Commercial leases: the exposure of a defaulting tenant can be enormous

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Commercial leases involve substantial risk; Mitigation can be a challenge

By Michael Starvaggi

mike starvaggi
Mike Starvaggi, Esq.

The RCBJ recently reported that Brixmor Property Group, owner of Rockland Plaza on Route 59 in Nanuet, is suing former tenant B. Good for $1.6 million in unpaid rent and lost future revenue. This potential price may give pause to any business that is or could become a tenant – and for good reason. Standard commercial lease clauses can be oppressive and are usually enforceable in court. Even more daunting is the prospect of personal liability for the business owner when the financial stakes are high, as is usually the case in these cases. In this article, I will discuss some of the bases of liability involved in the B. Good litigation in the hope that it will give business owners a better understanding of the exposure that commercial leases entail.

The primary category of damages in a case like B. Good’s is accelerated rent. Under a standard acceleration clause, when a tenant defaults, all rent from that time until the end of the lease term becomes due immediately. The landlord has a duty to limit his damages by attempting in good faith to rent the space to a new tenant,[1] the future rents received offsetting the liability of the defaulting tenant. However, the potential exposure for the defaulting tenant is still great, especially if it takes a long time for the landlord to find a new tenant. One way for a tenant to counter the potential impact of accelerated rent is to have a manageable initial term of around five years, with the ability to extend for successive periods of five years. This protects against the extended financial liability of accelerating long-term rental obligations while giving the tenant the right to remain in the premises at the end of the initial term by exercising their option. Of course, the ability to get a landlord to agree to this structure is strictly bargaining leverage – something not all tenants have.

The B. Good lease also contains a “going dark” penalty, which states that the tenant is responsible for triple its ordinary rent in the event of cessation of activity (goe dark). The theory behind this type of penalty is that having an old storefront is bad for the optics and foot traffic of a mall or mall. It can also be based on a more tangible factor when the lease provides that a percentage of the tenant’s income must be paid to the landlord. In this scenario, of course, the tenant is hurting the landlord’s cash flow by going out of business, even though the tenant continues to pay base rent. Courts sometimes find dark penalties too speculative and deny all or part of damages. However, since the courts generally do not protect businesses against oppressive contract terms as they do individuals, a tenant should assume that a disappearing penalty will be enforceable.

If there is adequate bargaining leverage, the tenant could negotiate the opposite of a penalty to avoid such exposure. This would be a provision that allows the tenant to cease operations without consequence as long as they continue to pay their base rent, or perhaps a pre-negotiated premium rent. Again, the availability of such a provision will depend on the relative influence of landlord and tenant during negotiations.

Another category of liability that a defaulting tenant faces is attorney fees. In addition to paying their own attorney, commercial leases generally require the tenant to bear the cost of the landlord’s attorney fees incurred in enforcing the lease, including any eviction or rent collection litigation. This, of course, can significantly increase the tenant’s overall liability under the lease and is deemed to be enforceable by the courts.

Things get even scarier when the landlord requires the business owner to personally guarantee the lease obligations, which is more common than not for small and even medium-sized businesses. The personal guarantee makes the individual guarantor(s) liable for all damages and interest due by the tenant under the lease. This, of course, raises the stakes considerably, as the business owner’s personal assets are at risk and the exposure is potentially severe. However, one way to limit (not avoid) personal exposure is to negotiate a “benevolent” guarantee, in which the guarantor is only liable for unpaid rents that become due while the defaulting tenant continues to occupy places. As soon as the tenant leaves, personal liability ceases. This is intended to discourage non-paying tenants from remaining in possession of the premises while eviction proceedings drag on in court.

These and other seemingly oppressive commercial lease provisions are, in fact, standard in most rental agreements and should be carefully considered and negotiated by the tenant with the assistance of competent legal counsel.

This article is intended for general informational purposes only and should not be considered as giving individual legal advice.

[1] The costs incurred by the landlord in finding the new tenant are often in addition to the defaulting tenant’s damages under the lease.

Michael Starvaggi is a lawyer based in Nyack. [email protected]

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