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LEASE LANGUAGE: Default measures

Since the economy has slowed, landlords and tenants should review the remedy provisions for defaults under their leases. Like so many legal documents, the details become important. This article outlines some of the important issues to which both parties should give close scrutiny, but it does not address issues that may arise under bankruptcy laws.

Most leases contain a notice and cure provision for a default by a tenant. Landlords should determine what type of notice of default a tenant must receive under the lease, to whom it should be sent and by what means, and how much time, if any, a tenant has to cure the default. Improper notice could prolong and jeopardize a landlord's ability to exercise its default remedies. A tenant may lose the benefit of its cure periods if it does not follow the procedures in the lease in responding to a landlord's notice of default.

Lease provisions regarding late fees and interest charges also merit scrutiny during economic slowdowns. Leases often provide for both late fees and interest charges for late payments of amounts due under the lease. In many lease transactions, interest is charged at a rate that is sufficiently high to prevent the landlord from being an attractive alternative to the tenant's banker, but interest must always be within the maximum lawful rate within the relevant jurisdiction. A landlord interested in regaining control of its premises may agree to forgive late fees and interest charges if a tenant orderly vacates the premises without the necessity of legal proceedings.

Acceleration of rent is another remedy that landlords may possess under a lease. The lease may provide that if a tenant defaults and applicable notice and cure periods expire, the landlord may accelerate the rent and demand payment of the entire remaining unpaid rent balance due over the term of the lease. Leases frequently limit a landlord's acceleration remedy to the net present value of the remaining rent. If the rent is based substantially on a participation in the revenue generated from the premises, the exercise of this remedy will present a hardship to the landlord. To avoid this problem, the lease may contain a liquidated damages provision.

The nature of tenants' security deposit and the existence of other security for tenants' lease obligations may affect the outcome of a default situation. The security deposit may be the only available remedy for the landlord. If the landlord is holding any third-party guaranties, the guaranties may apply to payment or performance obligations or both. Guaranties may either have specific notice requirements or require no notice other than notice to the tenant and some may give the third-party guarantor certain cure rights. A landlord who delays in exercising its remedies under a letter of credit or third-party guaranty may lose its rights.

Many jurisdictions provide a landlord with a statutory lien on the tenant's goods and fixtures. In some jurisdictions, the landlord's lien is created only if the lease so provides. The lease may specify that the landlord's lien is subordinate to the lien of the tenant's lender or purchase money vendor. These factors become relevant if a landlord is trying to generate funds with which to cure a tenant's default or when a landlord is evaluating tenant's ability to cure its default.

Other lease provisions to consider in a default situation are the provisions regarding ownership of the leasehold improvements and the provisions describing what obligation a tenant may have to restore the premises to its original condition upon lease termination. If the tenant cannot pay the cost of any required restoration of the premises, the costs of restoration might be recoverable from a third-party guarantor. This same analysis applies to a landlord's enforcement of any remedies for breaches by a tenant of any environmental indemnities.

If you are a landlord with a tenant that has defaulted in its payment obligations under a lease or a tenant that is in default under its lease because it is unable to meet its financial obligations to a landlord, careful reading of the lease and any related documents, and consultation with an experienced attorney in the commercial and retail leasing area could save substantial costs and hardships in the long run.

Peter Segal is a partner in the Real Estate Development, Commercial Leasing and Finance, and Federal Housing Programs and Associations practice areas with the Washington, D.C.-based law firm Powell Goldstein Frazer & Murphy LLP.

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