Caps on Pass-Throughs, Continued

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While on the subject of capping some pass-through charges like taxes and CAM [that was my last posting], there is always the question of deciding if there will be any exclusions from the “Cap.” Common exclusions from a Cap on CAM include snow removal, ice treatment, insurance premiums, and utility charges. If a letter of intent spells these out, that’s fine and dandy. But, what if the letter of intent is silent? Is the “gap filler” to assume that when the parties have agreed that CAM charges will be subject to a Cap, it carries the implied understanding that highly variable (perhaps) components such as the ones above are to be “carved out” from under the Cap? Or, does silence imply that there are no carve-outs?

Does it make a difference if the Cap is escalated each year based on the previous year’s Cap or if it is based on the prior year’s actual charges to be paid by the Tenant. Logic would say that wildly swinging items (think – snow removal) should always be carved out it the Cap is based on the prior year’s actual charges to the Tenant whether or not the “excess” unbilled charges can be carried over to the following years.

It isn’t that simple to make that assumption if each year’s Cap is based on the prior year’s Cap and there is a carryover provision. The logic supporting that statement is that the Cap certainly was agreed-upon to satisfy some need of the Tenant, not of the Landlord. A legitimate need is to avoid a “shock” to the Tenant’s budget. So, if that is the real reason for the Cap, the Tenant is prepared to pay as much as the extent of the Cap, say 5%, more each year than the prior year. Combine that with an honest desire of the Tenant to ultimately pay whatever the pass-through charges turn out to be, then a carry-over, year to year, seems fair and a carve-out for wildly swinging items makes sense as well.

Having said that, why are utility charges and insurance premiums included in the same concept as snow removal charges? My thinking has been that there is some sense that the reason for carving out a particular item is that the item is “not in the Landlord’s control.”  Somehow, that seems to cut both ways. If a Tenant thinks that one supporting reason for a Cap is that it gives a Landlord an incentive to control costs, then carving out uncontrollable items makes sense from a Landlord’s point of view. If the overriding logic is to avoid budget shocks, then it doesn’t make sense.

When it comes to Taxes, the logic is a little more puzzling. The Landlord doesn’t have control over the Taxes. They are what they are. Big changes should be addressed in a tax appeal provision. Further, tax charge changes, when resulting from tax rate changes, are generally in a range that can be estimated and are rarely “crazy.”  The real issue would be assessment changes, and that is the subject matter for a tax appeal provision or for provisions that deal with taxes on “banked land” or the addition of new improvements with significantly higher per square foot values than what existed at the property before the improvements were made. To deal with those by way of a Tax pass-through Cap is to deal with the issue indirectly and not very effectively.

What does anyone think?

Speaking of Taxes, the next time, I’d like to vent about the Texas “Margin Tax.”

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  1. Mark Morfopoulos says:

    As far as determining what the “gap filler” will be when the LOI is silent on that topic, I would think that would be a question that could be answered by going back to the LOI. Did you, as the attorney, prepare the LOI? If yes, then you may very well have had a discussion with your client as to this particular issue. If you did not discuss this point when you drafted the LOI or did not have any input into the preparation of the LOI, it may be prudent to speak to your client to find out if a conversation was had with the other side regarding exclusions even if such exclusions are not mentioned within the four corners of the document. Depending upon the parties’ level of sophistication, you may be surprised what you will hear. Also, I would be more hesitant to try and fill in the gaps if the parties were both sophisticated and had gone through this “dance” many times before. Finally, if I did not know anything about the deal and was just told to prepare the lease, why not add the carve out if it furthers your client’s interest or leave it out if it does not. Then it would be up to the other side to either agree to leave the carve out in the lease of argue that it should be omitted.

    You have said many times, it is important to “know” your client. Part of that endeavor is to have discussions with your client about potential issues that could adversely impact upon their bottom line. For example, if a LOI (or any document for that matter) is not clearly written, it can lead to unintended results. That is why it is important to have attorneys involved even at the earliest stage of the process, including the preparation of an LOI.

  2. Caps should be limited to items within the landlord’s control. To suggest that the landlord should assume the expense and risk for ‘budget shock’ on behalf of the tenant is a one-sided proposition.

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