Looking at Lease Provisions from the Litigator's Angle

Once the parties begin negotiating and drafting the actual lease, the best advice to minimize future litigation is 'clarity, clarity, clarity.' Many lease disputes arise because the parties do not focus on how a court, years later, will interpret particular lease provisions. When the landlord and tenant are amicable, disputes can often be resolved through reasonable discussions. When they are not, the parties then begin to take a careful look at the language of the lease. It is far better to reduce the number of potential disputes by taking more care with respect to the important provisions of the lease. One such type of provision that results in considerable litigation is the 'use' provision. Either the landlord or the tenant can utilize the 'use' provision to gain a marketing or negotiating advantage during the lease term. The landlord can rely upon the provision to stop a tenant from expanding its scope of business into another tenant's realm, to terminate the lease, and to obtain money damages. Tenants, too, can and do utilize 'use' provisions in their favor. If the tenants are given exclusive rights for a particular use in the center or office building owned by the landlord, then the tenants can prevent the landlord from leasing to competitors. Tenants can also utilize a landlord's breach of the 'use' provision to excuse themselves from having to pay any further rent to the landlord.

Although a lease consists of real property and contract components, it is generally interpreted under the rules of contract construction. Therefore, to avoid future disputes, the parties should clearly and expressly designate both the permitted uses of the leased premises by the tenant as well as those uses that the landlord cannot allow other tenants to undertake. General, broad descriptions can result in litigation later on, as can uses that are too narrow in their description.

Duty to Repair

Another area for post-closing confusion arises when there is a major repair that needs to be made to the leased premises. Again, the focus here is that the parties must clearly describe who has the duty to make the needed repairs, the landlord or the tenant. In California, as recently held by an appellate court, the commercial landlord does not have a duty to keep the leased premises in repair in the absence of an express provision in the lease ' except if the landlord keeps control over an area commonly used by the public or the other tenants. According to that court, there is no implied covenant that the landlord keeps the commercial premises in any particular condition. Therefore, it is incumbent upon the parties to state expressly whether the landlord or the tenant has a duty to keep the premises in repair, and specify the scope of that duty.

Time to Cure

Standard or pre-printed commercial leases often have cure periods that are confusing. The most common default under a commercial lease is the tenant's failure to pay rent. Yet, many commercial leases provide 30 or more days for the tenant to cure such a default before the landlord can assert that the lease has been breached. The question is whether the landlord must wait both the cure period under the lease and the additional statutory cure period provided by state laws. For example, California's summary unlawful detainer practice provides a statutory 3-day period for tenants to cure a monetary default. Should the landlord limit the cure period provided by the statutory eviction procedure? Again, drafting clarity with respect to this provision may avoid needless disputes later on.

Liquidated Damages

A liquidated damages provision is an attempt by the parties to a contract to approximate the damages that would be incurred by a party when the other party breaches a particular provision. Examples of liquidated damages provisions include:

• 150% of rent if it is received late;
• 200% of rent if the tenant no longer operates its business at the site;
• Rent is increased by a percentage of sales at a tenant's other location because the tenant violated a 'radius restriction.'

The parties agree that the breaching party will pay the specified amount identified in the contract. The benefit of such a provision is that in situations in which damages are difficult to calculate, the parties have already agreed upon a number. However, if the parties do not follow the rules when drafting the provision, then a court may find that the provision is nothing more than a penalty and, therefore, unenforceable. In California, leases are subject to the liquidated damages rules. Those rules generally provide that liquidated damages provisions are valid 'unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made.' Care must be taken to avoid charging an unreasonable amount upon a lease default. If there is no reasonable relationship between the amount and the potential damages caused by a breach of the applicable lease provision, the court may very well hold that the provision is not enforceable.

Tenant Improvements

Where improvements by the tenant are required or anticipated in the lease, there are certain measures a landlord can take to protect itself against mechanic's liens. A landlord may require the tenant to provide a payment bond equal to the construction contract price before the work begins. A landlord may require that the contract between the tenant and its contractor specifically acknowledge that mechanic's liens will not be effective against the landlord. If the landlord is paying for the cost of the tenant improvements, the landlord should require that the tenant provide applicable mechanic's lien releases before payments are made to the contractor, subcontractors, and suppliers. The landlord may wish to consider requiring the tenant to provide monthly lien releases even where the landlord is not paying for the improvements, if the improvements are of a sufficiently large scale. Another means of protection is an increase in the security deposit until the improvements are completed and the landlord receives appropriate releases.

Alternate Dispute Resolution

Some states, such as California and New York, provide a summary court procedure for terminating leases and gaining possession of the premises in the event of a tenant's default. Typically, this type of lawsuit is used against tenants who fail to pay rent. However, with the California Supreme Court recently holding that a contractual pre-dispute jury waiver is not enforceable, the parties may want to consider either mandatory arbitration or judicial reference for the resolution of their disputes. The parties should weigh the perceived benefits of avoiding a jury, such as streamlining the process and avoiding triers of fact who are more likely to make decisions based upon emotion, against factors such as the added expense in having to pay the fees of an arbitrator or referee. In California, or another state in which the landlord is given a summary eviction procedure, it is unlikely that the landlord will want to opt out of that expedited process. However, the landlord may decide it is better to have a combination of dispute resolution procedures, retaining its right to the summary process for eviction but requiring the tenant to proceed by arbitration or judicial reference if the tenant has its own claim against the landlord.

Pre-Lease Considerations: Letters of Intent

Before the parties even sign a formal lease, they often (sometimes through their brokers) negotiate and then sign a letter of intent, also called an 'LOI.' The misunderstanding between the parties can begin at this early stage of the relationship if the parties do not each have the same intention. The basic question is whether the LOI is simply an unenforceable and non-binding list of deal points that, it is hoped, will evolve into a binding lease agreement, or whether the LOI is a mini-lease, binding between the parties even though the parties intend to enter into a more formal and detailed definitive lease agreement at a later date. Unfortunately, the LOI is not always clear in that regard. If the deal falls through, the party who liked the terms may attempt to enforce the LOI as a binding contract, while the other party may contend that the LOI was nothing more than an incomplete and unenforceable series of deal points. Be upfront and be clear. If the parties do not want a binding contract, then use the correct terminology. Add that 'this letter is not intended to be and is not a contractually binding agreement.' Add that 'neither party will be bound unless and until the formal lease agreement has been executed by both parties.' Further, avoid taking steps after the LOI is signed which could lead a judge to find that the parties entered into a contract. As an example, do not allow the tenant to begin tenant improvements until an actual lease is signed.

On the other hand, if the parties want a simple binding agreement that they will convert into a more detailed lease agreement, then they should specify that the LOI is binding. Examples of provisions that should be considered in such circumstances include:

• The LOI constitutes the landlord's offer to lease the premises and the tenant's acceptance of the terms of the LOI; or
• The LOI is intended to be a binding agreement of the terms of the lease.

In either event, have a lawyer review the LOI before it is signed to confirm that the LOI will be interpreted to be what it is intended to be.

In Summary

Not surprisingly, much can be learned in hindsight. A key to litigation avoidance is to project into the future and focus on those provisions that are more likely to result in disputes between the parties. Recognize that the 'boilerplate' provisions that are often 'cut and pasted' from one lease to another can be the most important provisions in determining where a lawsuit is to be filed, what constitutes a breach, and what remedies are available.

Frequently, commercial lease issues are brought to the attention of a litigation lawyer only after a dispute between the landlord and the tenant has erupted. Oftentimes, the dispute involves the 'boilerplate' provisions that do not raise much interest during the drafting phase because they are not considered to be economic deal points. See 'Revisiting Boilerplate or 'Miscellaneous' Lease Provisions' in the January 2006 issue of Commercial Leasing Law & Strategy. This lack of interest in boilerplate provisions is a mistake because it is much easier to resolve concerns regarding those provisions ' which become very important in the litigation context ' while the parties are amicably moving toward closing a deal, rather than during the pendency of a lawsuit. Many times, disputes could have been either avoided or minimized had the parties clarified certain important issues while they were negotiating and drafting. This article discusses several leasing issues that should be carefully considered while the parties are still on friendly terms.

Lease Terms

Use Provisions

Once the parties begin negotiating and drafting the actual lease, the best advice to minimize future litigation is 'clarity, clarity, clarity.' Many lease disputes arise because the parties do not focus on how a court, years later, will interpret particular lease provisions. When the landlord and tenant are amicable, disputes can often be resolved through reasonable discussions. When they are not, the parties then begin to take a careful look at the language of the lease. It is far better to reduce the number of potential disputes by taking more care with respect to the important provisions of the lease. One such type of provision that results in considerable litigation is the 'use' provision. Either the landlord or the tenant can utilize the 'use' provision to gain a marketing or negotiating advantage during the lease term. The landlord can rely upon the provision to stop a tenant from expanding its scope of business into another tenant's realm, to terminate the lease, and to obtain money damages. Tenants, too, can and do utilize 'use' provisions in their favor. If the tenants are given exclusive rights for a particular use in the center or office building owned by the landlord, then the tenants can prevent the landlord from leasing to competitors. Tenants can also utilize a landlord's breach of the 'use' provision to excuse themselves from having to pay any further rent to the landlord.

Although a lease consists of real property and contract components, it is generally interpreted under the rules of contract construction. Therefore, to avoid future disputes, the parties should clearly and expressly designate both the permitted uses of the leased premises by the tenant as well as those uses that the landlord cannot allow other tenants to undertake. General, broad descriptions can result in litigation later on, as can uses that are too narrow in their description.

Duty to Repair

Another area for post-closing confusion arises when there is a major repair that needs to be made to the leased premises. Again, the focus here is that the parties must clearly describe who has the duty to make the needed repairs, the landlord or the tenant. In California, as recently held by an appellate court, the commercial landlord does not have a duty to keep the leased premises in repair in the absence of an express provision in the lease ' except if the landlord keeps control over an area commonly used by the public or the other tenants. According to that court, there is no implied covenant that the landlord keeps the commercial premises in any particular condition. Therefore, it is incumbent upon the parties to state expressly whether the landlord or the tenant has a duty to keep the premises in repair, and specify the scope of that duty.

Time to Cure

Standard or pre-printed commercial leases often have cure periods that are confusing. The most common default under a commercial lease is the tenant's failure to pay rent. Yet, many commercial leases provide 30 or more days for the tenant to cure such a default before the landlord can assert that the lease has been breached. The question is whether the landlord must wait both the cure period under the lease and the additional statutory cure period provided by state laws. For example, California's summary unlawful detainer practice provides a statutory 3-day period for tenants to cure a monetary default. Should the landlord limit the cure period provided by the statutory eviction procedure? Again, drafting clarity with respect to this provision may avoid needless disputes later on.

Liquidated Damages

A liquidated damages provision is an attempt by the parties to a contract to approximate the damages that would be incurred by a party when the other party breaches a particular provision. Examples of liquidated damages provisions include:

• 150% of rent if it is received late;
• 200% of rent if the tenant no longer operates its business at the site;
• Rent is increased by a percentage of sales at a tenant's other location because the tenant violated a 'radius restriction.'

The parties agree that the breaching party will pay the specified amount identified in the contract. The benefit of such a provision is that in situations in which damages are difficult to calculate, the parties have already agreed upon a number. However, if the parties do not follow the rules when drafting the provision, then a court may find that the provision is nothing more than a penalty and, therefore, unenforceable. In California, leases are subject to the liquidated damages rules. Those rules generally provide that liquidated damages provisions are valid 'unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made.' Care must be taken to avoid charging an unreasonable amount upon a lease default. If there is no reasonable relationship between the amount and the potential damages caused by a breach of the applicable lease provision, the court may very well hold that the provision is not enforceable.

Tenant Improvements

Where improvements by the tenant are required or anticipated in the lease, there are certain measures a landlord can take to protect itself against mechanic's liens. A landlord may require the tenant to provide a payment bond equal to the construction contract price before the work begins. A landlord may require that the contract between the tenant and its contractor specifically acknowledge that mechanic's liens will not be effective against the landlord. If the landlord is paying for the cost of the tenant improvements, the landlord should require that the tenant provide applicable mechanic's lien releases before payments are made to the contractor, subcontractors, and suppliers. The landlord may wish to consider requiring the tenant to provide monthly lien releases even where the landlord is not paying for the improvements, if the improvements are of a sufficiently large scale. Another means of protection is an increase in the security deposit until the improvements are completed and the landlord receives appropriate releases.

Alternate Dispute Resolution

Some states, such as California and New York, provide a summary court procedure for terminating leases and gaining possession of the premises in the event of a tenant's default. Typically, this type of lawsuit is used against tenants who fail to pay rent. However, with the California Supreme Court recently holding that a contractual pre-dispute jury waiver is not enforceable, the parties may want to consider either mandatory arbitration or judicial reference for the resolution of their disputes. The parties should weigh the perceived benefits of avoiding a jury, such as streamlining the process and avoiding triers of fact who are more likely to make decisions based upon emotion, against factors such as the added expense in having to pay the fees of an arbitrator or referee. In California, or another state in which the landlord is given a summary eviction procedure, it is unlikely that the landlord will want to opt out of that expedited process. However, the landlord may decide it is better to have a combination of dispute resolution procedures, retaining its right to the summary process for eviction but requiring the tenant to proceed by arbitration or judicial reference if the tenant has its own claim against the landlord.

Pre-Lease Considerations: Letters of Intent

Before the parties even sign a formal lease, they often (sometimes through their brokers) negotiate and then sign a letter of intent, also called an 'LOI.' The misunderstanding between the parties can begin at this early stage of the relationship if the parties do not each have the same intention. The basic question is whether the LOI is simply an unenforceable and non-binding list of deal points that, it is hoped, will evolve into a binding lease agreement, or whether the LOI is a mini-lease, binding between the parties even though the parties intend to enter into a more formal and detailed definitive lease agreement at a later date. Unfortunately, the LOI is not always clear in that regard. If the deal falls through, the party who liked the terms may attempt to enforce the LOI as a binding contract, while the other party may contend that the LOI was nothing more than an incomplete and unenforceable series of deal points. Be upfront and be clear. If the parties do not want a binding contract, then use the correct terminology. Add that 'this letter is not intended to be and is not a contractually binding agreement.' Add that 'neither party will be bound unless and until the formal lease agreement has been executed by both parties.' Further, avoid taking steps after the LOI is signed which could lead a judge to find that the parties entered into a contract. As an example, do not allow the tenant to begin tenant improvements until an actual lease is signed.

On the other hand, if the parties want a simple binding agreement that they will convert into a more detailed lease agreement, then they should specify that the LOI is binding. Examples of provisions that should be considered in such circumstances include:

• The LOI constitutes the landlord's offer to lease the premises and the tenant's acceptance of the terms of the LOI; or
• The LOI is intended to be a binding agreement of the terms of the lease.

In either event, have a lawyer review the LOI before it is signed to confirm that the LOI will be interpreted to be what it is intended to be.

In Summary

Not surprisingly, much can be learned in hindsight. A key to litigation avoidance is to project into the future and focus on those provisions that are more likely to result in disputes between the parties. Recognize that the 'boilerplate' provisions that are often 'cut and pasted' from one lease to another can be the most important provisions in determining where a lawsuit is to be filed, what constitutes a breach, and what remedies are available.