For A New Landlord/Tenant, Does History Override An Unambiguous Lease Provision?

We think this comes up much too often, and, it is often about rent, more often about additional rent, and sometimes it is about a non-monetary issue. What is “this”? “This” is about when a lease says one thing and the parties, over a long period of time, do another. We bring this up today because we just read a June 6, 2019 decision by the District of Columbia Court of Appeals.

A long-term air rights lease called for rent to change every five years beginning on the 10th anniversary of the “Lease Commencement Date.” The lease provided that the new rent [that’s what the court wrote, but we all know what it meant to say as that the amount of the “rent increase“] would be the current rent:

multiplied by twenty-five percent of a fraction, “the numerator of which is the CPI at the date of adjustment and [ ] the denominator of which is the CPI at the immediately preceding date of adjustment[:]”

By the tenth grade we were taught to convert that text to the following formula:

New Rent = Current Rent + [Current Rent × .25 × (Current CPI / Base CPI)]

Without our elaboration, the court found this rent adjustment provision to be unambiguous. Ruminations does as well. [And, there was no issue over the definition of CPI (Consumer Price Index).]

So, what could go wrong? Well, there were two things.

First, for 35 years, until the underlying property was sold to the current landlord, the tenant (and its predecessors) and the prior landlord (and its predecessors) used the wrong date for the “Lease Commencement Date.” Even though the lease defined it to be “the date of this Lease Agreement,” those parties, instead, used the date the original tenant received possession of the space.

Then (second), historically (until the most recent landlord acquired the property and read the lease carefully), the parties used a different rent adjustment formula, one that looked like:

New Rent = Current Rent + [Current Rent × .25 × [(Current CPI – Base CPI) / Base CPI]]

Because this formula subtracts the Base CPI from the Current CPI in the numerator, the rent is increased by 25% of the rate of inflation at each adjustment date, whereas when the formula in the lease is used (with the inevitable increase in the CPI over time), the new rent would rise by a minimum of 25%. If the formulas confuse you and the text doesn’t “translate” easily for you, please trust our math.

We realize that some of us think the parties probably intended that the rent adjustment only reflect one-quarter of the increase in CPI, others think the parties intended the rent to go up by 25% once it was first adjusted for any increase in the CPI, and that the rest of us have no idea what the parties intended. Regardless of what any of us thinks, the lease was pretty clear. Or, was it? Specifically, if (historically) the parties had interpreted the lease in a way that increased the rent based on 25% of the CPI increase from what it was on the Lease Commencement Date, isn’t that what really counts? Shouldn’t the latest landlord be bound by the way all of its predecessors “read” the rent adjustment provision? And, what date should be used for the Base CPI or for the rent adjustment points if all of the earlier parties ignored the lease’s definition for “Lease Commencement Date”? While we are at it, if the lease’s unambiguous rent adjustment language applies, does the tenant now owe (a great deal) more money beginning with the initial (10th year) rent adjustment?

We feel obligated to repeat that the lease’s provisions for rent adjustments and for the “Lease Commencement Date” are clear on their faces. [Even the court agrees with us! (Actually, we agree with the court.)] If anyone wants to argue with the court and desires to use Ruminations as an intermediary, just post a comment. So, did the historical practices for applying the lease’s text constitute “lease modifications”? If they did, then is the current landlord bound by such modifications?

Here’s what the lower court wrote and what the appellate court endorsed:

[There was a] near thirty year misapplication of the formula …. There can be no mutual consent to modify if the parties were merely misapplying the formula set forth in the lease. Indeed, if the parties actually did consent to modify the lease, it is inexplicable (and unexplained) why they did not put it in writing. While the parties may modify an agreement via their conduct, … [T]he record here does not support the [tenant’s] assertion that its conduct was an intentional attempt at modification, rather than a mistaken belief as to what the rent escalation formula was. The tenant’s mere acceptance of the prior landlord’s favorable calculations of rent increases does not establish that there was mutual consent to modify the rent escalation clause. Moreover, even if we were to conclude that the lease agreement had been modified via the then-parties’ conduct, [the current landlord] as the successor-in-interest would only be bound by the modification if it had actual or constructive notice of the modification. … There is no evidence that [the current landlord] had actual notice of the conduct allegedly resulting in a modification, and the assertion that it had constructive notice is questionable at best.

Let’s translate that. The current landlord can adjust the rent exactly as the lease provision reads and isn’t bound by whatever was done before it acquired the property. This leaves at least a couple of questions such as: (1) could the earlier landlords, subject perhaps to the statute of limitations, retroactively correct its “erroneous” rent adjustment calculation; and (2) what if the current landlord had been aware of the “mistake” made by its predecessors?

While those are tough questions for us, they wouldn’t have been for a dissenting judge. He believed that, historically, the parties “must have intended, by their actions, to apply” the rent adjustment formula in the way they did and that they intended to redefine the “Lease Commencement Date.” He identified the parties as “sophisticated” and opined that the parties were aware of their deviation from what the lease actually said. As such, he interpreted the “mutual, consistent, and contrary behavior” as an assent that resulted in a lease modification. Further, he concluded that the current landlord, in the course of its own due diligence, actually or constructively knew that rent increases had always (on four prior occasions) been adjusted in a way that differed from what the lease actually provided. So, he would have required the current landlord to abide by the historic practice for rent adjustments.

So, where does this take us? Clearly, the tenant, as a beneficiary of both “errors” (or were they?) should have sought a formal lease modification. Our guess is either that it was lazy or, more likely, initially afraid to point out the discrepancy. Perhaps, it didn’t even realize that the earlier landlords weren’t following the lease’s text. Nothing in the court’s decision gives us any clue.

Where else does this case take us? Well, we learned again that facts really matter. Did the parties intend to amend the lease? Were these earlier rent adjustments each a one-time concession (waiver)?

And, one more thing: we think the current landlord didn’t discover the calculation discrepancy until the first rent change date after it became the property owner and when it followed the lease, the tenant was shocked by the rent increase. Until that time, no one was even thinking about the issue. So, basically, the court’s majority held that the earlier calculations were mistakes, whereas one judge, the Chief Judge, thought the revised method was an intentional lease change. Readers, when you chose a side in this dispute, remember: “You pays your money and you takes your choice.” Should the tenant have tried to memorialize the way the increase had actually been calculated? Did it know of the “mistake” and decide to keep quiet? Did the new owner purchase the property at a price that reflected the understated rent after having reviewed an estoppel certificate from the tenant setting forth that understated rent, and, if so, should the new owner get a windfall of that much higher rent than the prior owner should have been enjoying before the sale? Perhaps, as Frank Readick repeatedly said, “The Shadow knows!,” but Ruminations sure doesn’t.

[If you think it will help you decide for yourself, click HERE to read the appellate court’s decision.]