Hurricane Sandy devastates the northeast. As recently reported on Bloomberg (http://www.bloomberg.com/news/2012-11-09/lower-manhattan-quiet-as-sandy-shuts-one-third-of-offices.html) 33% of the 101 million square feet of lower Manhattan’s office space was inoperable as of November 7th, several days after Sandy’s landfall. Likewise, immediately after 9-11, areas of lower Manhattan were closed off for months. Manmade disasters and storms are not just limited to New York or the coastal areas. In 1992, Chicago’s Central Business District was closed for days due to a flood of an abandoned underground tunnel system. Falling into the trap – “it’ll never happen to me” – many tenants and landlords pay short attention to the lease provisions pertaining to a casualty. Outlined below are steps tenants can take pre-lease and during lease negotiations to safeguard their interests. Also addressed below is where there is no damage to the building, but the building is inoperable due to lack of utilities, access, etc. Most leases, however, do not provide the tenant with any rights if they are denied use of the building without building damage. Under a separate post, I address what tenants need to know about insurance.
Pre-Lease Building Due Diligence:
- For coastal properties, review maps of storm surge evacuation areas.
- As to power disruptions, is the building supported by two or more separate power grids
- To mitigate power disruptions, does the building have a back-up generator to support the building beyond life-safety systems? Can tenant install its own generator? If so, there are multiple issues to be documented in the lease from maintenance obligations of the generator, providing fuel, ownership of the generator, etc…
- What about water and sewer service? While electric power can supplemented with a generator, if there is no water or sewer service, will restrooms be available? What about fire sprinkler systems?
- Will the municipality allow occupancy if not all utilities are provided to the Building?
Pre-Lease & Lease Negotiations:
As with any important lease term, the savvy tenant will negotiate these terms during the Letter of Intent stage and ultimately into the lease. The earlier they’re introduced by the tenant, the more favorable they’ll be to the tenant.
Usually falling under the label of “Casualty”, this clause defines the rights and responsibilities of landlord and tenant in the event of damage to the Building or Premises. The boilerplate language will provide landlord with the right to terminate the lease and the right (not necessarily the obligation) to rebuild. Underlying this Casualty provision are the competing interests of the parties. The landlord wants the most latitude to consider whether to repair and timing to do so. By contrast, the tenant wants functional space ASAP which includes relocation where necessary and relief from rent where the space is unusable.
In reviewing the Casualty provision, the tenant should ask and consider:
- Does the damage extend beyond the Building and Premises to include “essential services” as well as access to the Premises? Denial of “use” in the absence of loss to the Building must be carefully considered so that the tenant is not paying rent on a space it cannot use.
- Is there an objective party that promptly determines how long it will take to restore?
- When must landlord decide on restoration? Typically, the negotiated decision timeframe ranges from 1 to 3 months.
- After that determination is made, is the tenant entitled to terminate the lease if the restoration period exceeds a certain number of days?
- If the casualty occurs in the last 12 months of the lease term, can tenant terminate?
- Where the landlord has the right to terminate, is the landlord required to terminate the leases of similarly situated tenants? This precludes the landlord from terminating tenants who are paying below market rent, etc…
- What is the standard of restoration? Is it to the same condition immediately preceding the casualty or does the landlord have more latitude?
- Is restoration subject to receipt of insurance proceeds?
- For a major tenant, can they require the lender to release insurance proceeds to first apply to restoration of the Building and Premises?
- If landlord does not restore within the estimated restoration timeframe, can tenant terminate the lease?
- Can landlord extend its timeframe to restore claiming Force Majeure? If so, is Force Majeure defined?
- Regardless of termination or restoration, do all of tenant’s rental obligations abate as of the initial day of loss through either termination or 10 days after restoration (to allow tenant time to move back into the Premises)?
- Where the lease is terminated, are all deposits and prepaid rent returned to tenant within a certain timeframe?
- Where the lease is terminated, is tenant allowed a certain timeframe to relocate?
- Be sure there is not a provision in the lease or Nondisturbance Agreement that would allow the Lender to trump tenant’s right to abatement of rent or termination.
- Remove language where tenant loses their rights of rent abatement and cancellation where tenant is the cause of the casualty. The tenant’s argument is that the casualty is covered by insurance, which is paid for by the tenant.
Service Interruption Remedy – under the “Services” section of the lease, tenants should negotiate an interruption remedy if there is a failure to deliver essential services (i.e., utilities, elevator service) which preclude tenant’s use of the Premises. Similar to the Casualty section, this remedy takes the form of rent abatement and termination. Such a remedy addresses the denial of use dilemma where there is no direct damage to the building.
Landlords will resist at first, but will typically allow such a remedy; however, they almost always condition that the services being interrupted are “within the reasonable control of the Landlord”. While those arguments certainly sound reasonable, they ignore the underlying insurance policies which the tenant pays for through its rent (as part of operating expenses). Landlords commonly (almost always as required by its lender) carry Rental Income Insurance where the insurer pays landlord the loss rental income due to tenant’s rent abatement right less any monies landlord does not have to expend as tenant is not occupying the Premises. So, tenants should push to remove such a condition.
Blackacre Advisors LLC
DISCLAIMER. Our writings are from a real estate transaction perspective and for informational purposes only. Nothing herein shall be considered legal, accounting, tax, or architectural advice. Please consult with the appropriate professional(s).