Escalation Wars!

This article focuses on two recent skirmishes in the ongoing escalation wars between New York landlords and tenants. In one case, a tenant tried to revive an otherwise stale overcharge claim by invoking the Federal Arbitration Act. In another case, the tenant attempted to take advantage of the 80% “new hire rate” first implemented in the 1996 Collective Bargaining Agreement between Local 32B-32J and the Realty Advisory Board.

Tauber v. AMA: The Federal End Run Fails

Many New York commercial leases call for the arbitration of escalation disputes. New York case law, however, is unkind to tenants who fail to timely or effectively challenge escalation increases. In Laszlo N. Tauber & Assocs. I, LLC v. American Management A'ssns, 304 A.D.2d 413, 757 N.Y.S.2d 553 (1st Dep't 2003), a tenant foreclosed from arbitrating an escalation dispute under New York law ingeniously argued that the dispute was covered by the more liberal Federal Arbitration Act (FAA) (9 U.S.C. '1 et seq.). The Appellate Division, First Department disagreed, and permanently stayed the arbitration under CPLR 7503(b).

The escalation clause in Tauber was typical of many New York City commercial office leases. Each year, the landlord would render a “Landlord's Statement” setting forth the final tally of operating expenses for the preceding year, and the tenant's corresponding rent increase. The lease provided that the “Landlord's Statement shall be conclusive and binding upon Tenant unless … within sixty (60) days after receipt of such Landlord's Statement Tenant shall notify Landlord that it disputes the correctness of Landlord's Statement, specifying the particular respects in which Landlord's Statement is claimed to be incorrect.” If the tenant timely challenged the Statement, the parties would have 90 days to settle their dispute. If the dispute was not settled within 90 days, the tenant had 60 days to submit the dispute to arbitration.

The tenant in Tauber did not timely follow the lease procedure. The landlord served the tenant with the 1999 Landlord's Statement in August of 2000. Five months later, the tenant asked to inspect the landlord's books and records as “a matter of routine diligence in the normal course of our business.” The inspection took place in January 2001, and 3 months later the tenant formally disputed the Landlord's Statement and demanded arbitration.

The landlord moved Supreme Court for a permanent stay of arbitration under CPLR 7503(b). The landlord's case seemed airtight; the tenant's escalation challenge was clearly untimely. Because the arbitration clause was a “narrow” one — the arbitrator was empowered to resolve escalation disputes, but was not authorized to resolve all disputes under the lease — the court, rather than the arbitrator, would determine the threshold issue of timeliness. Silverstein Properties Inc. v. Paine Webber Jackson & Curtis, Inc., 65 N.Y.2d 785, 493 N.Y.S.2d 110 (1985). New York courts have consistently held that under a narrow arbitration clause, untimely escalation challenges shall be permanently stayed. See Salomon Smith Barney Holdings, Inc. v. 7 World Trade Co., L.P., 278 A.D.2d 63, 718 N.Y.S.2d 298 (1st Dep't 2000); Jack Kent Cooke Inc. v. Saatchi & Saatchi North America, 222 A.D.2d 334, 635 N.Y.S.2d 611 (1st Dep't 1995); Home Ins. Co. v. Olympia & York Maiden Lane Co., 219 A.D.2d 469, 613 N.Y.S.2d 158 (1st Dep't 1995).

The tenant, facing a permanent stay of arbitration, argued that the lease evidenced a transaction involving “interstate commerce,” such that the FAA governed the dispute. Conveniently, threshold issues of timeliness under the FAA are determined by the arbitrator, rather than by the courts. If the tenant could convince the court that the FAA applied, the matter would go to arbitration, where the tenant could hope to prevail on the timeliness issue, or, at the very least, settle the matter.

The tenant, in support of its interstate commerce argument, asserted that AMA was a truly national organization, which held conferences at the subject building attended by persons from 35 different states, plus “Canada, Europe, Asia, Africa, the Middle East and the West Indies.” Supreme Court (Wetzel, J.) was unimpressed. Justice Wetzel held that “[t]he use that is made of the premises, as well as the diversity of citizenship of the parties to the lease, are not relevant to the applicability of the FAA.” The court permanently stayed the arbitration, concluding that “it cannot possibly be asserted that the escalation clause provision in a lease involves interstate commerce.”

The Appellate Division, First Department affirmed Supreme Court, holding that “[t]he subject lease is for office space in a commercial building located in Manhattan and does not, by its terms, contemplate or facilitate any involvement in interstate commerce.”

Escalation clauses contemplate the tabulation of various expenses and the subsequent rendering of a statement. If such clauses involved interstate commerce, the FAA would govern every arbitrable escalation dispute in New York City. Tauber serves notice on tenants that the FAA end run will not succeed in the First Department.

The 80% Solution?

Porter wage escalations were at the center of the dispute in Sage Realty Corp. v. Omnicom Group Inc., 183 Misc. 2d 574, 705 N.Y.S.2d 500 (Sup. Ct. N.Y. Co. 2000), aff'd 278 A.D.2d 57, 718 N.Y.S.2d 304 (1st Dep't 2000). In Sage, the original 1975 lease provided for a porter wage escalation above an existing “Wage Rate.” The lease defined that term as follows:

” 'Wage Rate' shall mean the minimum regular hourly wage rate plus all other sums required to be paid to or for the benefit of porters engaged in general maintenance and operation of office buildings of the type and in the vicinity of the Building pursuant to a collective bargaining agreement between Realty Advisory Board on Labor Relations, Inc. … and Local 32-B '.”

At the time the parties entered into the 1975 lease, the CBA had only one wage rate for straight-time work for regular employees in the porters' work category. As the tenant was quick to point out, that wage rate was the lowest rate for all porters, ie, the “minimum” regular hourly wage rate.

On Feb. 4, 1996, however, a new wrinkle emerged. For the first time, the CBA called for a “new hire rate” for new employees (including porters), which was pegged at 80% of the “minimum regular hourly wage rate.” The tenant argued that the “Wage Rate” was supposed to be the lowest rate payable to porters, and that the 80% new hire rate so qualified. The tenant argued that the porter expense had thus decreased by 20%, such that the tenant was entitled to a substantial refund.

Justice Paula Omansky rejected the tenant's claim. She observed that only 3% of the local 32B-32J porters were “new hires,” such that using the new hire rate would result in a substantial windfall to the tenant. 183 Misc. 2d at 578. A unanimous First Department thereafter affirmed, stating: “We reject the tenant's claim that this new, lower rate for new hires became the index for calculating additional rent as of the effective date of the 1996 collective bargaining agreement, entitling it to a reduction in rent retroactive to that date. The temporary nature of the wage differential for new hires, and the fact that the two-tier system could not have been contemplated by the parties' predecessors when they entered into the original lease 21 years before, militate against the construction of the lease that would have the lower rate for new hires serve as the rent-adjustment index.” 278 A.D.2d at 57; see also, 1411 Trizechahn-Swig, L.L.C. v. Henry I. Siegel Co., Inc., 2001 WL 1657274 (N.Y.C. Civ. Ct. 2001).

Conclusion

It would appear for now that the courts in the First Department have foreclosed future porter wage challenges based on the “new hire rate.” Landlords drafting new leases, or renewals of existing leases, are well advised to avoid this dispute by clarifying that the “new hire rate,” or any unforeseen change in a future CBA, shall not be used to calculate the landlord's porter wage expense.

Some certainties in life are ever present, like death and taxes. Some are seasonal: Every winter, birds fly South, and every March 19, the swallows return to San Juan Capistrano.

Operating escalation challenges falls into the seasonal category. When economic times are good, commercial tenants pay rent escalations like clockwork. When times are hard, the same tenants — aided by lease audit consultants working on a contingency basis — suddenly “discover” hundreds of thousands of dollars in alleged escalation overcharges.

Landlords facing escalation challenges must walk a fine line. Rejecting a claim may alienate an otherwise valued tenant paying a good rent. Acceding to a questionable claim may encourage the tenant to raise similar claims in the future, and may embolden other tenants in the building to challenge their escalations.

This article focuses on two recent skirmishes in the ongoing escalation wars between New York landlords and tenants. In one case, a tenant tried to revive an otherwise stale overcharge claim by invoking the Federal Arbitration Act. In another case, the tenant attempted to take advantage of the 80% “new hire rate” first implemented in the 1996 Collective Bargaining Agreement between Local 32B-32J and the Realty Advisory Board.

Tauber v. AMA: The Federal End Run Fails

Many New York commercial leases call for the arbitration of escalation disputes. New York case law, however, is unkind to tenants who fail to timely or effectively challenge escalation increases. In Laszlo N. Tauber & Assocs. I, LLC v. American Management A'ssns , 304 A.D.2d 413, 757 N.Y.S.2d 553 (1st Dep't 2003), a tenant foreclosed from arbitrating an escalation dispute under New York law ingeniously argued that the dispute was covered by the more liberal Federal Arbitration Act (FAA) (9 U.S.C. ' 1 et seq. ). The Appellate Division, First Department disagreed, and permanently stayed the arbitration under CPLR 7503(b).

The escalation clause in Tauber was typical of many New York City commercial office leases. Each year, the landlord would render a “Landlord's Statement” setting forth the final tally of operating expenses for the preceding year, and the tenant's corresponding rent increase. The lease provided that the “Landlord's Statement shall be conclusive and binding upon Tenant unless … within sixty (60) days after receipt of such Landlord's Statement Tenant shall notify Landlord that it disputes the correctness of Landlord's Statement, specifying the particular respects in which Landlord's Statement is claimed to be incorrect.” If the tenant timely challenged the Statement, the parties would have 90 days to settle their dispute. If the dispute was not settled within 90 days, the tenant had 60 days to submit the dispute to arbitration.

The tenant in Tauber did not timely follow the lease procedure. The landlord served the tenant with the 1999 Landlord's Statement in August of 2000. Five months later, the tenant asked to inspect the landlord's books and records as “a matter of routine diligence in the normal course of our business.” The inspection took place in January 2001, and 3 months later the tenant formally disputed the Landlord's Statement and demanded arbitration.

The landlord moved Supreme Court for a permanent stay of arbitration under CPLR 7503(b). The landlord's case seemed airtight; the tenant's escalation challenge was clearly untimely. Because the arbitration clause was a “narrow” one — the arbitrator was empowered to resolve escalation disputes, but was not authorized to resolve all disputes under the lease — the court, rather than the arbitrator, would determine the threshold issue of timeliness. Silverstein Properties Inc. v. Paine Webber Jackson & Curtis, Inc. , 65 N.Y.2d 785, 493 N.Y.S.2d 110 (1985). New York courts have consistently held that under a narrow arbitration clause, untimely escalation challenges shall be permanently stayed. See Salomon Smith Barney Holdings, Inc. v. 7 World Trade Co., L.P., 278 A.D.2d 63, 718 N.Y.S.2d 298 (1st Dep't 2000); Jack Kent Cooke Inc. v. Saatchi & Saatchi North America , 222 A.D.2d 334, 635 N.Y.S.2d 611 (1st Dep't 1995); Home Ins. Co. v. Olympia & York Maiden Lane Co. , 219 A.D.2d 469, 613 N.Y.S.2d 158 (1st Dep't 1995).

The tenant, facing a permanent stay of arbitration, argued that the lease evidenced a transaction involving “interstate commerce,” such that the FAA governed the dispute. Conveniently, threshold issues of timeliness under the FAA are determined by the arbitrator, rather than by the courts. If the tenant could convince the court that the FAA applied, the matter would go to arbitration, where the tenant could hope to prevail on the timeliness issue, or, at the very least, settle the matter.

The tenant, in support of its interstate commerce argument, asserted that AMA was a truly national organization, which held conferences at the subject building attended by persons from 35 different states, plus “Canada, Europe, Asia, Africa, the Middle East and the West Indies.” Supreme Court (Wetzel, J.) was unimpressed. Justice Wetzel held that “[t]he use that is made of the premises, as well as the diversity of citizenship of the parties to the lease, are not relevant to the applicability of the FAA.” The court permanently stayed the arbitration, concluding that “it cannot possibly be asserted that the escalation clause provision in a lease involves interstate commerce.”

The Appellate Division, First Department affirmed Supreme Court, holding that “[t]he subject lease is for office space in a commercial building located in Manhattan and does not, by its terms, contemplate or facilitate any involvement in interstate commerce.”

Escalation clauses contemplate the tabulation of various expenses and the subsequent rendering of a statement. If such clauses involved interstate commerce, the FAA would govern every arbitrable escalation dispute in New York City. Tauber serves notice on tenants that the FAA end run will not succeed in the First Department.

The 80% Solution?

Porter wage escalations were at the center of the dispute in Sage Realty Corp. v. Omnicom Group Inc. , 183 Misc. 2d 574, 705 N.Y.S.2d 500 (Sup. Ct. N.Y. Co. 2000), aff'd 278 A.D.2d 57, 718 N.Y.S.2d 304 (1st Dep't 2000). In Sage, the original 1975 lease provided for a porter wage escalation above an existing “Wage Rate.” The lease defined that term as follows:

” 'Wage Rate' shall mean the minimum regular hourly wage rate plus all other sums required to be paid to or for the benefit of porters engaged in general maintenance and operation of office buildings of the type and in the vicinity of the Building pursuant to a collective bargaining agreement between Realty Advisory Board on Labor Relations, Inc. … and Local 32-B '.”

At the time the parties entered into the 1975 lease, the CBA had only one wage rate for straight-time work for regular employees in the porters' work category. As the tenant was quick to point out, that wage rate was the lowest rate for all porters, ie, the “minimum” regular hourly wage rate.

On Feb. 4, 1996, however, a new wrinkle emerged. For the first time, the CBA called for a “new hire rate” for new employees (including porters), which was pegged at 80% of the “minimum regular hourly wage rate.” The tenant argued that the “Wage Rate” was supposed to be the lowest rate payable to porters, and that the 80% new hire rate so qualified. The tenant argued that the porter expense had thus decreased by 20%, such that the tenant was entitled to a substantial refund.

Justice Paula Omansky rejected the tenant's claim. She observed that only 3% of the local 32B-32J porters were “new hires,” such that using the new hire rate would result in a substantial windfall to the tenant. 183 Misc. 2d at 578. A unanimous First Department thereafter affirmed, stating: “We reject the tenant's claim that this new, lower rate for new hires became the index for calculating additional rent as of the effective date of the 1996 collective bargaining agreement, entitling it to a reduction in rent retroactive to that date. The temporary nature of the wage differential for new hires, and the fact that the two-tier system could not have been contemplated by the parties' predecessors when they entered into the original lease 21 years before, militate against the construction of the lease that would have the lower rate for new hires serve as the rent-adjustment index.” 278 A.D.2d at 57; see also, 1411 Trizechahn-Swig, L.L.C. v. Henry I. Siegel Co., Inc., 2001 WL 1657274 (N.Y.C. Civ. Ct. 2001).

Conclusion

It would appear for now that the courts in the First Department have foreclosed future porter wage challenges based on the “new hire rate.” Landlords drafting new leases, or renewals of existing leases, are well advised to avoid this dispute by clarifying that the “new hire rate,” or any unforeseen change in a future CBA, shall not be used to calculate the landlord's porter wage expense.