants can negotiate for their payment to not increase over the agreed upon %. Certainly attorneys who draft such documents should work with a commercial real estate agent / broker for the true implications of the documents they are creating.

  4. RLGunn Associates LLC says:

    I’m not exactly sure about what I am going to state but, there could be an accounting and store bonus threshold “game afoot”. I have seen store and district level bonus programs for retailers where bonuses were based upon operating profit. Having capped monthly expenses allows the store and district to hit and make the operating profit goals. The annual catch up of operating expenses would not come from the regular store level operating budget but for a regional or “different bucket/account” .

    Is it possible that the lease was drafted in a manner that didn’t match the intent?, Yes. While it is somewhat far fetched, there could be a reason for the fixed monthly below the actual annual cost.

    PS: I know the accountants will tell me that the auditors will catch up with this. In the field interesting things happen. I have “found” warehouses, silo’s and sheds that plants had squirreled away equipment that was “off book” that they could put into production to “improve” the return on assets for their production runs. I have seen “off book tank farms” and tanker trucks shuttling from place to place cucumbers in brine.

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