Commercial Leasing

Case Highlights Importance of Rent Acceleration Clause In Commercial Leases

In a decision underscoring the importance of careful commercial lease drafting, the Massachusetts Supreme Judicial Court has ruled that a commercial landlord must wait out a 12 year lease term to recover unpaid rent from a tenant who abandoned the premises in year 2 of the lease. We lawyers call this a Pyrrhic victory: “a victory offset by staggering losses.” The case is 275 Washington Street Corp. vs. Hudson River Int’l, LLC (SJC-11217). 

Practice Pointer: This case is an important reminder for all residential and commercial landlords to have their leases reviewed to ensure that they can recover all available lost rental damages. Contact me at info@vetsteinlawgroup.com for a lease review.

Facts: Dental Practice Goes South Quickly

The landlord and tenant, a dental practice, entered into a 12-year lease beginning in 2006 for medical office space located at 221-227 Washington Street in downtown Boston. Barely a year later, the dental practice went under and closed. In May 2008, the dentist told the landlord that he would not be making any further lease payments.

Fortunately, the landlord found a new tenant. A new 10 year lease was signed, covering the remainder of the dentist’s term, but at a lower rent. The landlord sued the dentist for the rent differential — some $1 Million Dollars.

Standard Indemnification Clause

The lease contained a standard default indemnification clause found in many older standard lease forms:

The LESSEE shall indemnify the LESSOR against all loss of rent and other payments which the LESSOR may incur by reason of such termination during the residue of the term.  If the LESSEE shall default, after reasonable notice thereof, in the observance or performance of any conditions or covenant on LESSEE’s part to be observed or performed under or by virtue of any of the provisions in any article of this lease, the LESSOR, without being under any obligation to do so and without thereby waiving such default, may remedy such default for the account and at the expense of the LESSEE.

Common Law Rule: Put It In The Lease

The SJC pointed out long standing Massachusetts common law “where the contract is a commercial lease, our common law does not provide ‘benefit of the bargain’ damages in the event of termination of the lease following a breach. Once a landlord terminates a lease, the tenant is no longer obligated to pay the rent, and, unless the lease otherwise so provides, the landlord is not entitled to posttermination damages.” This may be contrary to common understanding, but it’s the reason why lawyers have developed rent acceleration and liquidated damages provisions for commercial leases.

Despite the urging of the Real Estate Bar Association, which filed a friend-of-the-court brief, the SJC saw no need to alter the harsh common law simply because this particular landlord’s lease failed to provide a proper rent acceleration clause. Justice Gants didn’t mince his words in cautioning commercial landlords to use proper lease provisions:

 A landlord left without an adequate remedy following breach of the lease by a tenant has only itself to blame for entering into a lease that fails to provide such a remedy. We shall not disrupt the settled expectations of leasing parties in order to protect a landlord from the consequences of failing to insist on an adequate remedy in the negotiation of a commercial lease. Nor shall we invite uncertainty as to the availability and scope of a landlord’s remedy for “benefit of the bargain” damages where the contours of such a remedy are not delineated in the lease but left to be determined under the common law.

Solution: Rent Acceleration/Liquidated Damages Clause

The lease in this case appears to be of an older variety and did not contain a rent acceleration/liquidated damage clause. Such a clause provides that upon a rent default, all unpaid rent is due through the end of the lease term as liquidated damages. All commercial leases should contain this type of rent acceleration clause, and I would also recommend a provision enabling the landlord to recoup the cost of expensive tenant build outs where a tenant has defaulted early in the lease term. Contact me at info@vetsteinlawgroup.com for a lease review.

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Richard D. Vetstein, Esq.Richard D. Vetstein, Esq. is an experienced Massachusetts real estate attorney. For more information, please contact him at 508-620-5352 or info@vetsteinlawgroup.com.

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Insured Gets The Short End Of The Insurance Coverage Stick For Parking Lot & Building Flooding

The Massachusetts Supreme Judicial Court has not been too kind to insureds these days. For the second time in 2 months, the SJC has upheld the denial of a property owner’s claim in connection with flooding, this time in the commercial setting.  In Surabian Realty Co. v. NGM Insurance Co., the Court ruled that a commercial property owner’s claim for flooding caused by a blocked parking lot catch basin was not covered under an “all risk” commercial/business insurance policy.

Blocked Drain

Surabian Realty owned an office building in Foxborough. During heavy rains in 2009, rainwater stopped flowing down the parking lot drain. The drain had become clogged with debris. Rainwater then ponded in the lot and seeped under the door of the building, flooding its lower level. The flooding caused damage to the carpeting, baseboards, and walls, totaling approximately $34,000.

Surabian made a claim under its “all risk” commercial insurance policy which had a special indorsement for this type of situation, which provided, “The most we will pay for loss or damage caused by water that backs up or overflows from a sewer, drain or sump is $25,000 for any one occurrence.” The insurance company, however, denied  the claim on the grounds that the flooding was still excluded from coverage as it was caused by “surface water.”

Court Rules For Insurance Company (Again)

The SJC took an electron microscope to the policy language, parsing the language almost to a fault and unfairly (in my opinion) against the insured. The Court held:

“Construing these clauses in combination, we interpret the insurance contract, as amended by the indorsement, to exclude damage caused by flood waters that spread over the surface of the ground without having entered a drain, but to cover damage caused by water that backed up after entering a drain.”

So basically, the court said that the rainwater has to actually enter the drain, then backup, while a blocked drain that doesn’t allow water to fall down the pipe won’t be covered. Um, ok…. A better rationale would have been that the claim wasn’t covered because maintaining and keeping the drain free of debris was really the responsibility of the insured property owner, not a risk that the insurance company assumed. But I’m not the judge.

This is also the second instance in the last few months where the Court has relied upon the policy’s “anti-concurrent” clause which excluded coverage where  the damage results from the combination of a covered peril and an excluded peril.

Lessons For Property Owners

Aside from making sure catch basins are cleaned, the tough lesson for property owners here is that your supposed “all risk” insurance policy isn’t really “all risk” as you probably perceive it. It seems that these days a lot of insurance claims are denied or insureds are scared of even making a claim lest they get cancelled by the insurance company. It’s a tough predicament.

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Richard D. Vetstein, Esq. is an experienced Massachusetts real estate and commercial insurance coverage attorney. For more information, please contact him at 508-620-5352 or info@vetsteinlawgroup.com.

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Update (5/3/13): SJC Upholds Ruling, Landlords Should Add Rent Acceleration Clause to Leases

Commercial Landlord Must Wait Out 12 Year Lease Term To Recover For Tenant’s Early Termination

In a decision which underscores the importance of careful commercial lease drafting, the Massachusetts Appeals Court has ruled that under a standard form default indemnity provision in a commercial lease, a commercial landlord must wait out the end of a 12 year lease term to recover unpaid rent from a tenant who abandoned the premises in Year 2 of the lease. The practice pointer here is to always have a current acceleration/liquidated damages clause in your commercial lease. See below for some form language.

The case is 275 Washington Street Corp.. vs. Hudson River Int’l, LLC (Mass. Appeals Court March 9, 2012), and is embedded below.

Dental Practice Goes South Quickly

The landlord and tenant entered into a 12-year lease beginning April 13, 2006, and ending April 16, 2018. The premises, located at 221-227 Washington Street in downtown Boston, were intended for use as a dental practice. Within a year of the lease commencement, the dental practice went under and closed. In May 2008, the dentist told the landlord that he would not be making any further lease payments.

Fortunately, the landlord found a new tenant. A new 10 year lease was signed, covering the remainder of the dentist’s term, but at a lower rent. The landlord sued the tenant for the rent differential.

Standard Indemnification Clause

The lease contained a standard default indemnification clause found in many older standard lease forms such as this:

The LESSEE shall indemnify the LESSOR against all loss of rent and other payments which the LESSOR may incur by reason of such termination during the residue of the term.  If the LESSEE shall default, after reasonable notice thereof, in the observance or performance of any conditions or covenant on LESSEE’s part to be observed or performed under or by virtue of any of the provisions in any article of this lease, the LESSOR, without being under any obligation to do so and without thereby waiving such default, may remedy such default for the account and at the expense of the LESSEE.

Indemnity Provision Lacking

The problem is that under Massachusetts law, recovery under an indemnity clause of a lease cannot be had until the specified term of the lease has ended. The reasoning underlying this legal tenet is that such liability is ultimately “contingent upon events thereafter occurring, because the full amount which the lessee eventually must pay for the remainder of the term cannot be wholly ascertained until the period ends.” Although somewhat reluctant, the Court was bound to follow the law in this instance:

We are cognizant of the concerns raised by this long-established rule barring recovery until the end of the original lease, given the possible intervention of factors, presently unknown, that make the determination of damages uncertain at the present. We also recognize the possibility that this rule, which forces this landlord to wait until 2018 to determine post-termination damages, may in effect make it impossible for the landlord to recover its true damages from this corporate tenant or guarantor, because of the protections afforded by legal processes, such as dissolution or bankruptcy. However, given the present state of the law and the specific terms of the contract to which parties of equal bargaining power agreed, we are constrained, nonetheless, to deny recovery to the landlord under the indemnification clause of this lease.

Time To Change The Old Law?

The Appeals Court, especially the concurring opinion of Justice Kantrowitz, suggested that the time may be ripe for the Supreme Judicial Court to re-examine and modernize the law in this area. So look for this case to possibly go up on appeal.

Solution: Acceleration/Liquidated Damages Clause

The lease in this case did not contain the more current acceleration/liquidated damage clause which provides that upon a rent default, all unpaid rent is automatically due through the end of the lease term as liquidated damages. I recommend language such as this to prevent what happened to the landlord in this case:

If LESSEE shall default in the payment of the security deposit, rent, taxes, substantial invoice from LESSOR or LESSOR’s agent for goods and/or services or other sum herein specified, and such default shall continue for ten (10) days after written notice hereof, and, because both parties agree that nonpayment of said sums when due is a substantial breach of the lease, and, because the payment of rent in monthly installments is for the sole benefit and convenience of LESSEE, then in addition to the foregoing remedies the entire balance of rent which is due hereunder shall become immediately due and payable as liquidated damages. The Parties acknowledge and agree that (i) the liquidated damages hereunder is the best estimate of such damages which would accrue to Lessor in the event of Lessee’s default hereunder; (ii) said deposit represents damages and not a penalty against Lessee.

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Richard D. Vetstein, Esq. is an experienced Massachusetts real estate attorney. For more information, please contact him at 508-620-5352 or info@vetsteinlawgroup.com.

275 Washington Street Corp v. Hudson River International LLC (Mass. App. Ct.)

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A Guest Post By Bryan Gitlin, Managing Partner, Cambridge Capital Advisors

Why Investors Are Actively Pursuing Net-Leased, Investment Grade Commercial Real Estate As A Safe Haven In Today’s Troubled Economic Environment.

The investment community is slowly continuing its recovery from the effects of the sub-prime mortgage crisis as well as the collapse of the CMBS market. At this time, public and private, institutional and non-institutional real estate investors have continued to actively invest in an asset class where the laws of supply and demand are creating CAP rate compression where real estate values across the board have largely depreciated. The genre of commercial assets that is being referred to is comprised of single tenant, net leased, investment grade properties.

Analysis Factors

In acquiring an asset of this nature, the investor typically purchases a fee simple interest in the property. The property, comprised of the land and the structure that sits on top of the land, is leased by a corporate tenant with an investment grade credit rating (S&P rated BBB- or better) on a long term basis. In analyzing the merits of a single tenant, net-lease deal an investor will research and underwrite the strength of the corporate credit that guarantees the lease payments, the terms of the lease and any lease options, the landlord and tenant responsibilities that are enunciated in the lease and the relative strength of the demographics and trade corridor where the property resides. In addition, the investor will look at the intrinsic value and location of the property, the rent that the tenant is paying per square foot and the sales data for the location if available. This analysis is critical in underwriting the viability of the tenant and their ability to successfully operate in the location over the duration of the lease term. The investor will also look at the capitalization rate as a function of determining the rate of return on the investor’s equity in the event that acquisition is made entirely with cash. An investor looking to utilize leverage will also search out financing options if higher returns are mandated by that investor’s acquisition criteria and may also depend upon the amount of equity the investor is looking to place.

Risk Factors

The obvious worst case scenario for an investor in a net lease deal would arise in the event that the tenant abandons the location. This scenario emphasizes the importance of underwriting the tenant’s credit worthiness as the tenant would still be responsible for paying rent through the balance of the term regardless of their occupancy of the real estate. Furthermore, the importance of evaluating the intrinsic value and location of the real estate in addition to the rent being paid by the tenant as a function of whether the rent is in line with the local market is critical in the event that the tenant is ever declared insolvent or adjudged bankrupt as the responsibility of re-letting the building would fall on the property owner. The risk assumed in this absolute worst case scenario is more than offset by conservatively underwriting the tenant and their credit in addition to the overall market demand for the real estate.

Benefits of Asset Class

Furthermore there are a number of reasons why investors looking for higher yields in today’s economic climate are looking to invest in this asset class. Where yields in the stock market, bond market, money market accounts and CD’s have clearly suffered, investors in single tenant net-leased, credit real estate are experiencing returns in the seven to twelve percent range depending upon how the real estate is financed. Considering the non-management intensive nature of ownership, the tax benefits of real estate ownership, and the principal reduction of the debt that is afforded by the tenant in the event that the acquisition is financed, these investments are highly preferential for a wide variety of cash return driven investors including those that are in the process of estate planning.

If you are interested in obtaining further information on investing in single tenant, net-leased, commercial real estate or would like a free consultation/valuation of your investment property, please contact Bryan Gitlin via email (click here) or by telephone at 617-964-1031.

Bryan Gitlin, J.D. has been actively involved in the acquisition, re-development, management, leasing and disposition of commercial real estate since 1998. A founding member of Cambridge Capital Advisors and seasoned investment broker, Mr. Gitlin’s concentration is the acquisition, disposition, underwriting and deal sourcing of investment properties with a primary focus on single-tenant net leased properties and shopping centers nationwide.

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Apparently for the first time, a Massachusetts trial judge has used a newly decided corporate successor liability theory to hold a newly formed company responsible for the debts of its predecessor, yielding a $2 million judgment for back rent and interest. The plaintiff in the case, Renaissance Worldwide, had leased space to Sitara Networks, a voice-over-Internet (VOIP) company, in a Waltham building. Sitara arranged for a creditor to foreclose on its assets and then bought them back, reopening as a new entity, Converged Access. Converged claimed that it should not be responsible for the hundreds of thousands of dollars in back rent and interest owed by Sitara.

Superior Court Judge Bruce R. Henry said “not so fast,” and ruled that Sitara’s plan to reemerge as Converged Access was improperly designed to shed the company’s unsecured debt, scrubbing the books clean with the transaction. He ordered Converged Access to pay a whopping $1.2 million in back rent plus $800,000 in interest and attorneys’ fees. Judge Henry’s ruling is reportedly the first major decision relying on a year old Milliken decision from the Massachusetts highest court on corporate successor liability. The judge wrote:

“That plan causes me the same concerns as did the similar plan of the defendant in the Milliken case,” Henry wrote. “As the Supreme Judicial Court found in Milliken, ‘Notwithstanding our respect for the integrity of corporate structures, we are troubled by the notion that by merely changing its form, without significantly changing its substance, a single corporation can wholly shed its debts to unsecured creditors, continue its business operations with an eye toward returning to profitability, and have no further obligation to pay such creditors.'”

A Young Company Pursues VOIP Technology But Runs Into Trouble

Sitara, the young company was pursuing voice-over-Internet protocol technology – or VoIP – which essentially allows phone service to work over the Internet. In April 2002, Sitara stopped paying its rent and began talking to Renaissance, the landlord, about renegotiating the lease, but the two never reached a revised agreement. Sitara failed to pay the rent over the next 15 months, accumulating a $1.2 million debt. (Why the landlord let the rent accrue this much is beyond me).

Meanwhile, it owed Lighthouse Capital Partners, a secured creditor, $1.1 million. In 2004, Sitara began working with Argus Management Corp., a consulting firm that specializes in helping distressed companies. Argus tried to negotiate a reduced rent, but the two sides never agreed to terms. In April 2004, one of Sitara’s founders, Malik Khan, sent an e-mail to some colleagues discussing the rent negotiations with Renaissance and outlining several options, including selling the company to Lighthouse and buying the assets back. “We hand the keys to Lighthouse and then purchase the assets back from them,” he wrote. “We have spent time working this last option out with Argus, who have much more experience at this than we do. … Financially, this is a better deal for all of us but more complicated.” In a later e-mail to an investor, Khan spelled out the plan in greater detail: Lighthouse would take over the assets and a new company would buy them, getting “Sitara’s current business, assets, IP, brand names, trade marks and copyrights, with no debt on its balance sheet.” And he noted that, if done “expeditiously,” there would be “a seamless transition from employees, customers and the market, with minimal disruption to business.”

Not So Fast Says The Judge

After several years of litigation, the Judge ruled in a jury waived trial that the plan “engineered by Khan with assistance from Argus and the cooperation of Lighthouse was designed to permit Sitara to continue its business, albeit with a new name, and to shed its unsecured debt.” He ordered the defendants to pay $1.2 million in rent plus roughly $800,000 in interest, as well as attorneys’ fees, which have not yet been calculated.

Take Away

The take-away from this case is think twice before you engage in an end-game corporate foreclosure strategy under which a new related corporate entity is formed to “cleanse” the debts of the predecessor insolvent company. This applies not only in the real estate leasing context but for all types of corporate debt situations. With the economy still recovering, I would expect to see more of these “loan-to-own” successor liability cases as companies squeezed by the credit crunch look to get rid of debt while avoiding the longer, more expensive bankruptcy process. There is still much distressed corporate debt out there and otherwise sound companies that are victims of the credit crisis.

I’ve been waiting for an opportunity to write about commercial leasing and this new case which just came down provided a great opportunity. The case, Renaissance Worldwide Inc. v. Converged Access Inc., can be read here.

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