Who Should Write Settlement Agreements? The Courts?

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Today’s Ruminations is triggered by a court decision that may not have reached the “correct” result. If that suspicion is correct, then why do we promulgate its holding? There’s a simple answer. Had more talent been employed in negotiating the agreement dissected by the court, there would have been no court involvement. There would also be a different blog posting today.

The facts appear to be somewhat simple. They might be simpler had the court shown more of the actual agreement in its written decision. Instead, it gave us its characterization. Normally, when courts do so, they do it in a way that tilts the “story” to support its decision. So, we’ll assume that the characterization is the strongest the court could write to support the outcome. Enough with the mystery – here’s the story.

A fitness center leased space. The lease was subsequently amended, at which time the tenant’s owner signed a personal guaranty. The document was denominated as a limited guaranty, but the only “limitation” was its dollar amount cap. Otherwise, it appears to have been what we call a “come heck or high water” obligation. [Some would give it a different, but similar nickname.] The guaranty expressly said that the guarantor’s liability was “co-extensive with that of” the tenant. [Read more…]

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Chickens, Eggs, And Waivers of Claims

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When a tenant’s property is ruined by rain coming through the roof of its leased space, what caused the damage? Was it the water or was it the landlord’s failure to repair the roof? That’s today’s issue to Ruminate about.

Right after a tenant moved into its space, it noticed the presence of water after what was called, “inclement weather.” We might have called it “rain.” So, it notified its landlord. Without delay, the landlord dispatched someone to investigate. His conclusion was the water was coming from an air conditioning unit. The tenant immediately called an independent HVAC repair company. Its conclusion was that the roof was leaking and the air conditioning unit was fine. The landlord did not make any roof repairs.

After that, each time it rained, water came into the space. After one rainstorm, only four months after the tenant moved in, so much water came in that there was damage to equipment, furniture, interior walls, and to over one million dollars (at retail) of inventory. At that time, the tenant again put its landlord on notice of the leaking roof, the damage caused, and the failure of the landlord to make repairs. The landlord had the roof inspected again. This time, its foreman determined that the water intrusion was the result of the building’s improperly constructed exterior and by something wrong with its downspout. Apparently, the landlord still did nothing, not even in response to repeated notices subsequently sent by its tenant every time water came into the space. A lawsuit followed. [Read more…]

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Did They Guaranty The Lease For Its Extended Term?

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We’ve written about guaranties before, most directly in postings that can be seen by clicking: HERE and HERE. Today, we drill down to the enforceability of a lease guaranty after the lease has been modified, but without notice to or knowledge of the guarantor. Today’s Ruminating is informed by a January, 2018 unpublished opinion from the Maryland Court of Special Appeals. [Readable by clicking: HERE.]

A church’s lease was guaranteed by its Pastor, his wife, and six other church members. The church defaulted and its landlord sued for the remaining rent under a three-year extension properly signed by the Pastor on behalf of the church, but without the knowledge of the six church members. In fact, they didn’t even have a hint that the lease had been extended despite each being some form of “leader” in the church, though those roles appeared to be substantially ceremonial. Their only financial connection to the church was their obligation to tithe to it. The lower court described them as “commercially” unsophisticated.

The lease extension was by way of amendment. The lease did not have an extension option. The additional three-year term was related to a rent reduction sought by the Pastor and agreed-to by the landlord. The church performed until it didn’t with eight months to go in the lease’s term. At that time, by agreement with its landlord, the church vacated its premises. [Read more…]

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Does The Broker Get Paid? Efficient Producing Cause And The Facts

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Last week, we set the background for understanding what it means for a broker to be the “efficient producing cause” behind a lease or sale. The background was in the form of a story from a 2012 unpublished New Jersey court decision. The long version can be seen by clicking: HERE. For those who missed last week’s blog posting, here is a precis.

An individual property owner and a real estate broker executed a commission agreement. Then the owner transferred the property to a newly formed limited liability company. A drugstore lease, requiring the owner to construct the store, was signed. The drug store’s parent company guaranteed the lease. Construction (likely “non-construction”) took years. The tenant hung on. To get the project moving, the property was transferred to a joint venture, with the new 75% owner taking over operational responsibility. Under the joint venture agreement, the new entity agreed to be responsible under the original brokerage agreement. Two days after the joint venture agreement was signed, the owner terminated the brokerage agreement. More than two years after that, the original drug store lease was terminated and a new lease was signed. The new lease was between the joint venture and the original tenant’s successor by merger. Again, the drug store parent company signed a guaranty. All of the documents signed by each of the original and new drug store were signed by the same person who signed the guaranties. The business terms of the new lease differed in rent amount and lease term from the original lease. The store opened. [Read more…]

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Can A Tenant Walk Out And Lawfully Stop Paying Rent When It Tires Of The Space?

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A restaurant’s lease permitted leasehold mortgages with the following proviso:

Tenant shall have the right … to encumber Tenant’s leasehold interest under this Lease … through a Mortgage (`Leasehold Mortgage’) with an institutional lender…. Landlord agrees that in the event the Leasehold Mortgagee succeeds to Tenant’s interest under this Lease (in which event it shall assume all of Tenant’s obligations under this Lease), Landlord shall, at the time of such succession, recognize such mortgagee, trustee or lender as the then Tenant under this Lease upon the same terms and conditions contained in this Lease and for the then unexpired portion of the Term.

Any such leasehold lender had the right under the lease to take over the tenant-borrower’s leasehold interest through a foreclosure. [Read more…]

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The Invisible Hand Behind A Lease (It’s Economics)

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How is rent determined? Is it just tossed-out by one party or the other (most often the landlord) and then hashed out without reference to outside sources of information? A long time ago, market information may have been difficult to obtain. Today, that’s not the case. Those who choose to ignore market information negotiate in the dark. But, competitive rent rate information is not all that can or should go into negotiations.

If any reader is expecting Ruminations to now present a formula or algorithm that will eliminate rent negotiation, that reader gives us too much credit. We do think that the day will come when rent negotiations will be done between “machines,” but we neither see “when” that will happen or “how” that will work. Today, in what we hope will be a relatively short blog posting (for Ruminations), our goal is to toss out a theory of how rent is set while recognizing that no one will agree with us because we’ll be positing a theory involving “invisible” factors.

“Market rent” is a real thing. It may be difficult to ascertain precisely, but it is a number that reflects actual rents in the marketplace. Yes, defining the “marketplace” is an art and, yes, adjusting each lease in the market data bank to a “standard” is an art, but that doesn’t mean there isn’t such a thing as “market rent.” When one party or the other throws out a rental figure to start a leasing discussion, it is done with some sense of the market rent for the available space. The negotiations that follow, i.e., where they go from the starting figure, do so based on each party’s own sense of market rent and, even if both agree on the “market rent,” there still remains the duel between how much the tenant really wants “that” space and how much the landlord wants to lease “that” space. [Read more…]

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There’s A Material Thought Buried In Here

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We’re not sure if what we write in today’s blog posting could reasonably be expected to influence any reader’s use of the term: “material” in documents she or he prepares. If it could, then this posting would meet the criteria for materiality under a newly proposed, revised definition of “material” to be used by accountants in preparing financial statement or in conducting audits.

Long-time Ruminators with good memories might recall that we covered the topic of “materiality” before, specifically in late 2012. For those who were not then clued into Ruminations or for those with sieve-like memories like our own, that posting can be seen by clicking: HERE.  In yet another posting, this time only a year ago, we labeled “material” as a “weasel word,” but not as a term of derision.[That blog posting can be seen by clicking: HERE.]

We’ve met people who object to the use of the word “material,” such as when writing that one party will not materially interfere with the other’s business operations. Another place this “discussion” arises is when something (usually bad) happens if a party makes a material misstatement. The question in each of these cases and in all of the other cases readers can conjure up is; “What is material –can’t we be more definite and make a list of what would be material or, at least, include a definition for the word?” The position Ruminations has taken is that, at the end of the day, when something happens and the parties disagree whether the “something” was material, a judge will decide. And, judges, when resolving a dispute, will take into account all of the facts and circumstances that actually come up, and not all of the things that could have happened, but didn’t. That’s what judges are paid to do – make judgments. That’s why they are called judges.

The funny thing about the use of the word “material” to condition one thing or another in our agreements is that there aren’t a lot of cases where a judge has been asked to use her or his judgment as to what is material. That’s not to say there aren’t any court decisions, nor is it to say that there aren’t important court decisions in other areas about the word, but given how many agreements use the word, almost always multiple times, perhaps “material” “works.”

The business of real property agreements isn’t the only business where these “discussions” arise. As noted at the outset, accountants have the same discussion. But, in the case of accountants, they have a definition for the word. The definition differs depending on whether one looks to the Financial Accounting Standards Board (FASB) or to the International Accounting Standards Board (IASB). Today, we’ll work with the international standards because right now those are in the process of being updated.

Here is the most recently proposed language:

Material:

Information is material if omitting, misstating or obscuring it could reasonably be expected to influence the decisions that the primary users of a specific reporting entity’s general purpose financial statements make on the basis of those financial statements.

Materiality depends on the nature or magnitude of information, or both. An entity assesses whether information, either individually or in combination with other information, is material in the context of its financial statements. Material information might be obscured if it is not communicated clearly—for example, if it is obscured by immaterial information. A misstatement of information is material if it could reasonably be expected to influence decisions made by the primary users.

Assessing whether information could reasonably be expected to influence decisions of the primary users of general purpose financial statements requires consideration of the characteristics of those users judged in the entity’s circumstances.

Compare that to FASB’s understanding of the US Supreme Court’s definition of materiality:

… the U.S. Supreme Court’s definition of materiality, in the context of the antifraud provisions of the U.S. securities laws, generally states that information is material if there is a substantial likelihood that the omitted or misstated item would have been viewed by a reasonable resource provider as having significantly altered the total mix of information.

These two approaches are rooted in the same concept: if it really didn’t matter to the person who used the information (i.e., if that person didn’t rely on it), then the information (e.g., “representation”) was not material (a/k/a: it was immaterial).

What the proposed, revised definition from the IASB adds to the discussion is the concept of “obscuring.” When we write our agreements, the most likely battlefield upon which the “material” fight takes place is within the sections dealing with representations and warranties. But, in those sections we write about “material misstatements or omissions.” We don’t think about the burying of a true, but not very pretty, disclosure inside long boring prose or within voluminous documents “incorporated by reference.” Basically, our profession resorts to the principal of “caveat emptor,” something described by Investopedia as “a neo-Latin phrase meaning ‘let the buyer beware.’ It is a principle of contract law in many jurisdictions that places the onus on the buyer to perform due diligence before making a purchase.”

Should we impose greater responsibility on a party to a specific agreement to scrutinize every word in that agreement than we place on someone in the amorphous class of people who might read a financial statement? Probably, “Yes.” But what about a professional reader of financial statements such as a lender considering whether to make a loan? Great minds will differ and some will conclude that it is acceptable to obscure material (damaging) facts in an agreement or in a data dump of 10,000 due diligence documents, but somehow it doesn’t seem right to allow that to happen.

So, with that in mind, what do our loyal readers think about adding the underlined text to the following, pretty common words we all see in agreements:

[Seller represents that] this Agreement contains no untrue statement of material fact and does not omit a material fact necessary in order to make such information not misleading, and no material facts have been presented in this Agreement in a way that a reasonable person would conclude those facts have been intentionally obscured such that such obscured material facts were, in effect, omitted.

Yes, even to us, the underlined addition sounds like an unmanageable (unprovable) standard. That is, it does, until we compare it to the generally acceptable standard that precedes it: “and does not omit a material fact.” Placing a material (adverse) fact (expressed with 10 words) inside a 30 page exhibit might “technically” be disclosure of that fact, but, as we are starting to see, doing so is just a sneaky way of “omitting a material fact.”

Ruminations has no belief that anyone will be running to revive their documents or, if they do, that anyone will accept the added text. Nonetheless, this blog is aimed at provoking thought and discussion. If it has, then we’ve been successful (today, at least).

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Luddites Unite – Artificial Intelligence Will Replace Us

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We’ve been thinking about artificial intelligence applications and how they might change, even transform, the way we do our business. Then, we heard an interesting story on public radio. It was about a Southern California manufacturer of sex dolls who was introducing models incorporating artificial intelligence. For reasons quite obvious, the story didn’t get very deep into the details, but we learned that these new models were designed to figure out what their owners wanted and to respond appropriately.

We thought this application to be quite amazing in that here was a business way ahead of our own. Artificial intelligence is being used to read medical images with better results than even experienced radiologists achieve. It is being used to screen job applicants, much, much faster than humans doing so and with more satisfactory outcomes. Artificial intelligence is at the heart of visual recognition, allowing machines to replace people in manufacturing operations. It is used to write newspaper articles, such as those reporting sporting events. The list could go on and on. But, what it won’t include is negotiating agreements such as leases. That is, not yet.

Agreements such as leases are not zero-sum games. Though the parties exchange things of equal value, one needs to ask, “Value to whom?” Basically, when someone gets an item of value to them worth, say, $100, the other person may be giving up something worth only $60 to them. Someone may have two widgets and only need one. The duplicate widget isn’t very valuable to that person. A second person may need a widget and have two gizmos, but only need one. In each case, one widget or gizmo has a utility value of $100, but a duplicate one has a utility value of $60. Thus, if the parties trade widget for gizmo, each gives up $60 of value and gets $100 of value in return. That trade creates $200 of value out of $120 of value – a good deal for each trader. [Read more…]

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