Seven Secrets to Drafting An Effective Commercial Lease Default Clause
By Adam Leitman Bailey
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 in not only have a successful relationship but also ensuring 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.
I. TOOLS OF THE EFFECTIVE DEFAULT CLAUSE:
A. ADDITIONAL RENT
It is important that all monies the lease requires the tenant to pay during the term of the lease, other than the rent itself, be expressly designated as “additional rent.” Additional rent can include late charges, taxes, various building expenses, attorney’s 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 additional rent, whether or not the tenant has paid the requisite monthly base rent.[1]
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.[2]
Where the lease itself is reasonably susceptible of more than one interpretation, as to 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 since the beginning of the tenancy.[3] 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 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.[4] 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.[5] 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.[6]
B. 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 made 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.[7]
[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.[8]
However, as discussed at length below, the Court of Appeals’ recent decision in 172 Van Duzer v. Globe Alumni[9], 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.[10] 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.[11]
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.”[12] 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.[13] Further, it has been held that a single default in the payment of rent is sufficient to effectuate an acceleration clause.[14] 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.[15]
It should be noted that the Second Department has held that “accelerated rent” is not “rent due.”[16] As the Court 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.[17] 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.”[18]
C. 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.[19] 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.[20] In such cases, the landlord’s entitlement for damages for the remaining installments of rent will ripen and may be sued for at the end of the lease term.[21]
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.[22] 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.[23]
D. CHRONIC NONPAYMENT
A necessary part of an effective default clause is a provision enabling the landlord to cancel the lease for the frequent delinquency of rent payments, commonly referred to as a “chronic nonpayment” of rent due termination clause. It often happens that a landlord who is forced to commence a nonpayment proceeding in New York City Civil Court, or other local court with summary jurisdiction, is faced with a tenant who is either chronically late in paying the rent or does not pay the rent at all, thus causing the landlord to have to institute repeated legal proceedings to procure the timely payment of rent.[24]
Including the time it takes to obtain a court date, to request shortened adjournment periods, and a resolution by settlement, trial, or default in the case of a non-appearance, the earliest a landlord can expect to obtain an eviction will be no less than three to five months after commencement of the nonpayment process.[25] Even after an eviction is scheduled, RPAPL §751(1) mandates that the tenant be given ten days to pay the amount of rent owed to stay the issuance of a warrant and avoid eviction.
For many landlords, the cycle of late payments or nonpayment is repeated continuously and, in many cases, perennially. To further exacerbate their frustration, in addition to the wasted energy, time, and money they expend in participating in the process, many cases result in empty tenancies with thousands of uncollectible dollars. Accordingly, although “[a] history of repeated nonpayment proceedings brought to collect chronically late rental payments supports an eviction proceeding on the ground that the tenant has violated a ‘substantial obligation’ of the tenancy,”[26]attorneys should strive to draft into any default clause a provision by which the tenancy is terminated for the chronic nonpayment of rent.
A chronic nonpayment provision terminates the tenancy upon the happening of multiple defaults in the timely payment of rent. A typical clause will terminate the tenancy once a tenant fails to timely pay the rent at least three times within a twelve consecutive month period. Even where the lease contains a grace period (typically five days) within which the tenant is normally permitted to cure a default for nonpayment after issuance of a notice of default, the chronic nonpayment provision can prescribe that, after two consecutive defaults, the landlord, prior to serving the notice of termination, is not required to serve the tenant with a notice of default for a third consecutive default, but may, after the expiration of the five-day grace period, immediately serve the notice of termination. Therefore, the third consecutive default triggers the termination of the lease automatically.[27] At this point the commercial tenant cannot ward off eviction by paying the rent in full. As a result of the chronic nonpayment clause, the landlord has the option of evicting the tenant, so long as the requirements of the chronic nonpayment provision have been followed and proven in court. This is one instance where the precedents are clear both that a summary holdover proceeding lies and that it does not require an antecedent notice to cure.[28]
E. SELF-HELP EVICTIONS
Upon termination of the lease or upon the commercial tenant’s defaulting on payment of rent or other lease terms, a landlord may reenter the leased premises peaceably without resort to court process, when the right to do so is expressly reserved in a commercial lease.[29] A commercial landlord’s common law right to use “self-help” to reenter its property peaceably to evict a defaulting tenant or other person with no right to possession has been recognized from time immemorial.[30] Nevertheless, although the common law right of self-help reentry is not abrogated by the statutory remedy of summary proceedings,[31] it is a remedy that is rarely used and in many municipalities throughout the state abolished or restricted. The extent of self-help available also varies by Judicial Department.[32]
Attorneys who represent commercial landlords are often reluctant to advise their clients to use this neglected self-help remedy to regain possession of leased premises from defaulting commercial tenants.[33] This reluctance stems, in part, from the perception that courts are generally hostile to a commercial landlord’s use of self-help, because self-help renders a forfeiture of the premises before a tenant can litigate its right to remain in possession.[34] In addition, because of the lack of use of self-help many attorneys are unfamiliar with this body of law and are hesitant to employ such an aggressive measure. Courts also refuse to approve use of self-help where there is ambiguity in the lease terms or factual questions concerning the expiration of the lease.[35] Moreover, under RPAPL §853, a tenant wrongfully ejected from real property by force or other unlawful means may sue to recover treble damages from the landlord and be restored to possession if ejected before the end of the lease term.[36]
As a result of the combination of general court hostility and attorney reluctance to recommend the use of proper self-help measures, commercial tenants have been allowed to violate their leases or extend them based on technical or frivolous defenses, sometimes for months or years at a time, in blatant disregard of the lease terms.[37] In addition to the loss of rental income that often accompanies such disputes, landlords faced with this situation lose valuable time to repair, renovate, and re-let their premises to responsible tenants. These circumstances also adversely affect any effort by the landlord to sell the leased premises to potential buyers.
Landlords have every incentive to insist on including a proper and effective self-help provision in their commercial leases. With appropriate drafting and proper execution of the self-help measures provided in their leases, commercial landlords should be able to exercise their right to peaceable reentry whenever such action is warranted. With the availability of self-help written into the lease, tenants are likely to be more careful to avoid any action that will place themselves in default and thereby become subject to immediate peaceable eviction. Thus, commercial landlords may both (a) provide an incentive for their tenants to comply with the lease terms, and (b) be able, when compelled to use self-help, to timely re-let the premises without first having to await the outcome of costly and lengthy litigation before doing so.
Nevertheless, landlords who use self-help will not necessarily be able to avoid all litigation. There is always a possibility that the landlord will be required to litigate (a) whether the tenant was in default at the time of the landlord’s reentry, and/or (b) whether the self-help used was peaceable and otherwise lawful.[38] Therefore, landlords should (a) carefully document a tenant’s default before reentering the leased premises and (b) ensure that reentry is accomplished peaceably. Where it is not crystal clear that the lease term has expired or that the tenant is in default, the landlord should not use self-help, but should resort only to summary proceedings or other legal process. However, recognizing that the outcome of any litigation is always uncertain, a landlord may view the possibility of a future, adverse treble damages judgment as a risk worth taking in order to obtain the real, current ability to re-let the premises to a responsible tenant who will pay rent during the litigation that ensues between the landlord and the evicted tenant. Also, it is wise to remember that three times zero is still zero. If there are no genuine damages, trebling them is not going to hurt the landlord.
In deciding whether or not to run that risk, the landlord should consider the kind of damages that the evicted tenant will have a right to claim; i.e., whether any injury caused by the reentry will be limited to property damage only or whether the evicted tenant will be able to claim and prove damages measured by the loss of the value of the leasehold.[39] Where the lease has expired or been terminated by reason of the default, the tenant is not entitled to possession.[40] In that situation, the tenant’s damage is likely to be limited to such property damage as may occur during the course of the reentry only – the sum of which a landlord may be more than willing to bear – but a judgment that the landlord may also be able to avoid by taking care to see that the tenant’s property is carefully removed from the premises by persons other than the landlord itself, such as a bonded moving company, and placed in a reputable storage facility.
Whether a landlord’s reentry is deemed peaceable or not will depend on whether it is made in a “forcible” manner. For a reentry to be forcible, the force used:
must be unusual and tend to bring about a breach of the peace, such as an entry with a strong hand, or a multitude of people, or in a riotous manner or with personal violence, or with the threat and menace to life or limb, or under circumstances which would naturally inspire fear and lead one to apprehend danger or personal injury if he stood up in defense of his possession.[41]
In the absence of force that tends to breach the peace, hiring trucks and workers and even a garbage company to evict a tenant does not constitute forcible entry, [42] even if, in the case of a municipal landlord, the eviction is performed with the assistance of armed police.[43] However, to ensure that its use of self-help is indeed “peaceable” and that there is no confrontation during the eviction, the landlord should arrange for the reentry to occur during late night/early morning hours when the tenant’s business is closed and when the landlord’s agents are certain that no one is present on the leased premises before entering. When conducting the eviction, if there is any conflict with the tenant or its representatives, the attempted eviction should be abandoned and accomplished at a later date or under court order.
Upon reentry, when the peaceable self-help eviction is successful, the landlord may then change the locks or padlock the doors. To thwart any potential damage claims, the entire reentry operation should be videotaped, and all items of tenant property removed from the property should be photographed and inventoried. The tenant’s property should then be placed in storage, for a reasonable period of time[44], in accordance with a lease provision that contemplates such action in the event of an eviction.
Ultimately, whether or not the landlord is permitted to use self-help to regain possession of the leased premises will depend on whether the landlord’s right to do so is reserved in the lease. The lease should expressly provide (a) that, if the tenant defaults in the payment of rent or commits any other violation of the lease constituting a default, the lease shall terminate automatically, (b) that the landlord may thereafter recover possession in accordance with its common law rights, (c) that the landlord may do so without any duty, requirement, or necessity to provide due process or to seek prior court approval, through summary dispossess proceedings or any other action or proceeding at law, before evicting the tenant and removing tenant’s property and/or any person from the premises, and (d) that the term “re-entry” is not used in its technical or narrow sense but in the sense that the landlord may effect physical entry of the premises.[45] Such a provision does not preclude the landlord from initiating summary proceedings if it chooses to do so. However, the landlord should exercise its options carefully. If the landlord does not use self-help initially, but commences a summary proceeding in the first instance, the right to use self-help thereafter may be considered waived.[46]
The lease terms should also obligate the tenant to pay the landlord all monies owed by the tenant up to the time of the landlord’s recovery of possession, whether the landlord recovers possession through self-help or summary proceedings. In addition, the lease should reserve the landlord’s right to sue after reentry for any damages incurred as a result of the tenant’s actions, such as an unlawful holdover that causes the landlord to lose an opportunity for re-letting the premises. The lease should provide that the landlord need not assert such claims against the tenant in summary proceedings only, but may do so in a separate plenary action.
While there are decided risks involved in using self-help measures, the careful landlord and the careful landlord’s attorney should generally be able to avoid the pitfalls that exist and make self-help work to the landlord’s benefit in the long run.
Credit:
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 book which is expected to be published next year with permission by editor Joshua Stein.
[1] See Melick v. Ken’s Service Station, Inc., 44 Misc.3d 143(A), 2014 WL 4251023 (N.Y. Sup App. Term)(2d Dept.)
[2] See, e.g., Perrotta, supra Note 8; 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).
[3] One Hundred Grand, Inc. v. Chaplin, 70 AD3d 513, 895 NYS2d 68, 69 (1st Dept. 2010).
[4] 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).
[5] 930 Fifth Avenue Corporation v. Shearman, 17 Misc.3d 1126(A), 851 NYS2d 71 (NYC Civil Court 2007) (Lebovitz, J.).
[6] See 225 Holding Co., LLC v. Beal, supra note 29.
[7] See Muss v. Daytop Village, Inc. 43 AD2d 945, 352 NYS2d 28 (2d Dept. 1974).
[8] Fifty States Management Corporation v. Pioneer Auto Parks, Inc., 46 NY2d 573, 577, 415 NYS2d 800 (1979).
[9] 172 Van Duzer Realty Corp. v. Globe Alumni Student Assistance Association, Inc., ___ NY3d ___, 2014 WL 7177502 (12/18/14). 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.
[10] Fifty States, supra note 33.
[11] Id.
[12] Id., 46 NY2d at 578.
[13] Id, subject to Van Duzer, supra note 34.
[14] GAB Management, Inc. v. Blumberg, 226 AD2d 499, 641 NYS2d 340 (2d Dept. 1996).
[15] See Madison Avenue Leasehold, LLC v. Madison Bentley Associates LLC, 8 NY3d 59, 861 NYS2d 254 (2006).
[16] Ross Realty v. V&A Fabricators, Inc., 42 AD3d 246, 836 NYS2d 242 (2d Dept. 2007).
[17] Id.; see also 930 Fifth Avenue Corporation., supra Note 31; Marketplace v. Smith, 181 Misc.2d 440, 694 NYS2d 893 (Justice Ct., Monroe Co. 1999).
[18] Ross Realty, supra Note 41.
[19] See, e.g., Goldman v. MJI Music, Inc., 17 Misc.3d 1127 (A), 2007 WL 3378369 (NYC Civil Ct., Kings Co., 2007).
[20] See, e.g., Barr v. Country Motor Car Group, Inc., 15 AD3d 985, 789 NYS2d 350 (4th Dept. 2005).
[21] Id.
[22] See, e.g., K.I.D.E. Associates, Inc. v. Garage Estates Company, 280 AD2d 251, 720 NYS2d 114 (1st Dept. 2001).
[23] Wilsdorf v. Fairfield Northport Harbor, LLC, 40 HCR 134A, 34 Misc3d 146(A), 950 NYS2d 494 (AT 9 & 10 2012).
[24] See, e.g., National Shoes v. Annex Camera & Electronics, Inc., 114 Misc.2d 751 452 NYS2d 537 (NYC Civil Ct. 1982).
[25] Some less urban areas of the State report shorter periods, but not by a lot.
[26] Adam’s Tower Ltd. Partnership v. Richter, 28 HCR 531A, 186 Misc.2d 620, 757 NYS2d 825 (App. Term, 1st Dept. 2000); see also Sharp v. Norwood, 89 NY2d 1068, 659 NYS2d 834 (1997).
[27] See, e.g., Midco Nowash LLC, supra note 3; see also Estate of Birnbaum v. Yankee Whaler, 75 AD2d 708, 427 NYS2d 1291 (4th Dept. 1980).
[28] Definitions Personal Fitness, Inc. v. 133 E. 58th St. LLC, 41 HCR 492B, 107 AD3d 617, 967 NYS2d 647 (AD1 2013); Adam’s Tower LP v. Richter, supra note 51.
[29] See Bozewicz v. Nash Metalware Co., Inc., 284 AD2d 288, 725 NYS2d 671 (2d Dept. 2001); Matter of 110-45 Queens Blvd. Garage, Inc. v. Park Briar Owners, Inc., 265 AD2d 415 (2d Dept. 1999); Matter of Jovan Spaghetti House, Inc. v. Heritage Company of Massena, 189 Ad2d 1041, 592 NYS2d 879 (3d Dept. 1993).
[30] See Bliss v. Johnson, 73 NY 529, 534 (1878)(“The true owner of land wrongfully held out of possession may watch his opportunity, and if he can regain possession peaceably may maintain it – and lawfully resist an attempt by the former occupant to retake possession, nor will he be liable to be proceeded against under the statute of forcible entry and detainer. There can be no wrongful detainer by the true owner when the entry was both lawful and peaceable.”); Fults v. Munro, 202 NY 34, 39 (1911)(“Statutes relating to forcible entry and to forcible detainer, which are separate and distinct wrongs, have existed for centuries.”); see also Mayes v. UVI Holdings, Inc., 280 AD2d 153, 723 NYS2d 151 (1st Dept. 2001).
[31] See Cohen v. Carpenter, 128 AD 862, 113 NYS 168 (2d Dept. 1908); Liberty Industrial Park Corp. v. Protective Packaging Corp., 71 Misc.2d 116, 335 NYS2d 333 (Special Term, Kings Co., 1972), affirmed, 43 AD2d 1020, 351 NYS2d 944 (2d Depts. 1974).
[32] Practitioners should be certain to know the local ordinances on the subject prior to expressing an opinion.
[33] Self-help is limited to the commercial context only. New York City Administrative Code §26-521 prohibits the use of self-help in the residential context.
[34] Courts created the so-called “Yellowstone” injunction to allow the parties to dispute their differences while the tenant remains in possession and to prevent forfeiture. See, e.g., John Stuart, a Division of Robert Allen Fabrics of NY, Inc. v. D&D Associates, 160 AD2d 547, 545 NYS2d 197 (1st Dept. 1990).
[35] See Sol de Ibiza, LLC v. Panjo Realty, Inc., 26 Misc.3d 890 NYS2d 806 (NYC Civil Ct., 2009), reversed remanded on undeveloped record, 29 Misc.3d 72, 911 NYS2d 567 (App Term, NY Co., 2010).
[36] See Suffolk Sports Center, Inc. v. Belli Construction Corp., 212 AD2d 241, 628 NYS2d 952 (2d Dept. 1995).
[37] See, e.g., Million Gold Realty Co. v. SE&K Corp., 4 AD3d 196 772 NYS2d 271 (1st Dept. 2004).
[38] See Maracina v. Shirrmeister, 105 AD2d 672, 673, 482 NYS2d 14, 16 (1st Dept. 1984)(“RPAPL 853 no longer requires that the use of physical force be demonstrated.”).
[39] See Mayes, supra, note 55.
[40] See 110-45 Queens Blvd. Garage, supra, note 54.
[41] Fults v. Munro, supra, n 55.
[42] See Liberty Industrial Park Corp., supra, n 56.
[43] See Paulino v. Wright, 22 HCR 739A, 210 AD2d 171, 620 NYS2d 363 (1st Dept. 1994).
[44] Universal custom supported by no case law whatsoever, deems “reasonable time” to be thirty days.
[45] This clause is essential because much case law continues to define “re-entry” simply as the right to bring a summary proceeding.
[46] See Sol De Ibiza, LLC, supra, n 60.