I Surrender! Here’s Your Property Back: As-Is. Sue Me

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We are no fan of a particular type of “surrender” clause commonly found in leases, the “style” that calls for a tenant to “leave the property in as good condition as when it moved in, save normal wear and tear.” These clauses come in a variety of flavors, none of which Ruminations will offer today. In 2014, we shared some thoughts on this same topic in a posting that can be seen by clicking: HERE. We’ve also said (too) much about “wear and tear.” For those Ruminations of ours, search the blog site for (what else?) “wear and tear.” For the most part, our earlier writings have focused on the downside to tenants of this type of lease clause. Today, we’ll introduce a court decision that illustrates a giant shortcoming of the “same or better” condition requirement, one that should make landlords leery. Even readers who take a different approach to the condition of the leased property when its tenant departs will be interested in what the same court had to say about a property’s “move-in” condition and the implication for provisions dealing with the “move-out” condition.

A United States District Court in Michigan was faced with the following dispute involving a single-tenant industrial building. The issues presented easily could have come out of an office, residential or office lease. The lease being analyzed required the tenant to “leave the property in as good condition as when it moved in, save normal wear and tear.” Prior to the end of the lease term, the landlord notified its tenant that it would take almost $500,000 to “restore the Property to its move-in condition.” No repairs were made and the tenant vacated the property.

Less than two weeks later, the landlord contracted to sell the property. Following a 60- day due diligence period, closing took place. Shortly thereafter, the new property owner sued the now-departed tenant alleging “that, when [the tenant had] vacated the Property after the lease terminated, the Property was in substantial disrepair, not in good order and satisfactory condition, and otherwise in violation of the lease.” It claimed damages of over $600,000.

The tenant’s basic defense highlights a major deficiency behind this particular approach to specifying the required “surrender” condition. The tenant accurately pointed out that there was no evidence of the property’s move-in condition. [And, in past postings we’ve suggested a narrated video of the property at the time of delivery. Obviously, that advice was ignored here.] According to the tenant, without being able to present actual evidence of the condition to which the property needed to be returned, the landlord had no case. By the way, this was only a five-year lease. Readers, think how that same issue resonates when a tenant has occupied space for 20 or more years. Think about how making extensive improvements over a lot of years, some quite beneficial, makes the task even harder. Does a landlord really want the old urinals or light bulbs returned to the space? Should the tenant punch holes in the walls exactly where those holes resided 20 years earlier? Should new HVAC be replaced with 15- year old units as were in place way back when? But, we digress.

The new property owner was not without an answer. It pointed to the following provision of the lease:

Tenant’s taking possession of the Premises or any portion thereof shall be conclusive evidence against Tenant that the portion of the Premises taken possession of was then in good order and satisfactory condition. No promises of Landlord to alter, remodel, improve, repair, decorate or clear the Premises or any part thereof have been made as of the Effective Date and no representation respecting the condition of the Premises has been made to Tenant by or on behalf of Landlord.

According to the suing owner, this was proof that the property, at the outset of the lease term, was “in good order and satisfactory condition.” It had evidence of serious problems with the HVAC and to the fire suppression system in addition to a number of other aspects of the property. Interestingly, the dispute wasn’t about what the property looked like after the tenant moved out. It was only about whether the landlord could prove the “baseline,” the starting condition of the property. We think the property owner was not happy with the outcome, and here’s why.

The property owner interpreted “good order and satisfactory condition” in its objective sense – that the property’s condition was satisfactory for all purposes. The tenant, however, had a different take as to what that phrase meant. To it, it meant that “the Property was in satisfactory condition for [its unique] intended use, even if such condition would not be satisfactory to the needs of a subsequent tenant.”

Of course, it really doesn’t matter what either party to the lease, tenant or landlord, “thought.” What matters is what a court thinks. In this case, the court looked at the move-in condition clause (cited above) and understood it to mean no more than that the tenant would be precluded from suing its landlord over a defective condition existing at the time of move-in. The clause creates a contractual bar against such claims, effectively serving the same purpose as would the doctrine of “equitable estoppel.” [A reliable legal treatise puts “equitable estoppel” this way:  “In its broadest sense, equitable estoppel is a means of preventing a party from asserting a legal claim or defense that is contrary or inconsistent with his or her prior action of conduct.”]

We think the court gives a good explanation as to what this commonly used “move-in” language means. The example it uses does a nice job of illustrating the point:

… “good order and satisfactory condition” is subjective on its face—what a chemical-company tenant finds satisfactory in a property’s condition may vary drastically from what a catering-company tenant finds satisfactory. If a tenant subjectively says upon move-in, yes, the condition of this property is good enough for me, that tenant cannot later say that it was not. But that does not mean the tenant is representing that the property is in good order and satisfactory condition for all purposes. Such a reading would require a tenant to either not sign a lease until a landlord has made every single repair to a property or would make the tenant liable for any existing issues with the property when that tenant moved out — even if those issues did not preclude the property from being in good and satisfactory condition for that particular tenant’s purposes.

The lease did not frame the surrender condition in terms of calling for “good order and satisfactory condition.” Instead, the lease used objective criteria: It called for returning the property in a condition that matched the move-in condition (but allowing for differences caused by normal wear and tear). There is a big lesson here!

Reading between the lines, one wonders what the result would have been had the lease required that the property be returned in “good order and satisfactory condition.” For the purposes of surrender, would those five words be defined objectively or subjectively? Here’s what the court suggests might be at issue:

It would be confusing indeed, given the varied uses of particular tenants, to determine whether a property is in “good order and satisfactory condition.” No peeling paint? No scuff marks on the floor? No dents or cracks in the pavement?

Yes, it’s true that some of the court’s examples fall in the category of “normal wear and tear,” but not all do. So, there’s a warning here, and it is that a lease’s surrender provision should set objective criteria (as best as that can be done). Otherwise, the same analysis used to interpret this particular lease’s “move-in” clause seems to apply to any lease provision that calls for the return of space in “good order and satisfactory condition.”

Today’s takeaway: It is time to review your form lease’s surrender provision.

While we are at it, and for those readers whose patience hasn’t yet been exhausted, we offer what we think is a pretty good explanation of the difference between real property fixtures (sometimes just written as “fixtures” in a lease) and trade fixtures. The following comes from the same court decision as we’ve used for the thoughts in this week’s blog posting. [That court decision can be seen by clicking: HERE.

Property is a fixture if the following three criteria exist: (1) “annexation to the realty, either actual or constructive;” (2) “adaptation or application to the use or purpose to which that part of the realty to which it is connected is appropriated;” and (3) “intention to make the article a permanent accession to the freehold.”

A trade fixture, on the other hand, “is merely a fixture which has been annexed to leased realty by a lessee for the purpose of enabling him to engage in a business. The trade fixture doctrine permits the lessee, upon the termination of the lease, to remove such a fixture from the lessor’s real property. … A trade fixture is considered to be the personal property of the lessee.”

We’ve written about this distinction in the past. Again, go ahead and use the blog site’s search feature if you are curious as to those previous Ruminations.

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