distressed commercial real estate leases: a primer … 14... · phil1 806808-7 03/25/2009 02:20 pm...

PHIL1 806808-7 03/25/2009 02:20 PM Introduction to Real Estate Distressed Leases Copyright © 2008, Gregory G. Gosfield. All Rights Reserved.

DISTRESSED COMMERCIAL REAL ESTATE LEASES:

A PRIMER ON

NEGOTIATIONS, RESTRUCTURINGS AND

TERMINATIONS

Gregory G. Gosfield, Esq. Klehr, Harrison, Harvey, Branzburg & Ellers LLP 260 S. Broad Street • Philadelphia, PA 19102-5003 • Tel: 215.569.4164 • Fax: 215.568.6603 [email protected]

PHIL1 806808-7 03/25/2009 02:20 PM Introduction to Real Estate Distressed Leases

I. INTRODUCTION

The restructuring of a commercial real estate lease occurs when one of the parties seeks a privilege which is not addressed in the agreement. For example, if a marginally profitable tenant is being acquired by a private equity fund, the tenant may need landlord consent to the assignment of the lease. The analysis may vary if assigned as an asset or as change of ownership, control and management of the tenant in an assignment of the securities. In the case of a troubled commercial property, a prospective purchaser may need the consent of tenants to reconfigure the common areas to allow more occupancy, or to introduce an occupant who would otherwise violate use restrictions. Alternatively, restructuring may arise from conflicts between the parties, or the failure of the location to provide the anticipated benefits. Some disputes may arise from sight-specific issues such as inconvenient location, insufficient parking, poor views or site lines, exposure to disturbing weather, or environmental hazards. Disputes may arise due to changes in the financial wherewithal of either party, changes in the marketplace, or changes in other circumstances, such as a tenant’s need to move or a landlord’s need to reposition the development of the location. The parties will sometimes manufacture and instigate disputes with the goal either to terminate the moving party’s obligations or to compel the adverse party to pay or perform its obligations, or to consent to change. In some instances, the change is consensual and worked out through agreement. In other instances it is compelled by commercial litigation or bankruptcy. This paper will address some of the alternative responses to resolving distressed leases.

II. DEFAULTS

A. Classes and Grades of Disputes.

Though at a very simple level disputes will arise when one party’s desires or expectations are thwarted, in lease agreements the disputes can be classified in several ways. The most obvious and usually the only ones considered, are those based on defaults. Parties usually classify defaults as payment or performance defaults, and provide notice and cure periods according to the grade of the default. There can also be disputes arising from tortious actions, such as interference by one party with the other party’s business relationships, misconduct outside of the lease agreement such as one party instigating the misconduct of the other party’s competitor. Disputes can also arise from breach of statutory standards such as one party violating state fair business practice requirements or perpetrating a crime against the other party. Lastly, disputes can arise from failure to comply with common law requirements. Even among lease agreement defaults there are subclassifications for those that are considered willful and usually are not qualified for notice or cure periods, such as an assignment in violation of the contract provisions. There may be some that are considered within the knowledge and control of a party and therefore may be entitled to a cure period but not a pre-conditional notice, such as becoming subject to an involuntary bankruptcy or insolvency proceedings. There may be some that may not necessarily be within the knowledge and control of a party, but in allocating risk, the aggrieved party will not be further impaired by a cure period but no notice, such as a failure to pay rent. Even if a default or dispute arises, there may be gradations that define the remedies. For example, a diminimus or unintentional default such as failing to provide the other party with a required notice of change of insurance carrier may not entitle the other party to extreme remedies such as termination. On the other hand, an event which results in a material adverse

PHIL1 806808-7 03/25/2009 02:20 PM 2 Introduction to Real Estate Distressed Leases

change may by itself be a default, regardless of whether it is willful or even outside the reasonable control of the party. A fundamental change in a party, even if not a material adverse change, would also be considered appropriate as an event of default without a notice or cure period.

B. Contract Principles Not Fully Applicable to Lease Law.

A lease is composed of both contract rights and real property rights. Therefore, one would reasonably expect that all of the issues relating to contract terms would as well apply to lease contracts: breaches of promises to pay money, breaches of promises to perform acts, breaches of representations and warranties, breaches of conditions precedent and subsequent, breaches to defend and hold harmless. But the correspondence between the lease and the contract is not a perfect match. In some instances, there are contractual concepts related to default that have not yet been imported successfully into lease law.

1. Independent Covenants. The concept of independent covenants remains deeply embedded in lease law. The contract law doctrine of dependence-of-promises proposes that when two parties have made significant reciprocal inducing covenants, then failure to perform one party’s covenant provides the other party a defense to perform its reciprocal covenant.1 If the covenants are independent, the breach by one party has no effect on the obligation of the other party. As a drafting rule, covenants are deemed dependent unless the contract expressly provides otherwise.2 In the context of a lease, one respected commentator has posited that the independent nature of lease covenants has been one of its key distinctions when compared to contract.3 Thus, the ancient common law rule has been that the rent obligation for

1 RESTATEMENT (SECOND) OF PROPERTY, Landlord & Tenant § 7.1 (1977): § 7.1 Nonperformance of Landlord’s Promise – Remedies Available. Except to the extent the parties to a lease validly agree otherwise, if the landlord fails to perform a valid promise contained in the lease to do, or to refrain from doing, something on the leased property or elsewhere, and as a consequence thereof, the tenant is deprived of a significant inducement to the making of the lease, and if the landlord does not perform his promise within a reasonable period of time after being requested to do so, the tenant may:

(1) terminate the lease in the manner prescribed in § 10.1 and recover damages to the extent prescribed in § 10.2; or

(2) continue the lease and obtain appropriate equitable and legal relief, including: (a) the recovery of damages to the extent prescribed in § 10.2; (b) an abatement of the rent to the extent prescribed in § 11.1; (c) the use of the rent to perform the landlord’s promise to the extent prescribed

in § 11.2; and (d) the withholding of the rent in the manner and to the extent prescribed in

§ 11.3 until the landlord performs his promise. 2 “Absent a contrary agreement, the tenant’s obligations were not independent of the landlord’s promise under the noncompetition clause. When a noncompetition clause is breached by the landlord, a tenant may abate the rent in an amount proportionate to the rent which the fair rental value, after the landlord’s breach, bears to the fair rental value prior to the breach. It is permitted until the default is eliminated or the lease is terminated. Other remedies include termination, damages, use of the rent to perform the landlord’s promise and withholding rent.” Teodori v. Warner, 415 A. 2d 31, 35 (Pa 1980). 3 “The rule that covenants in a lease are independent, rather than mutually dependent, can hardly be overemphasized. It is the distinguishing feature between lease and contract.” FRIEDMAN ON LEASES, §1.2.2, pages 1-17 (5th Ed.).


land continues after the destruction of a building. The basis of the theory was that because rent is derived from the issues out of the land, as long as the tenant continues to lease land, then the subject of the lease continues. But the common law has been evolving from an agriculturally based economy, and by contrast, in the case of the lease of a building and not the land, at least one authority concludes that under common law the rent obligation is excused upon destruction of the building.4 If the parties do not expressly address the issue of dependent covenants, they can be deemed to apply to the lease. This is also the policy of a minority of jurisdictions.5

2. Real or Personal Covenants.

Within the class of contract rights, two subclasses can be identified: real covenants and personal covenants. Lord Coke coined the then new distinction of covenants that run with the land in his exposition of the meaning of Spencer’s Case.6 By that, he announced the rule to protect successor grantees from having to perform either personal service or covenants that were not essential to the indicia of ownership. Unfortunately by invoking the doctrines of privity of estate and privity of contract, as well as creating the principle that “real” covenants must “touch and concern” the land, English real estate law and theory was launched into the spheres of philosophy where metaphysics and other Aristotelian concepts continue to orbit a sun of intense debate about what parts of lease covenants are transferred with the real estate. The sum of that activity radiates great heat but little illumination. Applying the rules from Spencer’s Case, a number of lease covenants are considered to run with the land, and so join the extended family of rights related to property rights. Those covenants were commonly deemed to include the promise to pay rent, to preserve the leasehold from waste, to repair the leasehold, to pay taxes for the premises as well as option rights to cancel the lease, renew the lease, and to purchase the premises.7 Setting aside the convolutions, involutions and perturbations that are caused by 4 “In the case, on the other hand, of the lease of a building alone, without the land, or of merely certain rooms in or parts of a building, if the building, or the part thereof which is the subject of the lease, is destroyed, it has been usually held in this country that nothing remains from which the rent can issue, and that consequently the liability therefore immediately ceases.” (footnotes omitted) TIFFANY, THE LAW OF REAL PROPERTY, §905, page 569. 5 “In this case, we abandon the common-law rule of independent covenants in commercial leases in favor of the modern rule of mutually dependent covenants as reflected in the Restatement (Second) of Property (Landlord and Tenant) §7.1 (1977). In applying the rule of mutually dependent covenants to the facts present in this case, we conclude that a landlord’s failure to keep the roof of his building in good repair deprived the tenant of a substantial benefit significant to the purpose for which the lease was entered. Consequently, the tenant had the right to terminate the lease and recover reasonable relocation costs.” Wesson v. Leone Enterprises, Inc, 774 N.E. 2d, 611,613 (Mass. 2002). 6 Spencer’s Case 1583 5 Coke, 162-b, 77 Eng. Reprint, 72, 1 Smith, Lead Cas. 5th ed 125, 15 Eng. Rul. Cas. 233. “when the covenant extends to a thing in esse, parcel of the demise, the thing to be done by force of the covenant is quodammodo annexed and appurtenant to the thing demised, and shall go with the land, and shall bind the assignee although he be not bound by express words” *** “2 . . . . [A]lthough the covenant be for him and his assigns, yet if the thing to be done be merely collateral to the land, and doth not touch or concern the thing demised in any sort, there the assignee shall not be charged. *** “3 . . . . [I]f a man leases sheep or other stock of cattle, or any other personal goods for any time, and the lessee covenants for him and his assigns at the end of the time to deliver the like cattle or goods as good as the things letten were, or such price for them; and the lessee assigns the sheep over, this covenant shall not bind the assignee, for it is but a personal contract, and wants such privity as is between the lessor and lessee and his assigns of the land in respect of the reversion. But in the case of a lease of person good there is not any privity, nor any reversion, but merely a thing in action in the personalty, which cannot bind any but the covenantor, his executors, or administrators, who represent him.” 7 FRIEDMAN ON LEASES, Section 36.4 Transfer of Landlord’s Reversion (5th Ed.). In addition, Tiffany, LAW OF REAL PROPERTY at 206-208 lists more covenants that run with the land, and identifies some that do not. Those that


applying the rule of “touch and concern,” one distinguished commentator on the doctrine of covenants running with the land concluded that a loose and flexible common sense approach should be adopted.8 His folksy wisdom, however, highlights the very problem in trying to apply the rule.

A further interesting distinction relating to “real” covenants is that as a rule the benefit and burden transfers to a tenant’s assignee, but not a subtenant. There is neither privity of estate nor privity of contract between a prime landlord and a subtenant.9 The exception to the rule is the case of a concurrent lease, sometimes called a sandwich lease, where the landlord subsequently leases to another tenant the landlord’s interest, including rights as landlord under pre-existing leases which then become subleases.10

3. Anticipatory Breach. Another contract doctrine that parties have sought to import but which has not yet enjoyed great traction is anticipatory breach. The principle is that the early repudiation of a promise or duty for subsequent performance allows the damaged party to recover damages even though the default on the promise has not actually occurred. One

do are covenants to protect the property from liens, to not assign without landlord consent, to pay lienable taxes, to surrender in good repair, to operate an exclusive use, to vacate upon sale, to insure for property loss, the rights of lease renewal, and the right to purchase option. Covenants not running with the land are payments to strangers, radius restrictions outside of the property, and release from liability for casualty. Another long list can be found in the decision of the court in Northern Pacific Railway Co. v. McClure, 8N.W 52, 55(N.D. 1899) reciting other covenants running with the land as: “Among those, we name but a few: Covenants to repair. Shelby v. Hearne, 14 Tenn. 511, 6 Yer. 511 at 512; Allen v. Culver, 3 Denio 284. To pay for improvements. Ecke v. Fetzer, 65 Wis. 55, 26 N.W. 266. Not to erect and operate a rival mill. Norman v. Wells, 17 Wend. 136. To leave in repair. Demarest v. Willard, 8 Cow. 206; Myers v. Burns, 33 Barb. 401. To maintaining existing fences. Hurtung v. Witte, 59 Wis. 285, 18 N.W. 175; Kellogg v. Robinson, 6 Vt. 276. For right of ingress and egress to and from a building. Bush v. Calis, 1 Show. 389. Not to assign or underlet. Williams v. Earle, 9 Best & S. 740. Not to erect a building in front of the demised premises. Trustees v. Cowen, 4 Paige 510. Not to plow or cultivate in a certain manner. Cockson v. Cock, Cro. Jac. 125. To use land in a husbandlike manner, and leave it in like condition. Walsh v. Watson, Esp. N.P. 295. To manure land each year. v. Davis, M. S.M. T., 42 Geo. III. To leave land with certain crops planted. Hooper v. Clark, 8 Best & S. 150. To reside on the premises during the term. Taltem v. Chaplin, 2 H. Bl. 133. Not to carry on particular trades on the premises. Barron v. Richard, 3 Edw. Ch. 96. To erect only buildings of a certain kind, and use them only for a specified purpose. St. Andrew’s Lutheran Church’s Appeal, 67 Pa. 12. To erect buildings on the premises. Fisher v. Lewis, 3 Pa. Law J. 73. To erect and maintain an adjoining fence. Bronson v. Coffin, 108 Mass. 175. To insure buildings when the money is to be used to rebuild. Thomas’ Adm’rs v. Von Kapff’s Ex’rs, 6 G. & J. 372.” 8 “…there would be no reason for applying the rule of touching and concerning in an over-technical manner, which is unreal from the standpoint of the parties themselves. Where the parties, as laymen and not as lawyers, would naturally regard the covenant as intimately bound up with the land, aiding the promise as landowner or hampering the promisor in similar capacity, the requirement should be held fulfilled.” Charles E. Clark, REAL COVENANTS AND OTHER INTERESTS WHICH “RUN WITH THE LAND,” (1929) at page 78. 9 This legal nuance of lack of privity can obstruct the satisfactory consummation of a transaction which would use a master lease instead of a guaranty. For example, in at least one reported case, the lack of privity caused the prospective buyer of a loan, master leased by a borrower, to refuse to close because adequate SNDAs by subtenants were not delivered. Teachers Insurance Annuity Association of America v. Ocwen, 2002, US Dist. LEXIS, 2560 (2002). 10 Tiffany, LAW OF REAL PROPERTY, at 212.


reason may be, notwithstanding the independence of covenants, if the landlord fails to provide quiet enjoyment or evicts the tenant, the tenant cannot perform its promise.11

4. Mitigation of Damages. A third contract principle which is making incursions is the duty to mitigate damages upon acceleration of rent (discussed below).

5. Forfeiture. Another example of the cross-over of contract law concepts into lease law is the adoption of the principle of forfeiture. Forfeiture or termination of the estate before its maturity is an extreme result and one not lightly approved by courts.12 Immaterial breaches of a lease will not support forfeiture, and accordingly, a landlord will not be able to eject a tenant where the breach was immaterial, nor will a tenant claim a right of termination of the lease.13 Material breaches by the landlord or the tenant could provide grounds for ejectment or termination of the lease. The breaches in the following cases have been held to constitute grounds for forfeiture and ejectment:

a. Failure to pay rent.14

b. Tenant disclaimer of landlord’s title.15

c. Violation of restrictions on assignment or subletting.16

d. Violation of restriction on alterations.17

e. Violation of restriction against removal of personal property18

6. No Duty of Good Faith and Commercial Reasonableness. Contract law is generally governed by the principles of conduct that were codified in the Uniform Commercial Code: to conduct the negotiations in good faith19 and with fair dealing.20 By contrast, real estate law and negotiations have not yet assumed an implied duty of either of those. To the contrary,

11 2401 Pennsylvania Avenue Corp. v. Federation of Jewish Agencies, 319 Pa. Super. 228, 466 A.2d 132 (1983), aff’d, 507 Pa. 166, 489 A.2d 733 (1984); the court found no anticipatory repudiation by tenant where no proof was advanced that (1) the tenant disavowed the lease; (2) the tenant repudiated its duties under the lease; (3) the tenant absolutely and unequivocally refused to perform; (4) the lease contained an obligation for tenant to occupy the premises; and (5) the implied-in-law duty for tenant to occupy the premises existence. 12 Barraclough v. Atlantic Refining Company, 230 Pa. Super. 276, 326 A.2d 477 (1974) “when a party has honestly and faithfully performed all material elements of its obligation under a contract, but has failed to fulfill certain technical obligations, causing no serious detriment to the other party, it would be odious and inequitable to compel forfeiture of the entire contract.” 13 See Barraclouqh v. Atlantic Refining Company, supra (accidental payment of rent to bank previously, holding satisfied mortgage instead of to landlord did not justify eviction since breach was a minor technical breach and Tenant attempted to remedy its error) Brown v. Brown, 164 Pa. Super; 350, 64 A.2d 506 (1949) (inadvertent and unintentional failure. to sign rent check could not work forfeiture). 14 Burgess v. Clear, 153 Pa. Super. 566, 34 A.2d 265 (1943); Rostan v. Chookagian, 69 Pa. D&C 2d 255 (1974). 15 Jones v. Stiffler, 137 Pa. Super. 133, 8 A.2d 455 (1939) 16 O’Brien v. Bunn, .5 Pa. D&C 552 (1924). 17 Goenner V. Glumicich, 81 Pa. Super. 521 (1923). 18 Waldman v. Baer, 81 Pa. super. 390 (1923). 19 Uniform Commercial Code §1-203. 20 Uniform Commercial Code §1-201(b)(20).


the courts have supported the principle that real estate law is free from those public policy doctrines.21

C. Lease Law Principles Not Applicable to Contract Law.

But not only is lease law in some instances narrower than general contract law, in other instances it is broader having sprung from a different source and evolved to solve different problems than contract law. The practitioner should remain aware of real property issues that are special to leases and unimagined by contract law. They can be implicated as sources of disputes, and they usually revolve around issues of possession.

1. Tenant Defaults. A tenant may be in default for failure to take possession, for failure to remain in possession, whether by vacating or transferring possession, or for a failure to timely and properly surrender possession. The remedies are different based on the violation.

a. Failure to Take Possession. A tenant who fails to take possession is usually liable for damages, not for accelerated rent, under the principle of interesse termini22. This is a tenurial concept based on the unity of tenancy and possession, though its force has been eroded by developing case law. Under that principle the tenant may have the right to an estate, but because it lacks possession from the holder of the estate, it is not entitled to quiet enjoyment, and can be terminated without being deemed evicted.23 It may be based on the expectation that a tenant who has not adopted the use of the estate cannot expect the landlord or third parties to respect the existence and continuation of its estate.

b. Failure to Retain Possession. A tenant who fails to remain in possession may be subject to various claims for failure to continuously operate. This can be a very serious problem in a retail property if rent is pegged to a percentage of revenue, or if other leases have co-tenancy conditions and can be terminated if the tenant in question is out of possession. An absence of possession can presage other breaches, including a risk that the tenant will permit waste to occur to the estate, or that the improvements will be uninsurable because of the vacancy.

c. Abandonment or Surrender of Possession. Vacating by the tenant may or may not be abandonment or surrender. Abandonment implies the tenant has forsaken the estate. To establish an abandonment there must be (1) an intention to abandon and (2) conduct by which the intention is carried into effect. Where abandonment is found, the landlord can

21 GMH Associates v. Prudential Realty Group, 752 A.2d 889, 903 (Pa. 2000). 22 In all likelihood this was because at common law a lessee who had not entered into possession was not thought to have an estate in land. Rather, such a lessee was said to have an ‘interesse termini’, or an interest in a term. Co. Lit. 46b; 2 Blackstone, Commentaries *144. Soffer v. Beech, 409 A.2d 337, 341 (Pa. 1977). 23 “Because no livery of seisin is necessary to a lease for years, such lessee is not said to be seised, or to have true legal seisin of the lands. Nor indeed does the bare lease vest any estate in lessee; but only gives him a right of entry on the tenement, which right is called his interest in the term, or interesse termini: but when he has actually so entered, and thereby accepted the grant, the estate is then, and not before, vested in him, and he is possessed, not properly of the land, but of the term of years; the possession or seisin of the land remaining still in him who hath the freehold.” 2 WILLIAM BLACKSTONE, COMMENTARIES *144.


repossess property and exclude the tenant.24 Surrender implies that the tenant has returned the estate to the landlord.25 If the landlord accepts the surrender, then the leasehold estate is terminated along with tenant’s continuing obligation to pay rent.

d. Failure to Return Possession. If the tenant refuses to give possession after the leasehold is terminated, then it may be either a trespasser, a tenant at sufferance or at will, or a renewal tenant (described below).

2. Landlord Defaults. Similar to the framework for analyzing tenant default, all of the incidents of a breach of contract would apply to the analysis of landlord default. And as with the tenant analysis, the significant distinguishing elements of landlord default are those that apply to the unique nature of the real property right, the right of possession. A landlord defaults for failure to provide possession or to sustain the right of possession.

a. Failure to Provide Possession with Quiet Enjoyment. The concept of tenure dates back to Norman military feudalism. The grants of tenure reinforced the vassal’s fealty and submission. The force of arms that won the right to the land remained a dominant force in qualifying the relationship between the feudal king and his barons, at least as long as there were threats of war which could only be met by a volunteer army. He guaranteed to the barons the right of possession in exchange for their fealty. And similarly, the duty of the barons to their vassals, and them to theirs, was that the lord of the tenant had the duty to preserve the quiet possession of the land for those holding from the lord. The tenant’s hold of the land, his tenure, from his lord was founded on the reciprocal fealty of lord to tenant and the duty to render in return by the tenant to his lord. Royal feudal practice from the time of the Conquest allowed the enfeoffed holder, as tenant, to hold his feudal interest in the land with the exclusive lifetime right for occupancy and to benefit from its issues and profits. The right of tenure was conditioned on complicated rules relating to the type of rent rendered by the tenant, whether military service by knights (chivalry), spiritual service by clergy (frankalmoign), personal service by the King’s retinue (serjeanty), or economic service by freeholders (socage which later became fixed rent).26 However, at the same time, underlying Anglo-Saxon leases of the conquered populace perpetuated multi-generational rights which ultimately changed into perpetual rights27. The principles of quiet enjoyment, quiet possession, and non-disturbance all flow from the same spring.28 The concepts of quiet enjoyment and quiet possession are so 24 Eckel v. Eiswerth, 371 Pa. 490, 92 A.2d 1974 (1952). 25 Foureal Company v. National Molding Corp., 344 N.Y.S. 2d 598 (1973) in response to landlord’s allegation that it had the right to terminate the lease because the tenant had vacated or deserted the demised premises, the court held as a matter of law that where the tenant moved out of the leased premises, but continued to pay rent, kept the location under lock and key, and maintained trade fixtures at the leased premises, the tenant had not vacated the leased premises and therefore the landlord was not entitled to recover possession. Reeves v. McComeskey, 32 A. 96 (1895). 26 Tiffany, THE LAW OF REAL PROPERTY at Sections 12 and 13. 27 “The late Saxon leases had been granted for three lives only and the lines of inheritance specified in some of Oswald’s leases (those made in favour of members of his own family) were varied, not necessarily allowing the land to pass from father to son. The post-Conquest fiefs seem to have been heritable so that the lands became, in Bloch’s phrase, ‘the patrimony of the vassal’.” Christopher Dyer, LORDS AND PEASANTS IN A CHANGING SOCIETY: THE ESTATES OF THE BISHOP OF WORCESTER, 680-1540 (1980) at 48. 28…Oxford English Dictionary, “Disturb, 3. b. Law To deprive of the peaceful enjoyment or possession of. See Disturbance 4. *** [1292 Britton II., xxv. Section i. Ceux qi de commune sount engittez ou destourbez. transl. Those who are ejected or disturbed of their common.” “


intrinsic to the meaning of the property rights of possession that a number of jurisdictions have held them to be self-evident covenants, implicit if not explicit.29 The breach of the right of quiet enjoyment, whether it is considered a covenant or a warranty, is not conditioned on an absolute deprivation, but a substantial decrease in the tenant’s enjoyment of the premises due to landlord’s acts or omission.30

b. Failure to Sustain Tenant’s Possession. The dispossession of the tenant by landlord, whether direct or indirect, is eviction. Blatant eviction was a termination of the lease. But where the lease was silent on rent abatement, and the tenant lost the use of the premises, in some jurisdictions, the tenant had to argue that it has been constructively evicted from the space to avoid liability for rent.31 Conduct that does not result in the actual eviction of the tenant from the leased premises does not constitute a constructive eviction.32 The tenant must prove the acts of landlord caused the tenant to be prevented from using the premises. If the landlord is not the cause33 or the tenant has not actually abandoned the premises,34 there is no eviction.

D. Remedies

1. Tenant Default. Landlord’s traditional real estate remedies for breach of the lease contract were to either terminate the lease and tenant’s right to exclusive possession, or accelerate rent and preserve tenant’s right of possession, or re-enter and accelerate rent while “…A person is likewise disseised from the time that he or his family is disturbed in the enjoyment of his peaceable seisin by another, who by such disturbances claims freehold therein, either as to the whole or part, and either in the principal or in the appurtenances.*** So likewise is he disseised, who is disturbed in such manner that he cannot freely enter into his fee and distrain for arrears of services due from the tenement, of which services the lord has been seised.*** A person is also disseised at what time another disturbs and deforces him of his freehold, and does not deliver it up after our command to deliver it.” Francis Morgan Nichols M.A., BRITTON: THE FRENCH TEXT CAREFULLY REVISED WITH AN ENGLISH TRANSLATION INTRODUCTION AND NOTES, (1865), Ch. XI, Sections 6,7. See also “The writ forbidding a lord unjustly to vex his tenant. “The king to S., greeting. I prohibit you from unjustly vexing H., or permitting him to be vexed, in respect of his free tenement which he holds of you in such-and-such a will, or from demanding, or allowing to be demanded, customs and services which he is not bound to do for you, or which his ancestor neither did nor were bound to do in the time of King Henry my grandfather. If you do not do this the sheriff will, that he need no longer complain for default of justice in this matter. Witness, etc.” GLANVILL at Ch. XII, Section 10, page 141. 29 “There is an implied covenant of quiet enjoyment in every lease of real property. The covenant is between lessor and lessee. Any wrongful act of the lessor that interferes with the lessee’s possession, in whole or in part, is a breach of the covenant of quiet enjoyment.” Branish v. NHP Property Management, Inc., 694 A.2d 1106, 1107 (Pa. Super. 1997). 30 Checker Oil Co. v. Harold H. Hogg, Inc., 251 Pa. Super. 351, .380 A.2d 815 (1977). 31 Walnut-Juniper Co. v. McKee, Bereer & Mansueto, Inc., 236 Pa. Super. 1, 344 A.2d 549 (1975). 32 Chelten Ave. Bldg. Corp. v. Mayer, 316 Pa. 228, 172 A. 675 (1934). 33 It is unclear whether a tenant may argue constructive eviction based on the actions of other tenants. The cases throughout the country are split on the issue, see Friedman, §29.301, and Pennsylvania case law, is no exception. See Kuriger v. Cramer, supra (actions of third parties may form basis for claim); Lott v. Guiden, 113 P.L.J. 175, aff'd, 205 Pa. super 519, 211 A.2d 72 (1965) (actions of third party may not form basis for claim); Nadler v. Hatton, 16 Beaver 164 (1954) (actions by third parties may not form basis for claim). 34 See Kuriger v. Cramer, 345 Pa, Super. 595, 498 A.2d 1331 (1985) (no constructive eviction where Tenant remained in possession and withheld rent); Lindstrom v. Pennswood Village, 612 A.2d 1048, 1052 (Pa. Super 1992) re-iterating Kruger test for constructive eviction, but omitting intent.


attempting to re-let the premises on tenant’s behalf. A landlord must carefully consider the remedy it chooses to exercise. Depending on the jurisdiction, after a landlord has elected to deem the tenant either as a holdover or as a trespasser, the landlord cannot change that election.35

a. Lease Termination.

(i) Trespass. The landlord can characterize the tenant as a trespasser and have him removed by the sheriff or police as any common trespasser would. The tenant would be liable for damages which could include: (a)(i) the value of space during the possession and rent accrued to the time of ejectment,36 or (ii) rent during the period between the termination of the lease and the time the landlord elects to treat the tenant as trespasser,37 (b)(i) “damages” not “rent” during the period of the trespass;38 (c) the loss to landlord of the ability to improve the space and engage a new long term tenant; (d) the loss of “mesne profits”;39 (e) damages to the land by waste or otherwise; and, (f) consequential damages related to landlord liability to third parties, such as the new tenant who has been delayed and displaced during the trespass, landlord’s lender who may require additional collateral or default the mortgage loan due to the failure to install the new higher rent-paying tenant timely.

(ii) Tenant at Will. In most jurisdictions, a landlord can deem the tenant to be a tenant at will or at sufferance. Essentially they tenant remains in possession on a month to month basis with all of the attendant real property common law rights and duties of a tenant: for example, rights to quiet enjoyment and duty to prevent waste.

(iii) Hold Over. The landlord can deem the tenant a holdover tenant who extends the maturity date of the current lease under all of its terms and provisions. 40

b. Rent Acceleration. Depending on the jurisdiction, acceleration of rent clauses can be valid and enforceable. But they are frequently viewed as a penalty in favor of the landlord,41 rather than a true payment of declared rent. Some states allow landlords to sue for rent installments as they come due42 but not acceleration.43 Such clauses are not, however, self- operative and the landlord must exercise them to be effective.44

35 Emery v. Metsner, 191 Pa. Super. 440, 442, 156 A.2d ,627, 631,(1.959). 36 Mack v. Fennell, 195 Pa. Super. 501, 171 A.2d 844 (1988). 37 Mack v. Fennell, supra. 38 Williams v. Ladew, 171 Pa. 369, 33 A. 329 (1895); Mack v Fennell, 195 Pa, Super. 501, 171 A.2d 844:(1968). 39 Doyle v. Goldman, 407 Pa. 269, 180 A. 2d 521 (1979), aff’d, 496 Pa. 336, 437 A. 2d 381 (1981) 40 See, Pittsburgh v. Charles Zubik & Sons, Inc., 404 Pa. 219, 223, 171 A.2d 776, 778 (1961); Kaplan v. Bankers Securities Corp., 340 Pa. Super. 579, 583, 490 A.2d 932, 935 (1985). 41 Justine Realty Co. v. American Nat. Can Co., 745 F. Supp. 1943 (E.D. Mo. 1990), judgment rev’d 976 F.2d 385 (8th Cir. 1992); Heller Financial, Inc. v. Burry, 633 F. Supp. 706 (N.D. Ill. 1986) if no discount to present value; IPC Retail Properties, L.L.C. v. Oriental Gardens, Inc., 32 Kan. App. 2d 554, 86 P.3d 543 (2004) too broad; Ricker v. Rombough, 120 Cal. App. 2d Supp. 912, 261 P2d 328 (1953). 42 Cal. Civ. Code § 1951.4; Fla. Stat. Ann. § 83.595(1)(c); Vt. Stat. Ann. tit. 9 § 4462(b); Onal v. BP Amoco Corporation, 275 F.Supp.2d 650 (E.D. Pa. 2003); Bowdin Square, L.L.C. v. Winn-Dixie Montgomery, Inc., 873 So.2d 1091 (Ala. 2003); Weingarten/Arkansas, Inc. v. ABC Interstate Theaters, Inc., 306 Ark. 64, 811 S.W.2d 295 (1991); Kimber v. Towne Hills Development Co., 156 Ga. App. 401, 274 S.E. 2d 620 (1980); Lamb v. Decatur Federal Savings & Loan Association, 201 Ga. App. 583, 411 S.E. 2d 527, motion for reconsideration denied, 201 Ga. App. at 587, 411 S.E. 2d 531 (1991); CB Institutional Fund VIII v. Gemballa U.S.A., Inc., 566 So.2d 896 (Fla.


c. Re-entry. In many jurisdictions, upon default, if the lease provides, the landlord can accelerate for future rent accruing under the lease or eject the tenant, but not both45. The theory is that if rent is accelerated, then the tenant has paid for the right of possession, on the other hand, if the tenant is dispossessed, then it has no duty to pay rent because rent is the consideration for the right of possession.

d. Duty of Mitigation. Traditionally, the landlord was entitled to “permit the premises to remain idle and recover for the balance of the entire term.”46 But there is a duty to mitigate under contract law.47 A party cannot recover damages from a defaulting defendant which could have been avoided by the exercise of reasonable care and effort is applicable to all types of contracts.48 Some jurisdictions have no requirements to mitigate.49 Some states expressly reject the duty to mitigate.50 Some states impose a duty only if the landlord re-enters.51 The modern view appears to be to impose a duty to mitigate, tending away Dist. Ct. App. 4th Dist. 1990). in the absence of a clause providing for accelerated rent, rent is only available in installments; National Advertising Co. v. Main Street Shopping Center, 539 So.2d 594 (Fla. Dist. Ct. App. 2d Dist. 1982); Justine Realty Co. v. American Nat. Can Co., 745 F. Supp. 1943 (E.D. Mo. 1990), judgment rev’d 976 F.2d 385 (8th Cir. 1992); if no discount to present value – Heller Financial, Inc. v. Burry, 633 F. Supp. 706 (N.D. Ill. 1986); too broad – IPC Retail Properties, L.L.C. v. Oriental Gardens, Inc., 32 Kan. App. 2d 554, 86 P.3d 543 (2004); Ricker v. Rombough, 120 Cal. App. 2d Supp. 912, 261 P2d 328 (1953). 43 Peterson v. P.C. Towers, L.P., 206 Ga. App. 591, 426 S.E.2d 243 (1992) holding that accelerated rent provisions within leases are not valid liquidated damages unless (1) the injury caused by breach of the lease is difficult or impossible to estimate accurately, (2) the parties intend to provide for damages rather than a penalty, and (3) the stipulated sum is a reasonable pre-estimate of the landlord's probable loss; however, if these requirements are not met, then the accelerated rent provision fails as a penalty. HealthSouth Rehabilitation Corp. v. Falcon Management Co., 799 So.2d 177 (Ala. 2001) States holding that rent acceleration is enforceable: amount reflects what landlord could expect to suffer, but must use present value; Aurora Business Park Associates, L.P. v. Michael Albert, Inc., 548 N.W.2d 153 (Iowa 1996). Parrish v. Toth, 553 N.E.2d 369 (Ind. Ct. App. 3d Dist. 1990); Emrich v. Joyce’s Submarine Sandwiches, Inc., 751 P.2d 651 (Colo. Ct. App. 1987) Landlord may recover present worth of future rent less present worth of reasonable rental value of premises; Fifty States Management Corp. v. Pioneer Auto Parks, Inc., 46 N.Y.2d 573, 415 N.Y.S. 2d 800, 389 N.E.2d 113 (1979); GAB Management, Inc. v. Blumberg, 226 A.D.2d 499, 641 N.Y.S.2d 340 (2d Dep’t 1996). 44 See, Pierce v. Hoffshot, 211 Pa. Super. 380, 236 A.2d 828 (1967); Moretti v. Zanfino, 127 Pa. Super. 286, 193 A. 106 (1937). 45 Matovich v. Gradich, 123 Pa. Super. 355, 187. A. 65 (1936). 46 Ralph v. Deiley, 293 Pa. 90, 95, 141 A. 640, 643 (1928); General Tire & Rubber Co. v. General Tire & Sales Co., 93 Pa. Super. 173, 1975 (1927); but see Ralph v. Dailey that cautioned that “a landlord should be reasonably diligent in securing a desirable Tenant for the best rent obtainable to minimize the first lessee’s loss.” 47 Gaylord Builders v. Richmond Metal Mfg. Corp., 186 Pa. Super. 101, 140 A.2d 358 (1958). 48 Henry Shrank Co. v. Erie Co., 319 Pa. 100, 109, 178 A. 662, 666 (1935). 49 Ten Braak v. Waffle Shops, Inc., 542 F.2d 919 (Va. Ct. App. 4th Dist. 1976); Cohen v. Food Town, Inc., 207 A2d 122 (D.C. Ct. App. 1965); Ryals v. Laney, 338 So.2d 413 (Ala. Ct. App. 1976); Reget v. Dempsey-Tegler & Co., 70 Ill. App. 32, 216 N.E.2d 500 (1966) (no duty to mitigate, but must accept suitable subtenant if offered); Fla. Stat. Ann. § 83.595(1)(c); Vt. Stat. Ann. tit. 9 § 4462(b); In re Andover Togs, Inc., 231 B.R. 521 (Bankr. S.D.N.Y. 1999). 50 Browne v. Dugan, 189 Ark 551, 74 S.W.2d 640 (1934); Rau v. Baker, 118 Ill. App. 150 (1905); Jordan v. Nickell, 253 S.W.2d 237 (1952). 51 Welcome v. Hess, 90 Cal. 507, 2 P 369 (1891); Enoch C. Richards Co. v. Libby, 136 Me 376, 10 A2d 609 (1940); Deschenes v. Congel, 149 Vt. 579, 547 A.2d 1344 (1988). International Trust Co. v. Weeks, 203 U.S. 364, 51 L. Ed. 224 (1964); Condor Corp. v. Arlen Realty & Development Corp., 529 F.2d 87 (Minn. Ct. App. 1976); JCBC, L.L.C. v. Rollstock, Inc., 22 S.W.2d 197 (Mo. Ct. App. W.D. 2000); Circuit City Stores, Inc. v. Rockville Pike Joint Venture Ltd. Partnership, 376 Md. 331, 829 A.2d 976 (2003); McIntosh v. Gitomer, 120 A.2d 205 (Mun. Ct. App. Dist. Colo. 1956)


from classic property principles and closer to contract law.52 The manner of the duty is also subject to different results. Some states posit that it cannot be waived53, some that it can be waived.54 If mitigation is required, states differ on whether tenant55 or the landlord has the burden of proof.56 Some objective tests of meeting the duty of mitigation include (a) putting a “For Lease” sign, (b) advertising for several month, (c) hiring a leasing broker for several months. The tenant’s position57 for mitigation is for landlord to be given the leasing risk and simply exclude from accelerated rent the fair rental value for such period. Nevertheless, for a tenant, this is not always a panacea, and sometimes is only a placebo, because it is hard to prove that no effort at mitigation has occurred. The tenant has the initial burden of proof of landlord’s failure to mitigate damages.58 Ordinarily, if the tenant tenders proof, then the landlord has to show it has acted appropriately to mitigate its damages.59 Symptomatic of the shifting positions, Pennsylvania’s lower court, which is usually considered more experienced in matters of real estate law, concluded a duty of mitigation existed in Pennsylvania,60 but was overruled by the Pennsylvania Supreme Court61 which reaffirmed the traditional common law doctrine.62

e. Re-entry. So long as landlord has only reentered, and has not relet, or, relets on tenant’s behalf, the tenant can remain liable for costs.63 If the re-entry by landlord is

52 Friedman v. Colonial Oil Co., 236 Iowa 140, 18 N.W.2d 196 (1945); Lennon v. U.S. Theatre Corp., 920 F.2d 996 (D.C. Cir. 1990); Drutman Realty Co. Ltd. Partnership v. Jindo Corp., 865 F.Supp. 1093 (S.D.N.Y. 1994); In re New York City Shoes, Inc., 86 B.R. 420 (Bankr. E.D. Pa. 1988)(applying Pennsylvania law); In re Blondheim Modular Mfg., Inc., 65 B.R. 856 (Bankr. D.N.H. 1986)(applying New Hampshire law) Austin Hill Country Realty, Inc. v. Palisades Plaza, Inc., 948 S.W.2d 293, (Tex. 1997); Mar-Son, Inc. v. Terwaho Enterprises, Inc., 259 N.W.2d 289 (N.D. 1977). 53 An example of states that provide either through case law or statute that mitigation Drutman Realty Co. Ltd. Partnership v. Jindo Corp., 865 F. Supp. 1093 (S.D.N.Y. 1994); Maryland through Md. Real Prop. Code Ann. § 8- 207(d); and Texas via statute in Tex. Prop. Code Ann. §91.006(b). 54 North Carolina in Sylva Shops, Ltd. Partnership v. Hibbard, 623 S.E.2d 785 (N.C. Ct. App. 2006) and Ohio in New Towne, L.P. v. Pier 1 Imports (U.S.), Inc., 113 Ohio App. 3d 104, 680 N.E.2d 644 (6th Dist. Lucas County 1996). 55 Arizona - Stewart Title & Trust of Tucson v. Pribbeno, 129 Ariz. 15, 628 P.2d 52 (Ct. App. Div. 2 1981); California - Polster, Inc. v. Swing, 164 Cal. App. 3d 427, 210 Ca. Rptr. 567 (2d Dist. 1985);Colorado – Del E. Webb Realty and Management Co. of Colorado v. Wessbecker, 628 P.2d 114 (Colo. Ct. App. 1980); District of Columbia – Norris v. Green, 656 A.2d 282 (D.C. 1995); Georgia – Lamb v. Decatur Federal Savings & Loan Association, 201 Ga. App. 583, 411 S.E. 2d 527 (1991); Missouri – Superior Outdoor Advertising Co. Snadon, 965 S.W.2d 421 (Mo. Ct. App. S.D. 1998); Nebraska – Hillard v. Robertson, 253 Neb. 232, 570 N.W.2d 180 (1997); Hawaii – Marco Kona Warehouse v. Sharmilo, Inc., 7 Haw. App. 383, 768 P.2d 247 (1989); North Dakota – Ruud v. Larson, 392 N.W.2d 62 (N.D. 1986) – tenant has burden of proof. 56 Seventh Circuit - St. Louis North Joint Venture v. P&L Enterprises, Inc., 116 F.3d 262 (7th Cir. 1997); Iowa – J.M.Grimstad, Inc. v. Scangraphics, Inc., 539 N.W.2d 732 (Iowa Ct. App. 1995); New Jersey – McGuire v. City of New Jersey, 125 N.J. 310, 593 A.2d 309 (1991). 57 Which is adopted by some jurisdictions –check Indiana 58 In re New York City Shoes, Inc., supra. 59 Id. 60 Stonehedge Square Ltd. v. Movie Merchants Inc., 685 A.2d 1019 (Pa. Super. Ct. 1996). 61 Stonehedge Square Ltd. Partnership v. Movie Merchants, 714 A.2d 1082 (Pa. 1998) 62 Auer v. Penn, 99 Pa. 370 (1882). 63 Absent a specific lease provision, a landlord's right to rent and damages terminates upon termination of the lease. See generally Circuit City Stores, Inc. v. Rockville Pike Joint Venture Ltd. P'ship, 829 A.2d 976, 989 (2003). The lease provided “[N]otwithstanding any entry by [the landlord], whether by termination or otherwise, [the tenant] remained liable for and agreed to pay amounts equal to the installments of rent and other charges reserved in the lease, as if


deemed the acceptance of a tenant surrender, the landlord may have unintentionally terminated the lease and the landlord’s future right to rents.64 Careful drafting should avoid that.65 Inspection, repair, advertising and other incidents of a reletting are not of themselves a re-possession by landlord or an eviction of tenant that would discharge tenant from its duty to pay rent.66 Any rents collected from re-letting must be credited to the rental amounts owed by the defaulting Tenant, after accounting for the landlord’s expense in reletting.67

f. Confession of Judgment. This remedy is a summary action which permits entry of judgment without notice and hearing for the defendant. Some consider it a procedure which is unconstitutional on its face, and it is frequently challenged on public policy. Various jurisdictions have similar summary actions, though most do not eliminate an opportunity for notice and hearing. The action may be either for damages or for possession68 and neither one pre-empts the other. Under Pennsylvania law, a written lease or contract which authorizes a party to confess judgment must be clear and explicit. Such provisions are strictly construed.69 A confession of judgment clause will be upheld where the evidence shows that the tenant knowingly, voluntarily and intelligently waived his due process rights and agreed to the confession of judgment provision.70 Confession of judgment clauses may be used for accelerated and for back rent due, including from a holdover tenant because he is subject to the same terms and conditions of the lease as existed prior to the holdover.71

g. Self-Help. “Self-help” usually means that action is taken without the order or color of legal supervision or legal process. Self-help evictions are extremely difficult to implement because if the tenant objects there is a high likelihood that a landlord

the lease had not been terminated, whether or not the premises remained vacant. If the property was re-let by [the landlord], [the tenant] would be entitled to a credit equal to the net amount of rent received by [the landlord], after deduction of all actual and reasonable expenses incurred in the re-letting, including any remodeling costs.” 64 RESTATEMENT (SECOND) OF PROPERTY, Landlord and Tenant § 12. 1, comment i (1977). 65 To achieve landlord protection for collecting rent after tenant abandonment, or even lease termination, could include the following language: “notwithstanding a termination of this Lease (i) Landlord may declare all rent which would have been due under this Lease for the balance of the term to be immediately due and payable, plus the percentage rent for the entire term, based on the average monthly percentage rent earned during the three (3) prior Lease years, immediately due and payable at once whereupon Tenant shall be obligated to pay the same to Landlord, together with all loss or damage which Landlord may sustain by reason of such termination and re-entry, or (ii) Landlord may re-let all or any part of the demised premises for a term different from that which would otherwise have constituted the balance of the term of this Lease and for rent and on terms and conditions different from those contained herein, whereupon Tenant shall immediately be obligated to pay to Landlord as liquidated damages the difference between the rent provided for herein and that provided for in any lease covering a subsequent re-letting of the demised premises, for the period which would otherwise have constituted the balance of the term of this Lease, together with all of Landlord’s costs and expenses for preparing the demised premises for re-letting, including all repairs, Tenant finish improvements, broker’s and attorney’s fees, and all loss or damage which Landlord may sustain by reason of such termination, re-entry and re-letting, it being expressly understood and agreed that the liabilities and remedies specified in clauses (i) and (ii) hereof shall survive the termination of this Lease.” 66 Wilson Laundry Co. v. Joos, 200 Pa. Super. 595, 599, 189 A.2d 917, 920 (1963). 67 Auer v. Penn, 99 Pa. 370 (1882); Fitzpatrick v. Rogers, 75 Pa, Super. 273 (1920). 68 Federman v. Pozzonyi, supra. 69 Scott Factors, Inc. v. Hartley, 228 A.2d 887 (Pa. 1967); Fourtrees Co. v. Sterling Equip. Co. 242 Pa. Super. 199, 205-206, 363 A.2d 1229, 1232 (1976). 70 . Jordan v. Fox, Rothschild, O’Brien & Frankel, 20 F.3rd 1250 (CA 3 1994); Federman v. Pozzonyi, 365 Pa. Super. 24, 529 A.2d 530 (1987), citing O.H. Overmeyer Co. v. Frick Co., 405 174 (1972). 71 Charles Zubik & Sons, Inc., supra.


action over the objection of the tenant would be equivalent to a breach of the peace which is generally a criminal violation. In addition, jurisdictions generally provide that the statutory procedures pre-empt self-help, steering the landlord to seek relief under the applicable landlord and tenant act and the applicable states rules of civil procedure.72

h. Distress. One form of self-help developed under the extra-judicial process of distress. It was originated as a right arising in conjunction with tenant’s duty of rent service, in parallel with the feudal oath to martial or ploughing services. It entitles the landlord, as holder of the reversionary interest, to take personalty out of possession of the wrong-doer and into the custody of the party injured, to procure a satisfaction for the wrong committed.73 In Pennsylvania, however, the Superior Court confirmed that distraint74 is unconstitutional.75

72 See Kuriger v. Cramer, 345 Pa. Super. 595, 607-08 n. 14, 498 A.2d 1331, 1337, n. 14 (1985); Wofford v. Vaureck 22 D&C 3d 444, 450-52 (C.C.P. Crawford 1981); Lenair v. Campbell, 31 D&C 3d 237, 242 (C.C.P. Phila. 1984). 73 2 Blackstone Com. R42. 74 provided under the Pennsylvania Landlord and Tenant Act of 1951. 75 In that instance, a Pennsylvania court was given the opportunity to give distraint its final rites after a series of federal court decisions had been slowly confining its power. Allegheny Clarklift, Inc. v. Woodline Industries Pennsylvania, Inc., A.2d 606 (Pa. Super. Ct. 1986). The common law remedy of distraint was codified in the Pennsylvania Landlord and Tenant Act of 1951. Sections 250.302 through 260.404. In the Allegheny case, the court briefly reviewed a sequence of federal court decisions which sequentially narrowed the right of distraint, Santiago v. McElroy, 319 F.Supp. 284 (E.D. Pa. 1970), invalidated the sales provisions of the Act for failing to provide for the tenant’s right to prior notice and hearing; but, the other provisions of the Act were not held to be unconstitutional. In Gross v. Fox, 349 F.Supp. 1164 (E.D. Pa. 1972), reversed on other grounds, 496 F. 2d 1153 (3d Cir. 1974), the district court held that all of the distraint provisions of the Act were “unconstitutional on their face because they permit a landlord to levy on the property on a tenant’s premises without prior notice or hearing in violation of the Fourteenth Amendment’s due process clause.” (Id. at 1168); the Third Circuit’s reversal on appeal and refusal to address the constitutional issue was considered by the Allegheny court to compromise the position taken by the district court. Earlier cases were characterized as holding that no state action was present in distraint when posting and seizure was performed by a private party rather than a sheriff and, therefore, in the absence of state action, no constitutional issue emerged. SMI Industries, Inc. v. Lenard & Axilbund, Inc., 481 F.Supp. 459 (E.D.Pa. 1979) and Luria Brothers & Company, Inc. v. Allen, 452 F.Supp. 732 (W.D.Pa. 1978), reversed in part, 672 F.2d 347 (3d Cir. 1982). The Allegheny court pointed out that a then recent United States Supreme Court decision blurred the focus of these courts as to the constitutional issue by inducing them to avoid it when no state official is clearly involved in the procedure. Flagg Brothers, Inc. v. Brooks, 436 U.S. 149 (1978). The Allegheny court distinguished the conclusion and the effect of those other cases. Flagg Brothers decision from that of Lugar v. Edmonson Oil Company, Inc., 457 U.S. 922 (1982), stating that Lugar interpreted and clarified Flagg Brothers by holding that “the procedural scheme created by the state statute is the product of state action” and thus in Lugar, the prejudgment attachment provisions of the Virginia Code were properly held to be unconstitutional. The Allegheny court concluded that the appropriate rule is that “the state having once authorized private action in conjunction with its own officials, must insure at the outset that the procedural scheme to be followed is beyond (constitutional) reproach.” Allegheny, 514 A.2d. at 609. Based on that test, it found that the distraint provisions of the Act are invalid. Interestingly, in the absence of distraint, the power of the landlord’s lien, Pa. Stat. Ann. Tit. 68, §322 (1986), in Pennsylvania may be in jeopardy as well because the landlord’s lien arises only upon distraint under the Pennsylvania Landlord and Tenant Act. Under prior law, such lien, if perfected, could take priority over a Uniform Commercial Code security interest perfected earlier. In re Einhorn Bros., Inc., 272 F.2d 434, 440-41 (3rd Cir. 1959). Similarly, the landlord’s preference in the proceeds of an execution sale may be eliminated by the abolition of distraint because the preference is based on the property taken being “liable to the distress of the landlord,” Pa. Stat. Ann. Tit. 68 §321 (1986). Under prior law, that preference in distributions would be superior to an execution and sale brought by a prior perfected secured party. Thus, landlords should be wary of relying on the possible benefits of a landlord’s lien or a landlord’s preference because Pennsylvania law now condemns these creatures of statute to extinction. As other writers have suggested before the Allegheny decision, instead of depending on these


2. Landlord Default.

a. Lease Termination. Tenants retain the right of termination either upon a breach of the covenant of quiet enjoyment or upon actual or constructive eviction. In some jurisdictions there may also be rights based on theories of dependent covenants, anticipatory breach, and forfeiture

b. Offset/Setoff: The tenant has no specific common law right to reimbursement for payments made to cure landlord defaults. If the tenant has the contractual right to pay for what the landlord is obligated to perform but fails to perform, sometimes the tenant is entitled to set off, escrow, or suspend the cost against rents next due. On the one hand, this could be a direct threat to a mortgagee’s cash flow. On the other hand, if the mortgage lien is undersecured and absorbs the expected collateral value in a foreclosure, if the landlord is a single purpose entity, the tenant would have no meaningful right of recovery for its expenses. Some compromise can be found if the tenant spends only on items that improve the collateral value for the mortgagee and the mortgagee has advance approval rights.

c. Windfall Claims. The doctrine of unjust enrichment is a doctrine used by courts to rebalance equities where no contract otherwise protects the injured party. Though in simple terms it is intended to prevent someone from wrongfully reaping a windfall paid for by the injured party, some courts, such as those in Pennsylvania, have been using it to compel innocent enriched parties to repay foolish volunteers.76 There are some residential cases where tenants improved landlord’s property unilaterally to their own detriment. In those cases, the courts essentially wrote contracts, “quasi-contracts”, that had not previously existed.

III. DISPUTE RESOLUTION ALTERNATIVES

A. Arbitration.

1. Benefits. The perceived benefit of arbitration is that costs are saved in attorneys’ time because it is more informal than litigation. There is no jury. The scope and depth of discovery is much less. There is also a narrower scope of issues and damages. The procedure and decisions are shielded from public scrutiny. The results are binding and non-appealable. There is also a belief that arbitrators can be selected who more than a civil law judge, are seasoned and sensitive to the specialty issues in dispute.

2. Detriments. The perceived difficulties are that arbitration lacks the protections afforded by the laws of the judicial system. Not all parties in interest can be compelled to submit to the order, Court Orders may be needed to enforce arbitration clause. Selecting arbitrators is time consuming. Paying for the arbitrators and their forums’ costs is more expensive than court costs. There is no subpoena power to obtain information. There are no rules of civil procedure governing discovery. There is no enforceability for remedies other than

special statutory powers, the most prudent course of action for a landlord is (1) to have a provision in the lease grant a security interest in the tenant’s fixtures and inventory at the demised premises and (2) to file financing statements to perfect it. 76 Chesney v. Stevens, 644 A.2d (Pa. Super. 1994); Zvonik v. Zvonik, 435 A.2d 1236, 1239-40 (1981).


money damages. Arbitrators tend to “split the baby” to force the appearance of fairness. Litigation tends to reward only one side.

B. Mediation.

1. Benefits. The benefit of mediation is that the parties are motivated by their consensual effort to reach compromise. Because of the greater informality the expenses of time and money are considered much lower than in litigation. The setting is more relaxed because the outcome is clearly unenforceable. This encourages the parties to be more creative in seeking settlement.

2. Detriments. The difficulties of mediation are all the same as with arbitration. In addition, mediation is not designed to impose enforceability upon a resistant party.

IV. BANKRUPTCY ISSUES

A. Background

The rights of parties in a dispute are frequently tested against the hypothetical scenario of the counter party, whether landlord, tenant or subtenant, filing bankruptcy. The Bankruptcy Code77 provides rights and liabilities differently upon the filing for bankruptcy protection by the landlord or tenant. In analyzing the lease in the context of the bankruptcy of a party in interest, some courts have promoted a theory separating the lease property rights from the lease contract rights. For example, some courts postulate that a foreclosure may terminate a leasehold estate, but the lease agreement covenants may survive, and the breach of them may remain actionable.78 This concept plays out in the context of bankruptcy in various ways. As a general matter when either the landlord or the tenant is the subject of a bankruptcy proceeding, an automatic stay is imposed79 to prevent any change in the status of the estate which in part result from exercise of remedies by an adverse party. Consequently, the so called ipso facto clauses that provide for automatic default with right of termination upon filing of a bankruptcy are stayed upon filing of a bankruptcy.80 A lease that expires by its terms is not protected by the automatic stay.81

B. Tenant Bankruptcy

1. Assumption Generally. If a tenant is in bankruptcy, the debtor or the trustee as debtor-in-possession can assume or reject its unexpired lease if it is not in default. If the tenant is in default under the lease, the trustee cannot assume the lease unless: (i) it cures the 77 11 U.S.C. Section 101 et seq. 78 Consolidated Realty Group v. Sizzling Platter, Inc., 930 P.2d 268 (Utah App. 1996), holding that a foreclosure of a prior mortgage terminated the tenant’s interest in the property under a subsequent lease; but “…although it appears that Hewlitt [the tenant] could have brought action against Compark [the landlord] for any damages it may have suffered because of First Security’s [senior mortgagee’s] foreclosure, the lease as a property interest was terminated.” Id. at 272. The court went on to quote with approval a prior case for precedential authority. “See P.S.G. Ltd. v. August Income/Growth Fund, 115 N.M . 579, 855 P.2d 1043, 1048 (N.M. 1993) (‘A lease may be terminated in a foreclosure, and as a result, the lease provisions relating to the property rights are extinguished. However, the independent contract provisions relating to the liabilities of the parties may survive.’)” Id. 79 11 U.S.C. Section 362(a). 80 11 U.S.C. Section 365(e). 81 11 U.S.C. Section 362(b)(10).


defaults or provides “adequate assurance” that the default will be cured promptly, (ii) it compensates landlord for any damages or provides adequate assurance it will provide such compensation; and , (iii) provides adequate assurance for future performance of the lease82. “Assumption” of an unexpired lease makes it a binding obligation of the tenant’s bankruptcy estate. A subsequent breach of the lease would allow a claim for damages against the tenant’s estate that would qualify as an administrative expense priority, currently limited to 2 years of rent.83 Under the 2005 Bankruptcy Amendments84 an unexpired lease of nonresidential real property shall be deemed rejected if the trustee or debtor-in-possession does not assume or reject it within the earlier (i) 120 days after the commencement of the bankruptcy case or (ii) the date of the entry of an order confirming a plan of reorganization. Prior to the expiration of the 120-day period, the court may extend the period for assumption or rejection for no more than 90 days for a total of 210 days. The court may grant a subsequent extension only upon the prior written consent of the lessor in each instance.

2. Assumption of a Shopping Center Lease. Because of the special qualities of a shopping center, the Code further elaborates that “adequate assurance” for assumption of a shopping center lease must include: (i) the source of rent and other charges due; (ii) the percentage rent will not substantially decline; (iii) the lease remains subject to the core restrictions as to use, exclusive use, location, and radius restrictions; and, (iv) the assumption will not upset the natural tenant mix or balance.”85

3. Rejection Generally. “Rejection” of an unexpired lease constitutes a breach (a repudiation) of the lease under state law. Once the lease is rejected, the tenant’s estate has no further obligation to perform under the lease. The Code gives the landlord of a debtor tenant a claim for rejection damages that is deemed to be a prepetition obligation of the tenant’s estate.86 Of course, if the tenant is in bankruptcy and rejects the lease, the issue of what is “rent” also directly affects the calculation of landlord’s damages.

4. Landlord Damages. The landlord typically has three types of claims against a bankrupt tenant. One is prepetition arrearages for rent and other charges accruing but unpaid prior to the bankruptcy case. Prepetition arrearages are treated as general unsecured claims except to the extent that such amounts can be recovered from any security held by the landlord, such as a security deposit. A second is a post-petition administrative expense claim for rent and other charges accruing but unpaid after the commencement of the case. These administrative claims are unsecured claims, again except to the extent that the landlord chooses to resort to its security deposit to pay that claim. The third is the claim for rejection damages arising from tenant’s breach of contract subject to the follow limits: the future rent for the greater of one (1) year, or 15%, not to exceed three (3) years, of the remaining term of the lease, following the earlier of the date of the bankruptcy case or the tenant’s surrendered the property (“Landlord Damages Limit”).87 Some believe this provision of the Bankruptcy Code treats landlords worse than other creditors, because even though the Code compels the landlord to 82 11 U.S.C.A. § 365(b)(1) (Supp. 2005). 83 11 U.C.C. 503(b)(7). 84 U.S.C. § 365(d)(4) 85 11 U.S.C. Section 365 (b) (3). 86 11 U.S.CA §§ 365(g)(1), 502(g)(l) (Supp. 2005). 87 11 U.S.C.A. § 502(b)(6).


perform its contract, if a lease is rejected by a tenant, the Code has strong limitations on landlord's damages. On the other hand some commentators believe the landlord is in a much more favorable position compared to other creditors because the landlord ends up recovering a valuable asset without claims of third parties attaching to it, giving the landlord a chance to mitigate damages. In the case of rent reserved damage claims by the landlord, if “rent reserved” includes those items of additional rent payable to third parties it would increase the landlord’s claim.88 Some hold the test is: (i) it must be identified as rent or “additional rent”; (ii) it must be related to the value of the property or lease; and, (iii) it is in the nature of rent because it is a charge which is fixed, regular, and periodic.89 For example, there is some uncertainty as to whether amortized tenant improvement costs paid to landlord are rent.90 If the trustee or debtor assumes a lease and later rejects it, the landlord is entitled to administrative priority for its resulting claim for damages.91 If the defaults are not curable, the tenant’s estate need not cure.92 If the lease falls into default after the order for relief is issued, then the landlord may cease providing it services.93

5. Assignment and Designation. A properly assumed lease may thereafter be assigned if adequate assurance of future performance by the assignee is provided.94 In the case of a shopping center lease, the assignee must prove similar financial condition as the tenant and its guarantors at the time the lease was entered into.95 Any general anti-assignment clause is unenforceable.96 Similarly, landlord recapture clauses are held generally unenforceable. Once a lease is assigned in accordance with the Bankruptcy Code, the tenant’s estate has no further liability for any breach of the lease occurring after the assignment.97 One valuable outcome to the tenant and its other creditors is that the debtor tenant can sell the right to designate who will be the assignee of the lease. Sales of such designation rights, which commonly include the holder’s obligation to pay lease costs, can add significant value to the tenant’s estate. Consequently, in a retailer bankruptcy, the landlord may not get the full benefit of the heightened “adequate assurance of future performance.”

6. Post-Petition Obligations. In addition, as to nonresidential leases, the tenant’s estate is also required to comply with all its obligations under the lease arising after the commencement of the bankruptcy case. The court may extend, for cause, the time for

88 One current analysis for determining whether the payments are “rent reserved” is whether they meet a three part test: (1) is designated as rent or otherwise as tenant’s obligation, (2) is related to the value of the property or the lease, and (3) the charge is fixed, regular, or periodic. See In re McSheridan, 184 BR 91 (9th Cir. BAP 1995) 89 In re McSheridan, 184 B.R. 91, 99-100 (9th Cir BAP 1995). 90 See, In re Gantos, Inc., 181 Br. 903 (Bankr. E.D. MI 1995) disallowing recovery of the construction allowance because it did not constitute rent reserved pursuant to the terms of the statute. But see, In re Blatstein, 1997 WL 560119 (E.D. Pa. 1997) wherein the District Court held that the Amortized Improvement Cost was rent under the lease and was, therefore, includable in the landlord’s rejection damage claim. 91 11 U.S.C.A. § 365(g)(2) (Supp. 2005). 92 11 U.S.C. § 365(b)(1)(a) 93 11 U.S.C. Section 365(b)]. 94 11 U.S.C.A. § 365(f)(2)(b) (Supp. 2005) 95 11 U.S.C. Section 365 (b)(3). 96 11 U.S.C. §§ 365(e) and (f). 97 11 U.S.C.A. § 365(k) (Supp. 2005).


performance of any obligation that arises within the first 60 days of the case but the time for compliance may not be extended beyond the 60-day period.98

7. Lease Modification for Termination or Recapture. One effect of the uncertainty of outcome is that if a lease is amended to incorporate a recapture or termination agreement, or a separate termination agreement is entered into, it may be an executory contract. If the landlord paid a termination fee and the termination agreement was rejected as an executory contract, the landlord would forfeit the fee. One shield would be to advance the termination fee as a loan secured by a lien against tenant’s personalty until the termination occurs. If the termination agreement is deemed executory or otherwise frustrated, the fee, as a loan must be repaid and the landlord acquires the character of a secured party at least to the extent the collateral has value in excess of what tenant may have granted its revolver lender or its landlord. If the landlord is a single purpose entity, this solution may require the use of an affiliate to avoid violating the single purpose prohibition against entering in to debt relationships with third parties.

C. Landlord Bankruptcy

1. Generally. The Bankruptcy Code contains special protections for the holders of interests in real property.99 If the landlord’s estate as debtor rejects an unexpired lease of real property, the landlord’s estate is excused from further performance under the lease with some exceptions. The consequence is that the lease is deemed breached by the landlord.100

2. Tenant Termination or Possession. In the case of rejection by the landlord in bankruptcy, the tenant may respond to such deemed breach either (i) deeming the lease terminated or (ii) if the term of the lease has “commenced,” retaining its “rights” under the lease, including the amount and timing of payment of rent and other amounts payable by the tenant and the right of use, possession, quiet enjoyment, subletting, assignment or hypothecation, that are “in or appurtenant” to the real property for the balance of the term of the lease and for any renewal or extension of such rights to the extent that such rights are enforceable under applicable nonbankruptcy law. If the tenant elects to remain in possession, the tenant may offset future rent payable under the lease against the value of any damages caused by the landlord’s nonperformance of affirmative covenants after the date of rejection; but the tenant will not have any other right against the landlord’s estate for damages occurring after the rejection date from such nonperformance.

3. Realty Covenants Compared to Contract Covenants. The dynamic and stress embedded in these concepts are akin to the difference in a lease agreement between its contracts rights and its property rights. Because the term “lease” is used casually, it can denote an interest in the estate for years (the leasehold), the grant of that estate (the conveyance), the covenants that are realty covenants or personal covenants contained in the document essential to the lease relationship (lease contract), or the documentary evidence of the estate, its conveyance and the related covenants (lease instrument). Interpreters are put to the hard task of distinguishing the appropriate meaning from the context. It is generally agreed, however, that 98 11 U.S.C.A. § 365(d)(3) (Supp. 2005). 99 11 U.S.CA § 365(h) (Supp. 2005). 100 11 U.S.C. §502(g)


some covenants, including rental obligations can exist independently of other lease obligations and can be transferred independently of the leasehold estate.101 In keeping with the distinction between the landlord’s lease covenants and privity of contract, as compared to the landlord’s estate in reversion and privity of estate, when the landlord’s estate in reversion is assigned, privity of estate is broken as between the assignor and its tenant, but is instituted between the assignee and the tenant. Under statutes descended from Henry VIII’s dissolution of the monasteries, transfers of the fee estate are deemed to transfer the covenants running with the land. Even a sheriff’s deed out of foreclosure has been held to transfer those covenants running with the land.102

4. Assignment of Rents. The mortgagee of a bankrupt landlord may attempt to assert rights to collect rents or to divest the lease by foreclosure. But the automatic stay should prevent the prosecution of these actions.103 The mortgage may seek relief from the automatic stay if (1) there is not adequate protection of the mortgagee’s interest,104 or (2) landlord has no equity interest in the property and the property is not necessary for an effective reorganization.105 The mortgagee asserting the right to rents must prove its interest in rents was granted absolutely or perfected prior to the filing of the petition.106

D. The Sublease

1. Subtenant Risks. The relationships are further stressed and confused when there is a sublease involved. Then, if the paramount tenant is in bankruptcy, it has the power to reject the paramount lease.107 Rejection may cause a termination of the sublease,108 though termination is not always the outcome. The language of the paramount lease and the sublease, and the conduct of the parties,109 can affect the determination. Prior to such termination, the paramount landlord retains the right of reversion and the subtenant retains rights of possession under local law.110 To overcome the risk of divestiture by sublandlord’s rejection, the subtenant would negotiate for a recognition and attornment agreement to trigger a direct lease with the paramount landlord.

101 Tiffany, LAW OF REAL PROPERTY, Section 113 at page 178, fn. 8. “An assignment of all of the income under a lease does not operate or pass the reversion or any rights under the lease except that of receiving the rents.” Ward v. Commissioner of Internal Revenue, 58 F.2d 757, 760 (1932). 102 “The person held entitled to sue as transferee [of a real covenant] in Hayes v. New York Gold Min. Co. (1874) 2 Colo. 273, took title under a sheriff’s deed, having been mortgagee of the lessor.” 34 A.L.R. at 791. 103 11 U.S.C. § 362(a). 104 11 U.S.C. § 362(d)(i). 105 11 U.S.C. § 362(d)(2). 106 Commerce Bank v. Mountain View Village, Inc., 5 F.3d 34 (3rd Cir. 1993). 107 11 U.S.C. § 365(a). 108 “Rejection of a non-residential lease results in termination of the lease. Once the underlying lease is terminated, leasehold mortgagees or sublessees retain no interest that can be pursued in bankruptcy court or state court.” 6177 Realty Assoc. Inc., 142 B.R. 1017, 1019 (Bankr. S.D. Fla 1992) 109 “Here, since Peram [prime landlord] made no allegations that Chumash [subtenant] was not fulfilling its obligations as a sublessee, under the lease Peram was not entitled to evict or eject Chumash from the subleased premises, either because of Newton’s [prime tenant] surrender of his lease in bankruptcy or his nonpayment of rent.” Chumash Hill Properties, Inc. v. Peram, 46 Cal. Rptr. 2d 366, 369 (1995) 110 See Chaltos Sys., Inc. v. Kaplan, 147 B.R. 96 (D. Del. 1992), aff’d, 998 F.2d 1005 (3d Cir. 1993); In re Dial-A-Tire, Inc., 78 B.R. 13 (Bankr. W.D.N.Y. 1987); and In re Storage Technology Corp., 53 Bankr. 471 (Bankr. D. Co. 1985).


2. Sublandlord Powers. Instead of rejecting the paramount lease the paramount tenant in bankruptcy has the power to assume the paramount lease.111 Then the paramount tenant, as sublandlord, can either reject or assume the sublease.112 If the paramount tenant as sublandlord rejects the sublease, and the subtenant elects to retain possession, then the paramount tenant as sublandlord may not be able to nor want to pay rent under the paramount lease, especially if the subtenant exercises set off rights for curative advances. If the sublandlord assumes the paramount lease and rejects the sublease, the rejection of the sublease may not dispossess the subtenant but does prevent the subtenant from enforcing personal covenants against the sublandlord. One key covenant is the one that empowers the subtenant to enforce the prime lease, whether by the assignment of subtenant’s rights or by a grant of a power of attorney to perform in sublandlord’s name. If the paramount landlord fails to adequately perform, the subtenant may have no independent right to compel performance once the sublease is rejected but the subtenant retains possession under the Bankruptcy Code.

3. Subtenant Bankruptcy. If the subtenant is in bankruptcy, it can assume or reject the sublease in the same fashion as applies to any tenant. What is interesting is that at least one reported case113 concluded that the automatic stay in a subtenant bankruptcy prevented the paramount landlord from terminating the paramount lease because it would cause the subtenant to be dispossessed, notwithstanding the absence of any formalized relationship of privity.

E. Letters of Credit as Security Deposits

1. Landlord Collateral. Many leases call for the tenant to deliver a security deposit to landlord to cover unpaid tenant liabilities such as for repairs to the premises, unpaid rent, or other damages the landlord may bear. Traditionally, those funds belong to the tenant and are part of its bankruptcy estate even though the funds remain in the landlord’s possession.114 The possession by landlord perfects its security interest in that collateral. Upon tenant’s bankruptcy, the landlord is deemed to hold a secured claim based upon the security deposit. 115 However, the automatic stay prevents the landlord from exercising its rights against the security deposit for damages. Landlord is staid from applying the deposit to a prepetition or post-petition default without first obtaining authorization from the bankruptcy court.116

2. Letter of Credit. If a letter of credit instead of cash is used to fund the security deposit, the proceeds are not property of the tenant, unlike cash posted by the tenant. The current logic then unfolds that the automatic stay will not prevent the landlord from drawing under the letter of credit. Conflicting principles have created some uncertainty to landlord’s rights. The general rule is that a landlord of a bankrupt tenant is entitled to recover future rent 111 11 U.S.C. 365(a). 112 Id. 113 “…the landlord’s actions [terminating the prime lease] were intended to obtain for it by indirection that which it recognized it could not obtain directly -- recapture of the premises in which 48th Street [the subtenant in bankruptcy] had an interest. But that effort cannot be allowed to succeed, for [Bankruptcy Code] section 362(a)(3) stays not only acts to obtain “property of the estate” but acts to obtain “property from the estate” and the attempt to wrest possession of property away from a debtor without the imprimatur of bankruptcy court is therefore proscribed.” 48th Street Steakhouse, Inc. v. Rockefeller Center, Inc. et. al, 61 B.R. 182, 189 (1986) reported in Hargreaves-Heald. 114 11 U.S.C.A. § 541 (Supp. 2005). 115 11 U.S.C.A. §§ 506(a), 553 (Supp. 2005). 116 11 U.S.C.A. § 362(a) (Supp. 2005).


from a lease guarantor who is not in bankruptcy without being restricted by Landlord Damages Limits.117 Nevertheless, courts generally have held that a landlord may apply the proceeds of the security deposit letter of credit to the rejection damages but only up to the Landlord Claim Limits. The logic being, it is merely a substitute for cash, not really a guaranty by the issuing bank, and therefore should be treated as the equivalent of cash.

3. Overages. As a general matter, the landlord may not retain any security deposit amount that exceeds the sum of its prepetition arrearages, plus any unpaid post-petition rent, plus the full amount of the Landlord Damages Limit. The excess is paid to the tenant’s estate.

V. VOLUNTARY LEASE TERMINATION AGREEMENTS

Both the landlord and the tenant may sense opportunities and benefits in an early termination agreement.

A. Landlord Advantages

Landlord advantages can cover a number of areas. Removing defaulting tenants consensually avoids the administrative effort of managing a chronically difficult landlord-tenant relationship and the legal costs for eviction. It allows a landlord greater flexibility in repositioning space for new development or higher use tenant. It can allow landlord to comply with expansion rights which other tenants may need. If the rent is below market, it can prevent a loss of value if the tenant were to file bankruptcy and sell its leasehold interest.

B. Tenant Advantages

Tenant advantages can also cover a number of areas. It can eliminate continuing expense by closing an underperforming location. It can release tenant from obligations relating to covenants for continuous use or continuous occupancy. It can avoid the imminent expense for major upgrades or replacements related to “net” lease liabilities. It can complete the disengagement and mutual release between landlord and tenant, and its guarantors, or collateral or ancillary disputes. It can eliminate disputes over landlord consent to assignability or subleasing.

C. Posture and Protocol

Concepts and documentation relating to notice of default, settlement negotiations and forbearance could be adapted from similar language in the context of distressed debt. Upon determining that termination must be imposed, the steps and documentation follow lines similar to that of the conveyance in lieu of foreclosure, in this case a conveyance in lieu of eviction.

D. Consideration

Several factors affect whether tenant pays landlord or landlord pays tenant for any existing termination. If tenant has a below market rent obligation, then in the abstract it can have

117 Defined in IV.B.4 above.


a valuable commodity with a price equal to the present value of the difference between its undermarket rent, and the rent that would be paid if the property could be leased anew. If the balance is in the other direction the tenant may need to pay to be released. Other factors that affect the decisions are the performance costs. For a tenant the costs can include demobilizing, moving staff and property, transitioning relationships, and reporting the change in regulatory and accounting disclosures. For a landlord, the costs can include remarketing, site preparation, and potential co-tenancy risks of the lease terminations. In calculating a termination fee, a landlord may also want to weigh the sunken costs of installing the tenant originally, the unamortized value of tenant improvements, cost of financing them, and incidental costs incurred to induce the tenant to sign the lease initially, such as free rent, take-over rent for another location, or exclusives that excluded a stable competitor of tenant.

Another somewhat blunt issue is whether either landlord or tenant may be in the vicinity of insolvency. The threat being that decision making by the debtor or trustee after bankruptcy could be worse for the counterparty, or may undo the resolution of issues achieved prior to the bankruptcy.

If the tenant tries to cow the landlord by threatening to play the bankruptcy card, the landlord may not feel cowed because the tenant must either reject or assume the lease. If it assumes, it has to cure default and provide adequate assurance of future performance. The landlord is at least expecting the benefit of its bargain, even if it is a bad bargain. The landlord may also consider bidding for the rights of assignment, in essence paying a price to recapture the space. If the tenant rejects, then the landlord gets the space back and the right to an unsecured claim for the greater of the remaining rent of 1 year, or up to 15% of three years rent.

If the landlord is thinking of filing bankruptcy, then either it assumes the lease, and tenant retains the benefit of its bargain, or it rejects the lease and tenant retains rights to exclusive possession.

E. Diligence

To prepare for the negotiation of a termination agreement, both sides should perform sufficient diligence to understand what their respective rights and liabilities are, and what third party consents and approvals are needed. Both sides will need to review all existing lease documents including lease agreement, amendments, deed restrictions, estoppels, guaranties, SNDAs and recognition agreements, recorded memoranda. Each party would require reciprocal cooperation to secure copies of any expert reports, such as environmental and engineering studies, which the other party may have generated or obtained. The parties would analyze the effect of termination on subtenants, creditors, and their assignees, because they may prevent the desired termination. In the same vein, the parties would need to analyze requirements for third party consents, such as guarantors, investors, lenders, easement beneficiaries, governmental agencies.

F. Inspection

The parties should together inspect, investigate and video the premises to establish a stipulated record of its physical condition. The inspection could include engaging experts if


conditions are in dispute as to whether the premises requires repair or replacement, when tenant’s liability is for repair but not replacement. Frequent subjects of that dispute include roof, parking lot, and building systems, and sometimes bearing columns in warehouses.

G. Survival of Obligations

One factor the parties would need to analyze is the cost and timing of the terms of termination: whether any obligations arise or are to be completed upon surrender. Common obligations include those that relate to physical condition, removal or transfer of tenant trade fixtures and rights of third parties at the time of surrender. To the extent performance is required, the termination can be accomplished in phases and rent can be adjusted as it relates to a particular phase. The parties would also need to analyze whether any obligations survive surrender and termination to properly quantify the effect of releases and the potential future costs of the termination. Common surviving obligations include environmental liability, brokerage commission, holdover damages’, rights to insurance proceeds or condemnation awards, and readjustment of annual percentage rent as well as operating expenses after the completion of the annual accounting audit.

H. Covenants and Conditions

The termination agreement would reconfirm compliance with or violations of conditions precedent and subsequent for alterations, and any improvements constructed by tenant. The parties would also need to create procedures for third party support documents to be assigned or to revert back to landlord, such as guaranties, warranties, credit enhancements, bonds, development agreements, if assignable.

I. Representations and Warranties

In negotiating representations and warranties the parties will have similarities of interests in some cases, and dissimilarities in others. Both parties will have mutual desires to confirm the status, existence and authority of the other party, and its due execution and delivery of the Agreement and related documents. Both parties would also have mutual desire to confirm the transaction does not conflict with, violate, or cause a default under any requirements to get permissions, consents, and approvals by governmental or third parties. If either party is willing to give warranties, it would ordinarily seek to qualify them by knowledge of certain designated individuals whose scope of work would include that activity, but without independent investigation or inquiry. The warrantor would seek to limit survival period.

The tenant may seek to narrow, and the landlord to broaden, tenant’s warranties about the status of the physical condition of the leased premises, and any events which may have triggered further disclosure requirements under statutory or “commercially reasonable” standards. Along these lines, landlord may seek tenant’s representation that there are no written notices of existing violation of law, code or ordinance or other legal requirements including environmental laws with respect to the leased premises. In some instances, where tenant may otherwise be a potentially responsible party for hazardous conditions due to landlord’s pre-existing or concurrent acts, tenant may seek reciprocal representations from landlord.


There may be different levels of disclosure or liability, depending on whether the representation relates to defects which were introduced by tenant, or those which were assumed by tenant. Surviving obligations may need to be reflected expressly, or by reference, in a document of record.

An estoppel component would reiterate standard certifications to prevent a subsequent defense that the lease agreement could not have been modified because it was already defaulted, defective, or otherwise unenforceable. Commonly there is also a reliance provision, as in a formal estoppel, the parties, and their partners in interest acknowledge the counter party’s reliance on the estoppel for the benefit of and as a defense for the counter party who is trying to prove enforceability. Tenant will frequently be required to release landlord from known or unknown pre-existing claims, but not those arising under or the claim of financing difficulty, on the one hand, but sufficient solvency to avoid claims of fraudulent conveyance or preference after the termination agreement. If landlord releases the tenant when the release of tenant is based on tenant’s financial distress, the landlord would also expect to see financial statements to support.

J. Releases

Parties typically exchange mutual releases and/or covenants not to sue effective as of the termination date in the same fashion as in a settlement agreement for debt. Tenant remains liable for those arising during its tenure and landlord for those arising during landlord’s ownership before and after tenant’s tenure. Until the effective date of termination the parties should be obligated to continue to make all payments and perform all obligations. Thus, releases in termination agreement should not apply to representations, warranties and agreements under the termination agreement itself. Continuing default of the termination agreement could allow the parties summary remedies. The termination agreement could also extinguish releases or covenants not to sue.

K. Conditions to Surrender

The termination agreement would describe the effective date of the termination of the lease, or sequence of dates if there will be phased components or different survivals. The effect of termination can be an acceleration of the maturity date, or a mid-lease termination of the term. The former would act to preserve survival of warranties and indemnities that would have survived upon a maturity of the Lease by its terms. The latter would act to end all continuing liabilities. The negotiation could distinguish which provisions of the lease remain in effect, as well as which accrued obligations must be satisfied.

The lease termination date may be fixed for a future time, typically 11:59 PM on a stated date; but, the lease termination date may be triggered by another event, such as final removal of all personalty, relocation and re-opening by the tenant, sale of the tenant’s business, final settlement of a continuing dispute, or lease transfer and assumption by a new tenant. Sometimes the landlord will purchase a unilateral recapture right, exercisable upon prior notice.

Surrender should be free and clear of all actual physical possession or occupancy, all rights of subtenancies or rights of use, all liens or claims of liens (whether filed before or after


the surrender of the leased premises), and all other claims by third parties with interests obtained from tenant, such as options or rights of first offer or referral. Sometimes an early termination is “as is” and the tenant’s traditional surrender obligations are waived.

The termination agreement should expressly terminate any of tenant’s ancillary rights, such as non-competes, restrictions and exclusives as to other tenants' uses. It should also terminate any options to extend, renew, expand, or purchase. Other ancillary rights relating to off-site amenities such as parking, fitness clubs, childcare, and the like.

L. Holdover

The holdover of tenant after the termination date is a major risk for the landlord. It could prevent re-marketing the premises, or cause damages by blocking the entry of a new tenant. In the case of a creditworthy tenant, the landlord would seek a right to reinstate the lease in the event of holdover. A conservative landlord with a suspect tenant may seek a letter of credit to back-stop collection for damages from holdover and characterize it as an extension on a shorter term basis. In the case of a tenant with suspect credit, the landlord would look to create a process for summary eviction including by confessed or unanswered claim for eviction, or by conversion of the lease to a license with a limited right to use but without rights of possession.

M. Surrender Condition of Property

The surrender condition of the premises is usually an issue for negotiation. Landlord wants the surrender to be in good condition, subject to wear and tear. Tenant seeks to surrender the premises in an “as is” condition or “as is” but free of waste, including waste caused by tenant’s negligence or by insurable casualty. One compromise is for the condition to be “as good as at commencement, reasonable wear and tear, insured casualty and condemnation excepted.” The less apparent problem with measuring against the commencement day condition is how to agree today to what that condition might have been at commencement, if there is no contemporaneous record. Even then, another area of frequent dispute is whether a defect in the property condition at surrender is one that requires repair or replacement. Because landlord rather than tenant, is commonly responsible for replacement, tenant contends that surrender with a leaking roof or pot-holed parking lot is compliant with the covenant. A walk through prior to surrender usually sets the framework for these discussions.

The process of surrender also includes separating two classes of property, that which is to remain and that which is to be removed. Sometimes the confirmation is done by a walk through of the premise by the parties with color-coding decals to distinguish the two classes. It frequently covers more than just moveable compared to non-movable personalty. The landlord usually expects the tenant to remove alterations which landlord cannot put to a second or subsequent use. If the landlord is not relying on remarketing the space because, for example, it will demolish or substantially remodel or rehabilitate premises, the parties will frequently agree that tenant must remove only its alterations which would add to the landlord’s demolition cost.

When a tenant is leaving behind its trade fixtures or the improvements it has constructed, the landlord would seek a warranty as to title, so it will not be subject to claims by either tenant’s secured parties or purported purchaser of tenant’s assets.


The duty with respect to the condition of the Property gets more complicated when there have been expansions of the space during the term, or take over of other third party space.

N. Transfer of Property

The termination agreement should expressly provide for the extinguishment of tenant’s leasehold estate and for tenant transfers and releases to landlord of all interest in the non-leasehold property, including any buildings, furniture, fixtures, equipment, personal property and appurtenances sought by the landlord. Careful landlords will frequently exclude and disclaim the acceptance of any transfer of environmentally sensitive items, such as underground storage tanks and similarly high-risk property. As with the underlying lease, the termination agreement should anticipate that if the tenant fails to timely remove its property then landlord has the right to retain or dispose of the abandoned property at tenant’s cost. The abandoned property need not be accepted by landlord.

O. Taxes

An analysis would need to be made of any potential transfer taxes in the case a transfer back to landlord is deemed a taxable event. Accrued but unpaid tax liabilities would need to be analyzed. In addition, the effect of bulk sales restrictions would need to be analyzed as it affects transfer of tenant’s property. The parties would also attempt to focus on the income tax consequences, and their ability to report independently but consistently between them. Payments on account or in lieu of rents would normally be treated as ordinary income to landlord and expenses to tenant. Landlord would generally prefer capital gains treatment if it is justified. If the facts warrant, capital gains treatment may be appropriate for (i) payments that represent compensation to landlord for damages to leased premises, (ii) diminution in value to the property or good will to landlord’s business, or (iii) payment for release of existing restrictive covenants, might result in a more favorable treatment.

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