Truth, Justice, and the American Way.

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But Mom, it’s not fair! My child, life isn’t fair.

Let that be a lesson for all of us. Agreements don’t have to be fair. Liability doesn’t have to follow fault. If an agreement had to be “fair,” then we could cut out a lot of the typical text and leave it to society and society’s judges to allocate responsibility and costs based on a universal rule.

No, agreements aren’t about fairness, justice or fault. They are about allocating risk. That’s what parties bargain over. Let’s look at some examples.

What should happen if key entrances to a shopping center are closed through no fault of a party, say by the government or by reason of a bridge collapse? What’s fair? Why should the landlord not get ongoing rent? It didn’t blow up the bridge. Why should the tenant pay rent? It didn’t crater the public road. It can’t use the space it’s paying for. What’s fair?

A shopping center is under contract of sale when a major tenant files bankruptcy – whose risk, buyer or seller? Neither was at fault. Each could have investigated the probability of that happening. Is it fair that one or the other is “burned” depending on whether the tenant files a minute before or a minute after closing?

A visitor to the shopping center is hit by a car in the parking lot while going from a tenant’s store to the public rest room? Whose insurance should cover the claim – tenant’s or landlord’s?

A “midnight dumper” spills a barrel of seething stuff in the parking lot and it glows in the dark, setting off Geiger counters. The shopping center is closed. Is it fair for a tenant to have to pay rent (for an uninsurable peril, hence no business interruption coverage) or for the landlord to lose rental income (also uninsurable for the same reason) or for a buyer to be forced to take title?

Add your own examples.

None of these examples has a “fixed” answer. There are no standards, but for ignoring what has happened, i.e., pretending that there has been no significant event that has thwarted a party’s reasonable business expectation. Yes, that’s why parties make their deals in the first place. They have “business expectations.”

So, what do parties to a lease, sales contract or loan do? They negotiate solutions to problems they conceive as being reasonably possible. They do so based on their relative bargaining power (a Ruminations mantra). But, “bargaining power” isn’t just size and pocket book, it changes as a variety of circumstances change. The smallest of tenants has bargaining power when leased premises have gone begging for an occupant for five years. The biggest tenants yield on otherwise key issues when their competitors are panting for the same space.

What parties do after all of the protestations of “it’s not fair; it’s your fault” die out, is make a business decision on “how to allocate the risk of a future event.” Sometimes, it’s done on a semi-logical basis; sometimes on an arbitrary basis. Here’s an example.

For a brief period of time in the history of lease negotiations, the following arrangement found favor (i.e., before the “finding fault” people regained their strength). Landlords agreed to be completely responsible for all injuries in the common areas (or, in some cases, all areas outside of the leased premises) and tenants agreed to be responsible for all injuries in their own leased premises. Yes, in either case, the accident could be partially or entirely the fault of the other, but generally tenants had dominant control over the inside of their leased premises and landlords had dominant control over the rest of the property. So, in that unique, albeit brief, era, parties “allocated the risk” instead of engaging CIS – Shopping Center to solve the crime. But for jurisdiction-specific circumstances where one party isn’t lawfully allowed to cover (indemnify) the other when the other was solely negligent, there was a bright line test. And, insurance policies honored (and still honor) the outcome.

So, what happened? In crept – “But Mom, it’s not fair! It’s not my fault. She broke it, not me.” In crept, “each party shall indemnify the other for every possible thing except to the extent the other party is at fault.” Sounds fair, except it makes no sense. Certainly, it seems to say that to the extent a party is at fault it will step up to the plate. But, that’s tort law anyway and, in fact, it’s contract law as well. So, we haven’t done anything very helpful. All we have done is push the fight down the road to a time when we call in the forensic team from CSI – Shopping Center again. (And, if “it” is covered by insurance, all we’ve done is bargained for uncertainty and pushed the fight over to both carriers). What is more, is that we haven’t helped ourselves at all when it comes to situations where neither party is at fault. We haven’t done what contracts should do – we haven’t allocated risk on a business basis. We’ve reached for tort principles instead.

Why does the concept of “allocation of risk” instead of “follow the fault” make sense to this Ruminator? – because “it’s in the rent”; it’s in the purchase price; it’s in the interest rate. Yes, the risk is priced into the deal. Think of an insurance policy where the insured pays a price (the premium) for a carrier to bear the risk of loss. A simple example is a automobile collision coverage. The example could be a property insurance policy. You ram your car into a tree (or you leave the stove on overnight), and your property is damaged. The policy pays. Fault is not an issue. For the premium, the carrier took the risk.) But, you say, that was “insurance”! So what, it was a contract. The contract could have covered only incidents where you were legally parked and, while you were sleeping, a truck crushed your car. That would also have been “insurance.” The premium would have been lower. Yes, the way risk is allocated under a contract is “in the price.”

Here’s another example from left field. [That’s kind of a pun.] Imagine you are at a baseball card auction. Lot one is a Babe Ruth rookie card represented (warranted) to be in very good condition. You can examine it yourself, as can all other potential bidders. Lot two is a Babe Ruth rookie card in a sealed envelope, condition unknown. There are absolutely no representations or warranties. You can’t even see the card. It could be “pristine” or it could have be the victim of 500 rounds of card “flipping” and “card pitching for distance.” Lot one has a price. The marketplace set the price. You get what you examined and if you overpaid, too bad. You took the risk. If you underpaid, too bad the seller took the risk. As to lot two, it also has a price. Again, the marketplace set the price – what would people pay for a Babe Ruth rookie card, condition unknown? Open the envelope. If it turns out to be a pristine Honus Wagner card (presumably worth more than even a pristine Babe Ruth rookie card), can you keep it? (You didn’t see that one coming!) Can the seller demand its return?

What’s the answer? Simple – what are the auction’s rules? Auction rules are, for the most part, arbitrary as between buyers and sellers. They are written by auction houses to protect auction houses. They aren’t fair. But, what they do is “allocate the risk.” What’s the Honus Wagner – Babe Ruth answer? I don’t know.

If you opened the envelope and found the expected Babe Ruth card, did you overpay? Underpay? If either, “it wasn’t fair.” Except that it was! The risk of its condition was allocated to the buyer. Like the donkey behind door two.) The risk was in the price. The bids were based on the rules and, presumably the price was lower for lot two than for lot one because the risk fell on the buyer. The seller hid the card to avoid an argument over its condition and was willing to take less money for the card in return for avoiding the risk of a fight over its represented condition. OK, that’s not the greatest example. Go ahead, poke holes in it. Then, step back and absorb the principle.

One last thought. Who would bear the risk of a governmental closing of a major highway feeding a shopping center if the premises in question were “vacant and available for leasing” at that time? Would a prospective tenant agree to pay rent at all for such premises unless the access was restored? Of course not. It wasn’t the landlord’s fault that the highway was closed yet, under those circumstances, the rental value of the premises is zero. So, if a tenant leases the space based on there being acceptable access, should it then take the risk that it is paying rent for space worth “zero”? Before I get attacked for tenant-bias, I promise I could just as easily offer up an example where most readers would agree that the risk of a similar event should fall on the tenant. This blog entry, unlike some others, is landlord/tenant/buyer/seller neutral, even if the examples it uses are not.

Does anyone out there want to make the argument that agreements need to be fair, and that risk must follow fault, and justice is the goal, etc., etc.? Please do. Just share your comments right here at www.retailrealestatelaw.com.

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Comments

  1. Jack Levey says:

    Ira, insisting on fault costs both parties money in another way. Landlords want to be released for any damage to the tenant’s goods and contents, regardless of fault. The tenant (or the legislature, or the court) says “That’s not fair” and demands an exception for the landlord’s negligence. Now the landlord has to over-insure, being unable to predict the value of each tenant’s contents. Who pays for that insurance? The tenant, as part of CAM. Now the goods are damaged by a peril that the tenant insured against, regardless of who caused it. The tenant’s carrier pays the claim and sues the landlord, arguing that the exception for landlord’s negligence trumps the blanket waiver of subrogation and claims. The landlord’s carrier defends and probably pays. The landlord’s experience rating goes up and so does the tenant. Now the tenant has paid two premiums (for its own coverage and a pro rata share of the landlord’s coverage) to cover a single loss, and managed to drive its own rates up in the process. Sometimes it’s expensive to be right.

  2. The “baseball card in the envelope” is a good example of risk being built into the price, but more often than not the business deal is struck (and the price is set) without consideration of risk-allocation issues. How often do you see one of those issues addressed in an LOI?

  3. Good comments both to Ira’s post. Jack Levey, as an aside I’ve never seen an exception for fault in a waiver of subrogation (“WOS”) clause (except for intentional torts) . WOS is a no-fault concept and such an exception would vitiate the clause, no? And Ira, I believe you meant CSI-Shopping Center, not CIS.

  4. Another great post by the Ruminator!

    “Fairness” is a mirage. “Fairness” in lease negotiations is sophistry. One exception is when “fairness” is just short-hand for “somewhere near market price for that sort of risk in that sort of situation.”

    A risk is either acceptable–given the parties’ past experiences, current situations and future hopes and dreams–or it’s not. Don’t listen to the words of the lawyers and dealfolks prior to signature, read what actually got signed. When the sales forecast is juicy and it’s a market void we’ve drooled over, do we reach and stretch? Absolutely. And so we should. Our appetite for risk (business and legal) is in the judgment of our team. If the deal is so-so, the fill-in submarket is not our strongest and the profit potential is “just OK,” then certain risks are simply not acceptable.

    I really like it when a negotiator is adept at hearing our (perceived) risks/worries and creating options to mitigate them (in part or full)–all without offering unacceptable risks to her client. Then, the risk-defining and risk-allocating are in a whole different ballpark from “fairness.”

  5. Jack Levey says:

    I think it was leasing lawyer Ernie Wiener who said “Don’t ask me what’s fair; fair is chickens and pigs in the summer in Des Moines, Iowa.”

  6. While I agree on a theoretical level, where I find it breaks down in practice is in the many landlord-drafted leases I see where the tenant waives all claims against and indemnifies the landlord for everything under the sun. In my opinion the premise (“Landlords agreed to be completely responsible for all injuries in the common areas (or, in some cases, all areas outside of the leased premises) and tenants agreed to be responsible for all injuries in their own leased premises.”) does not work if the landlord refuses to indemnify the tenant for claims etc. related to the common areas. Similarly, I often see a one-way waiver of subrogation–this too only makes sense if it is mutual (and ideally the landlord has a contractual obligation to maintain insurance).

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