Five Secrets to Drafting an Effective Default Lease

If the lease requires the tenant to pay the particular charge but does not expressly designate the item as “additional rent,” it will not be deemed additional rent by the court. See, e.g., Rector, Churchwardens & Vestrymen of Trinity Church in City of New York v. Chung King House of Metal, Inc., 193 Misc.2d 44, 747 NYS2d 292 (NYC Civil Court 2002).

Where the lease itself is reasonably susceptible to more than one interpretation of how the additional rent is to be calculated, the court may properly consider evidence of the parties' course of conduct, including the methodology used by the landlord in its annual billing for additional rent, and the tenant's payment of such additional rent from the beginning of the tenancy. One Hundred Grand, Inc. v. Chaplin, 70 AD3d 513, 895 NYS2d 68, 69 (1st Dept. 2010). Nevertheless, attorneys should strive to eliminate all ambiguities concerning the calculations required to accurately determine the amounts that will become due as additional rent under the lease.

It should be noted that General Obligations Law (GOL) 103(1) provides that a tenant's security deposit, until repaid to the tenant at the termination of the lease or applied to payments due under the lease, “shall continue to be the money of the person making such deposit or advance and shall be held in trust by the person with whom such deposit or advance shall be made and shall not be mingled with the personal moneys or become an asset of the person receiving the same.”

It has been held, therefore, that the tenant's security deposit itself is not “rent,” and it cannot be recovered in a nonpayment proceeding. See, e.g., 225 Holding Co., LLC v. Beal, 34 HCR 630A, 12 Misc.3d 136(A), 820 NYS2d 846 (2d Dept. App. Term 2006). Nor does the New York City Civil Court or any local court have jurisdiction to order a tenant to replenish a security deposit that has been applied to payments due under the tenant's lease obligations. 930 Fifth Avenue Corporation v. Shearman, 17 Misc.3d 1126(A), 851 NYS2d 71 (NYC Civil Court 2007) (Lebovitz, J.). However, the failure to maintain the security deposit is a breach of a substantial obligation of the lease and is therefore a proper basis for a conditional limitation and ensuing holdover proceeding. See 225 Holding Co., LLC v. Beal, supra.

Rent Acceleration

As the most powerful weapon ever devised for a lease, aside from the guarantee provision, rent acceleration clauses provide a wonderful way to ensure that rent payments are not only made, but are timely. Upon a default in the payment of rent, a properly drafted acceleration clause permits the landlord to seek recovery of the total balance of rent due under the lease without having to wait until the lease's expiration date. Without a properly drafted acceleration clause, the right of the landlord to sue for damages for the breach of the lease accrues, generally, upon the termination date of the lease. See Muss v. Daytop Village, Inc., 43 AD2d 945, 352 NYS2d 28 (2d Dept. 1974).

As stated in Fifty States Management Corporation v. Pioneer Auto Parks, Inc., 46 NY2d 573, 577, 415 NYS2d 800 (1979), “[I]n rare cases, agreements providing for the acceleration of the entire debt upon the default of the obligor may be circumscribed or denied enforcement by utilization of equitable principles. In the vast majority of instances, however, these clauses have been enforced at law in accordance with their terms. … Absent some element of fraud, exploitive overreaching or unconscionable conduct on the part of the landlord to exploit a technical breach, there is no warrant, either in law or equity, for a court to refuse enforcement of the agreement of the parties”.

However, as discussed at length below, the New York Court of Appeals' recent decision in 172 Van Duzer Realty Corp. v. Globe Alumni Student Assistance Association, Inc., ___ NY3d ___, 2014 WL 7177502 (12/18/14), casts some doubt on the full collectability of accelerated rent. In Van Duzer, the court held that a hearing on the landlord's actual damages may be necessary to determine what portion of accelerated rent, undiscounted, will not constitute an otherwise forbidden penalty. Under “penalty” jurisprudence, a lease that provides for acceleration for breach of any of its terms, no matter how trivial or inconsequential, is likely to be considered an unconscionable penalty and will not be enforced by a court of equity. Fifty States, supra. For example, acceleration will not be permitted for a tenant's failure to comply with a covenant collateral to the primary obligation of the tenant. In such circumstances, acceleration will be held to constitute a forfeiture, as the damages reserved in the lease are likely to be disproportionate to any actual loss that could possibly accrue to the landlord from such breach. Id. (Author Bailey has his doubts about Van Duzer being good law and sees it as an anomaly. Since it is such a new decision, there is no track record with which to evaluate this position. The doctrine announced in the case is discussed infra.)

However, a covenant to pay rent at a specified time “is an essential part of the bargain as it represents the consideration to be received for permitting the tenant to remain in possession of the property of the landlord.” Id., 46 NY2d at 578. Therefore, acceleration is permitted as liquidated damages if the sum to be recovered is no greater than the amount the tenant would have paid had it fully performed and been entitled to possession upon payment. Id., subject to Van Duzer, supra. Further, it has been held that a single default in the payment of rent is sufficient to effectuate an acceleration clause. GAB Management, Inc. v. Blumberg, 226 AD2d 499, 641 NYS2d 340 (2d Dept. 1996). Moreover, where the lease terms can be construed to allow it, the tenant's guarantor can also be held liable for the accelerated sum due under the lease. See Madison Avenue Leasehold, LLC v. Madison Bentley Associates LLC, 8 NY3d 59, 861 NYS2d 254 (2006).

It should be noted that New York's Appellate Division, Second Department, has held that “accelerated rent” is not “rent due.” Ross Realty v. V&A Fabricators, Inc., 42 AD3d 246, 836 NYS2d 242 (2d Dept. 2007). As the court there explained, “accelerated rent” is “contractual damages not recoverable in a summary proceeding.” Accordingly, upon a default by the tenant, the landlord can use summary proceedings to regain possession of the premises with a judgment of eviction and a monetary judgment for past rent due. But, to recover the monies due upon the contractual claims for accelerated rent and other monetary obligations that survive the termination of the lease, the landlord must commence a plenary action. Id.; see also 930 Fifth Avenue Corporation, supra; Marketplace v. Smith, 181 Misc.2d 440, 694 NYS2d 893 (Justice Ct., Monroe Co. 1999).

The judgment entered for the landlord in the summary proceeding is neither res judicata nor an election of remedies, and therefore does not bar the landlord from seeking contractual damages in the plenary action. As the Second Department further explained, “[r]es judicata is inapplicable where a party is unable to seek a certain remedy or form of relief in the first action because of limitations on the subject matter jurisdiction of the court or restrictions on its authority to entertain multiple remedies or form of relief in a single action.” Ross Realty,supra.

Late Charges

Commercial lease clauses that impose late charges for failing to pay rent or other additional rent obligations in a timely manner, and which specify that the late charges shall also be deemed additional rent, are generally enforced by the courts. See, e.g., Goldman v. MJI Music, Inc., 17 Misc.3d 1127 (A), 2007 WL 3378369 (NYC Civil Ct., Kings Co., 2007). However, late charges, as additional rent, may be sought only for rent that is past due. At the time of a default, where a lease does not contain a rent acceleration clause, the landlord may sue only for the amount of late charges past due at the time the action or proceeding is commenced. See, e.g., Barr v. Country Motor Car Group, Inc., 15 AD3d 985, 789 NYS2d 350 (4th Dept. 2005). In such cases, the landlord's entitlement to damages for the remaining installments of rent will ripen and may be sued for at the end of the lease term. Id.

Whether or not the particular late charge specified in any commercial lease, or the formula used to calculate such late charge, as negotiated between sophisticated business people, may be found to be “unconscionable” will depend upon whether there is evidence suggesting that the late charge was unreasonable or against public policy. See, e.g., K.I.D.E. Associates, Inc. v. Garage Estates Company, 280 AD2d 251, 720 NYS2d 114 (1st Dept. 2001). The late fee must bear some reasonable relationship to the landlord's additional administrative expense by reason of the lateness. If the late fee is too high, the courts regard it as an unenforceable penalty. Wilsdorf v. Fairfield Northport Harbor, LLC, 40 HCR 134A, 34 Misc3d 146(A), 950 NYS2d 494 (AT 9 & 10 2012).

In next month's installment, we will discuss further lease clauses that can help a commercial landlord better ensure that rent is paid as agreed, or that swift eviction may follow from non-compliance with the lease terms.

*****
Adam Leitman Bailey, a member of Commercial Leasing Law & Strategy's Board of Editors, is the founding partner of Adam Leitman Bailey, P.C. He practices residential and commercial real estate law. John M. Desiderio chairs the Real Estate Litigation Practice Group at the firm. They may be reached at 212-825-0365. Portions of this article are taken from The Essential Guide to The Most Important Clause in a Commercial Lease: The Default Clause chapter in New York State Bar Association book, Commercial Leasing, 3rd Edition, which is expected to be published next year, with permission by editor Joshua Stein.

An effective commercial lease will dictate the future relationship between landlord and tenant. The more clauses forcing the commercial tenant to comply with its obligations, the better chance the landlord will have, not only to achieve a successful relationship, but also to ensure that the rent is paid and the tenant behaves. Below are some of the lesser-known, creative clauses used to ensure either payment of rent and compliance, or a swift eviction of the commercial tenant. They are what we call “tools of the effective default clause.”

Additional Rent

It is important that all monies the tenant is required to pay during the term of the lease, other than the rent itself, be expressly designated as “additional rent.” This can include late charges, taxes, various building expenses, attorney fees, letters of credit, insurance, and any other items specific to the particular premises involved that the landlord requires the tenant to pay. If such items are designated as “additional rent” in the lease, the landlord may initiate a summary proceeding to recover possession of the premises for the tenant's failure to make a required payment of such, whether or not the tenant has paid the requisite monthly base rent. See Melick v. Ken's Service Station, Inc. , 44 Misc.3d 143(A), 2014 WL 4251023 (N.Y. Sup App. Term) (2d Dept.)

If the lease requires the tenant to pay the particular charge but does not expressly designate the item as “additional rent,” it will not be deemed additional rent by the court. See, e.g., Rector, Churchwardens & Vestrymen of Trinity Church in City of New York v. Chung King House of Metal, Inc. , 193 Misc.2d 44, 747 NYS2d 292 (NYC Civil Court 2002).

Where the lease itself is reasonably susceptible to more than one interpretation of how the additional rent is to be calculated, the court may properly consider evidence of the parties' course of conduct, including the methodology used by the landlord in its annual billing for additional rent, and the tenant's payment of such additional rent from the beginning of the tenancy. One Hundred Grand, Inc. v. Chaplin , 70 AD3d 513, 895 NYS2d 68, 69 (1st Dept. 2010). Nevertheless, attorneys should strive to eliminate all ambiguities concerning the calculations required to accurately determine the amounts that will become due as additional rent under the lease.

It should be noted that General Obligations Law (GOL) 103(1) provides that a tenant's security deposit, until repaid to the tenant at the termination of the lease or applied to payments due under the lease, “shall continue to be the money of the person making such deposit or advance and shall be held in trust by the person with whom such deposit or advance shall be made and shall not be mingled with the personal moneys or become an asset of the person receiving the same.”

It has been held, therefore, that the tenant's security deposit itself is not “rent,” and it cannot be recovered in a nonpayment proceeding. See, e.g., 225 Holding Co., LLC v. Beal, 34 HCR 630A, 12 Misc.3d 136(A), 820 NYS2d 846 (2d Dept. App. Term 2006). Nor does the New York City Civil Court or any local court have jurisdiction to order a tenant to replenish a security deposit that has been applied to payments due under the tenant's lease obligations. 930 Fifth Avenue Corporation v. Shearman , 17 Misc.3d 1126(A), 851 NYS2d 71 (NYC Civil Court 2007) (Lebovitz, J.). However, the failure to maintain the security deposit is a breach of a substantial obligation of the lease and is therefore a proper basis for a conditional limitation and ensuing holdover proceeding. See 225 Holding Co., LLC v. Beal, supra.

Rent Acceleration

As the most powerful weapon ever devised for a lease, aside from the guarantee provision, rent acceleration clauses provide a wonderful way to ensure that rent payments are not only made, but are timely. Upon a default in the payment of rent, a properly drafted acceleration clause permits the landlord to seek recovery of the total balance of rent due under the lease without having to wait until the lease's expiration date. Without a properly drafted acceleration clause, the right of the landlord to sue for damages for the breach of the lease accrues, generally, upon the termination date of the lease. See Muss v. Daytop Village, Inc ., 43 AD2d 945, 352 NYS2d 28 (2d Dept. 1974).

As stated in Fifty States Management Corporation v. Pioneer Auto Parks, Inc. , 46 NY2d 573, 577, 415 NYS2d 800 (1979), “[I]n rare cases, agreements providing for the acceleration of the entire debt upon the default of the obligor may be circumscribed or denied enforcement by utilization of equitable principles. In the vast majority of instances, however, these clauses have been enforced at law in accordance with their terms. … Absent some element of fraud, exploitive overreaching or unconscionable conduct on the part of the landlord to exploit a technical breach, there is no warrant, either in law or equity, for a court to refuse enforcement of the agreement of the parties”.

However, as discussed at length below, the New York Court of Appeals' recent decision in 172 Van Duzer Realty Corp. v. Globe Alumni Student Assistance Association, Inc. , ___ NY3d ___, 2014 WL 7177502 (12/18/14), casts some doubt on the full collectability of accelerated rent. In Van Duzer, the court held that a hearing on the landlord's actual damages may be necessary to determine what portion of accelerated rent, undiscounted, will not constitute an otherwise forbidden penalty. Under “penalty” jurisprudence, a lease that provides for acceleration for breach of any of its terms, no matter how trivial or inconsequential, is likely to be considered an unconscionable penalty and will not be enforced by a court of equity. Fifty States, supra. For example, acceleration will not be permitted for a tenant's failure to comply with a covenant collateral to the primary obligation of the tenant. In such circumstances, acceleration will be held to constitute a forfeiture, as the damages reserved in the lease are likely to be disproportionate to any actual loss that could possibly accrue to the landlord from such breach. Id. (Author Bailey has his doubts about Van Duzer being good law and sees it as an anomaly. Since it is such a new decision, there is no track record with which to evaluate this position. The doctrine announced in the case is discussed infra.)

However, a covenant to pay rent at a specified time “is an essential part of the bargain as it represents the consideration to be received for permitting the tenant to remain in possession of the property of the landlord.” Id., 46 NY2d at 578. Therefore, acceleration is permitted as liquidated damages if the sum to be recovered is no greater than the amount the tenant would have paid had it fully performed and been entitled to possession upon payment. Id., subject to Van Duzer, supra. Further, it has been held that a single default in the payment of rent is sufficient to effectuate an acceleration clause. GAB Management, Inc. v. Blumberg , 226 AD2d 499, 641 NYS2d 340 (2d Dept. 1996). Moreover, where the lease terms can be construed to allow it, the tenant's guarantor can also be held liable for the accelerated sum due under the lease. See Madison Avenue Leasehold, LLC v. Madison Bentley Associates LLC , 8 NY3d 59, 861 NYS2d 254 (2006).

It should be noted that New York's Appellate Division, Second Department, has held that “accelerated rent” is not “rent due.” Ross Realty v. V&A Fabricators, Inc., 42 AD3d 246, 836 NYS2d 242 (2d Dept. 2007). As the court there explained, “accelerated rent” is “contractual damages not recoverable in a summary proceeding.” Accordingly, upon a default by the tenant, the landlord can use summary proceedings to regain possession of the premises with a judgment of eviction and a monetary judgment for past rent due. But, to recover the monies due upon the contractual claims for accelerated rent and other monetary obligations that survive the termination of the lease, the landlord must commence a plenary action. Id.; see also 930 Fifth Avenue Corporation, supra; Marketplace v. Smith , 181 Misc.2d 440, 694 NYS2d 893 (Justice Ct., Monroe Co. 1999).

The judgment entered for the landlord in the summary proceeding is neither res judicata nor an election of remedies, and therefore does not bar the landlord from seeking contractual damages in the plenary action. As the Second Department further explained, “[r]es judicata is inapplicable where a party is unable to seek a certain remedy or form of relief in the first action because of limitations on the subject matter jurisdiction of the court or restrictions on its authority to entertain multiple remedies or form of relief in a single action.” Ross Realty,supra.

Late Charges

Commercial lease clauses that impose late charges for failing to pay rent or other additional rent obligations in a timely manner, and which specify that the late charges shall also be deemed additional rent, are generally enforced by the courts. See, e.g., Goldman v. MJI Music, Inc. , 17 Misc.3d 1127 (A), 2007 WL 3378369 (NYC Civil Ct., Kings Co., 2007). However, late charges, as additional rent, may be sought only for rent that is past due. At the time of a default, where a lease does not contain a rent acceleration clause, the landlord may sue only for the amount of late charges past due at the time the action or proceeding is commenced. See, e.g., Barr v. Country Motor Car Group, Inc. , 15 AD3d 985, 789 NYS2d 350 (4th Dept. 2005). In such cases, the landlord's entitlement to damages for the remaining installments of rent will ripen and may be sued for at the end of the lease term. Id.

Whether or not the particular late charge specified in any commercial lease, or the formula used to calculate such late charge, as negotiated between sophisticated business people, may be found to be “unconscionable” will depend upon whether there is evidence suggesting that the late charge was unreasonable or against public policy. See, e.g., K.I.D.E. Associates, Inc. v. Garage Estates Company , 280 AD2d 251, 720 NYS2d 114 (1st Dept. 2001). The late fee must bear some reasonable relationship to the landlord's additional administrative expense by reason of the lateness. If the late fee is too high, the courts regard it as an unenforceable penalty. Wilsdorf v. Fairfield Northport Harbor, LLC, 40 HCR 134A, 34 Misc3d 146(A), 950 NYS2d 494 (AT 9 & 10 2012).

In next month's installment, we will discuss further lease clauses that can help a commercial landlord better ensure that rent is paid as agreed, or that swift eviction may follow from non-compliance with the lease terms.

*****
Adam Leitman Bailey, a member of Commercial Leasing Law & Strategy's Board of Editors, is the founding partner of Adam Leitman Bailey, P.C. He practices residential and commercial real estate law. John M. Desiderio chairs the Real Estate Litigation Practice Group at the firm. They may be reached at 212-825-0365. Portions of this article are taken from The Essential Guide to The Most Important Clause in a Commercial Lease: The Default Clause chapter in New York State Bar Association book, Commercial Leasing, 3rd Edition, which is expected to be published next year, with permission by editor Joshua Stein.