Mastering Commercial Landlord & Tenant Law — Build Outs and Free Rent Periods — Michelle Continuing Legal Education for Rossdale CLE
July 28, 2016
On July 27, 2016 Michelle Maratto Itkowitz taught a CLE for Rossdale CLE on Mastering Commercial Landlord & Tenant Law. Michelle had the privilege of teaching this seminar with Mindy Stern, the incoming president of the the Real Property Section of the New York State Bar Association.
Here is an excerpt from the material:
II. FREE RENT PERIOD AND BUILD-OUTS
A. Custom Made Clauses = More Imprecision
The “Landlord’s Work” section of a commercial lease is often susceptible to imprecise language, perhaps because this section is often heavily negotiated.
It is our experience in my firm, for us both as litigators and drafters, that when any section is heavily negotiated it is also often drastically re-written. And whenever a section is custom-made, it is also more likely to be a litigated.
B. Build Out Clauses and Free Rent Periods
Concepts needed to understand the hypothetical example coming up:
• Landlord’s Work – Build Out
• Tenant’s Work
• Free Rent Period
• Free Rent Contingent of No Default
• Lease Commencement Date
• Rent Commencement Date
• Claw-back
When a landlord is supposed to do certain work to prepare the space for the tenant, this section of a commercial lease is often called the “Landlord’s Work” section. The Landlord’s Work is often for big items which are building-wide, such as HVAC and plumbing.
The tenant’s work in the space will often be outlined in the lease, and this is know as the “Tenant’s Work” section.
When Landlord’s Work and Tenant’s Work is happening simultaneously, then any delay on the part of the landlord can theoretically be used as an excuse for the space not being ready on time for the tenant’s anticipated opening, as we will shortly see.
Many commercial tenants get a period of free rent at the beginning of the lease. The purpose of the free rent period is to allow the tenant time to build the space and start doing business before the rental obligation kicks in. Often the free rent period is contingent upon the tenant not later going into default under the lease. The date the lease is fully executed and becomes effective will be known as the Lease Commencement Date and the later date when the rent starts to become due will be known as the Rent Commencement Date.
Moreover, in the event of a tenant default, a commercial lease will sometimes give a landlord the right to recapture the free rent. This is sometimes called a claw-back. This kind of clause can be an added dis-incentive to a tenant to risk a default, particularly when the lease is accompanied by a personal guaranty.
You can imagine the disputes that arise when the space is NOT ready on time, and the free rent period ends. Let us not imagine one – let us look at a real life example next!
C. Example – Tenant’s Swanky Restaurant in a Land-marked Building
I recently had a case where a high-end sushi restaurant was going into a land-marked building in Brooklyn. I represented the landlord. I was not the leasing counsel. I was hired for litigation after the lease was executed.
The lease called for the tenant to install a front door to the premises. The tenant wanted to install a cool wooden door. The tenant could not install the door, however, because the building has a Landmarks Preservation Commission (“LPC”) violation on the facade. Any door installed needed to be approved by the LPC, and the LPC moves slowly.
Tenant was way behind schedule with its work and did not open when it expected to. The free rent period in said lease ended. Tenant did not start paying rent. I was hired by the landlord to sue the tenant for nonpayment.
The predicate Rent Demand that I served on the tenant did not just demand the rent due since the “Rent Commencement Date”, but I demanded rent due from the date the lease BEGAN, in essence demanding six months of rent that tenant anticipated were waived during the free-rent period. Landlord’s position was that such free-rent was conditioned on tenant not being in default, and now tenant was in default.
The tenant’s counsel wrote landlord a letter and blamed landlord for the delay in opening. Tenant’s position was that tenant has ZERO control over LPC, which was true. Only the landlord could go before LPC. Landlord’s architect was doing everything it could to get the LPC issue resolved, but there is no rushing the City of NY. I wrote tenant’s counsel back, as follows:
Of course, Landmarks approval for the facade is within tenant’s control. Landlord has been assisting as a courtesy, but that in no way even implies that this is Landlord’s responsibility. Let us look at ¶ 42 (Work To Be Performed) of the Lease:
42.01 Landlord shall perform or cause the performance at its sole cost and expense, the work (the “Initial Work”) set forth in “Landlord’s Work Letter” as described in Exhibit A hereto.
[The work letter concerned only a plumbing upgrade, which was done.]
Except for the Initial Work, Landlord shall have no obligation to perform any work in, or make any alteration, or improvements to, the Demised Premises or the Building to ready the Demised Premises or the Building for, or make any payment or other contribution to Tenant or otherwise in connection Tenant’s initial occupancy. …
42.02 Other than the Initial Work, Tenant has examined and inspected the Demised Premises. Tenant agrees to accept possession of the Demised Premises “AS IS” except as otherwise expressly provided herein. Landlord shall not be responsible for making any improvements, alterations or repairs therein or for spending any other money to prepare the Demised Premises for Tenant’s occupancy, except as expressly provided herein. All other improvements and alterations to the Demised Premises prior to or at anytime after the commencement of the term of this Lease shall be made at Tenant’s sole cost and expense, in accordance with the provisions of this Lease.
The façade is Tenant’s responsibility. There was an open Landmarks violation on the building, dating from 2011, which anyone could view online. Your client had an obligation to conduct some due diligence and plan with their architect and their team. Tenant took the space “AS IS”. Landlord did not guaranty anything about the use (§ 45 of the Lease) and Landlord has made no representations (§ 59 of the Lease). Bottom line – your client is not the first tenant dealing with an entrance to a Landmark building. That is no excuse for not paying the rent.
I saw some photographs of the space earlier today. It is still a construction zone. One suspects that your client’s reticence about paying the rent has less to do with a Landmark’s issue and more to do with just not being ready when the rent kicked in.
Finally, I note that § 41.02 states that the free rent is only applicable if there is “no Event of Default.” Your client is in default. Thus, the rent demand.
This is a poor beginning to a landlord and tenant relationship that my clients had high hopes for. Call me if you want to talk about getting things back on track.
[END OF LETTER]
Tenant, of course, said that is should be excused from performing in this case, i.e. from paying, based upon the defense of impossibility. “[I]mpossibility excuses a party’s performance only when the destruction of the subject matter of the contract or the means of performance makes performance objectively impossible.” Kolodin v. Valenti, 115 A.D.3d 197, (1st Dep’t 2014). The excuse of impossibility is generally “limited to the destruction of the means of performance by an act of God…or by law” 407 E. 61st Garage v. Savoy Fifth Ave. Corp., 23 N.Y.2d 275, 281 (1968).
The impossibility must, however, be the result of an unforeseen event that could not have been protected against in the contract. Kel Kim Corp. v. Central Mkts., Inc., 70 N.Y.2d 900, (1987).
Here are some instructive cases. In 143-145 Madison Ave. LLC v. Tranel, Inc., 74 A.D.3d 473 (1st Dept. 2010), the appellate court held that the motion court correctly rejected plaintiffs’ argument based on impossibility, since plaintiffs’ difficulties in obtaining sufficient water pressure to install a separate sprinkler system for the subject premises were foreseeable and could have been guarded against in the contract. The tenant, who had been in possession of the premises for years, was on notice, or at least inquiry notice, of the condition of the building and its plumbing before entering into the contract promising to install the sprinklers, it is their own negligence for which they seek relief. Moreover, the only evidence they submitted to support their contention that a separate sprinkler system was impossible was an affidavit by their plumber, who failed to refute any of the material assertions supporting defendant’s expert engineer’s opinion that a separate system could be installed.
In 250 West Broadway Realty Corp. v. FFE LLC, 23 Misc.3d 126(A) (AT 1st, 2009) the appellate court held that a possessory judgment was properly awarded to landlord upon tenant’s failure to establish its defense of impossibility of performance. The record showed that tenant’s inability to obtain the requisite permits from the Department of Buildings was not an unanticipated event that could not have been foreseen and guarded against in the contract. To the contrary, Article 63 of the governing commercial lease agreement made it clear that the uncertainty of the permit issue in that case was anticipated and that tenant was given the option to terminate the lease in the event that it was unable to obtain all “permits, consents, approval and or licenses” to operate a “wine restaurant.” While tenant’s excuse for its inability to cure its default was landlord’s failure to obtain a new certificate of occupancy, it never identified any lease provision requiring landlord to obtain a certificate of occupancy.
In RW Holdings, LLC v. Mayer, 131 A.D.3d 1228 (2nd Dept. 2015), the defendant did not show that it was unforeseeable that a change in the Town’s Zoning Code would render it impossible to subdivide the property as initially planned, and did not raise a triable issue of fact in opposition to the plaintiff’s showing that such a change was foreseeable.
Nor does the doctrine of impossibility avail plaintiff, since impossibility occasioned by financial hardship does not excuse performance of a contract. Moreover, an economic downturn could have been foreseen or guarded against in the lease. Urban Archaeology Ltd. v. 207 E. 57th Street LLC, 68 A.D.3d 562 (AD 1st dept. 2009).
In one case in 2010, a Ruby Tuesday Restaurant tried to say that it was impossible for it to open up because of the, “worldwide economic meltdown”. The court did not buy that. Courts generally are reluctant to excuse contractual non-performance based on claims of economic hardship and changing economic conditions. Further, it is well established rule of contract law that force majeure clauses must be narrowly construed. In essence, Ruby Tuesday’s own submission revealed it had ultimate control over the decision whether or not to open a restaurant and that its failure to do so was the product of a decision to apply its limited financial resources towards other obligations. Route 6 Outparcels, LLC v. Ruby Tuesday, Inc., 27 Misc.3d 1222(A) (Sup. Ct. Albany County, 2010).
The term “governmental prohibition,” as used in force majeure clause of commercial lease that provided landlord with additional time for performing in event its performance was affected by “governmental prohibition,” was broad enough to include temporary restraining order (TRO) that prevented landlord from proceeding with construction necessary to deliver possession of premises to tenant. Reade v. Stoneybrook Realty, LLC, 63 A.D.3d 433 (1st dept. 2009).
The parties did get things back on track and they settled. Interesting issue, right?
The lease language was imprecise. It was clear, but it was inadequate for the needs of the tenant in this case. Was this a failure in due diligence? Or a failure in the lease language? Or both?
In retrospect, the tenant’s leasing counsel should have carved out an exception for a delay in tenant’s work caused by landlord, or otherwise beyond tenant’s control.
