The American Bar Association conducted a survey of more than 14,000 attorneys between November 11 and 13, 2008, publishing the results in the January, 2009 issue of the ABA Journal, glibly entitled the “Special Recession Issue.” In response to this question—Who is most to blame for the recession?—came these lawyerly answers:
Financial Institutions 48%
Congress 14%
Federal regulators 11%
Presidents 10%
Lawyers 3%, and
None of the above 14%
We are not told whom or what is included within “None of the above.” One wonders if votes for either “I am” or “consumers” were included within the mailbags of responses.
The Associated Press story appeared in many city newspapers in December taken from The National Endowment for Financial Education in Englewood, Colorado. This advice includes the following admonitions to be provided to teenagers:
• Understand the difference between needs and wants
• Set financial goals and budget accordingly
• Learn if you’re a spender or saver, which helps with budgeting
• Always save a percentage of your earnings, and
• Start saving early
Reading the first two items alone is a show-stopper. How are elders to impart wisdom credibly to youth, when youth can see so readily that they are commanded what to do by those with no personal sense of financial discipline? How many members of the generation ranging from ages 25 to 60 have exercised any material financial self-control since the 1980s? If the figure is accurately reported today, the average credit card debt load of Americans is $11,000! Home equity lines of credit long ago ceased being used as designed--for home enhancements. Indeed, many borrowers use their home equity lines to pay off their credit card balances, to “clear room” for yet more plastic-card charges. HUD’s generally accepted definition of affordability is for a household to pay no more than 30 percent of its annual income on housing costs. How many American consumers have followed that rule in the recent past?
Face it: The entire purpose of advertising is to cast products and services in such lights as to eradicate the line between “needs” and “wants”—and that’s what Americans seem to yearn for: permission to need (so as to acquire) goods and services beyond their rational financial reach. Am I sanguine about the financial future of the American consumer? I wonder if there will continue to be millions of cases of “personal recessions” until a fundamental and personal change in the attitudes of individuals occur. Our governments cannot change attitudes; and no matter how ambitious the programs proposed by our incoming leadership, the outcome will not be to restore prosperity to Americans who won’t stop spending foolishly by relying on credit-gambles to achieve the ephemeral status of plenty.
In truth, government leadership does not lead in financial attitude-adjustment, by its very nature. Consider this kernel of wisdom from Thomas Sowell:
No political message has proven to be more welcome, in
countries around the world, in both democratic and undemocratic
nations, than the message that your problems are not your fault but
the fault of others—and it is they who must change, not you.
Applied Economics, Revised Edition, Basic Books, 2009
The genius of the American economic system is affording an opportunity to so many to achieve financial independence, if the individual is mentally acute, healthy and willing to sacrifice--and most times the price for prosperity is patience and expenditure of great energy. The so-called American dream is not a guarantee of homeownership or any other totem of affluence to anyone. On an individual level, we need to acknowledge that struggle is expected, and resume bending our backs and saving more than a token part of our earnings, so as to afford things in a future that is longer than 6 months distant.
-MNW
Wednesday, December 31, 2008
Monday, December 29, 2008
Realty Bytes, Episode Two: May the 'Force' Surround You!
I had a call the other day from a landlord who will not deliver timely its build-to-suit premises to his lessee. The landlord really could not prevent the circumstances--the by-now familiar, unyielding financial marketplace. The Lease did provide for delivery of the premises by a certain date, subject to delays for “Force Majeure”:
If the Possession Date has not occurred by December 31, 2008 (except for Force Majeure events or in circumstances of affirmative interference by Tenant or its agents), Tenant may terminate this Lease by affording Landlord written notice of its intended termination, and affording Landlord a ten (10) day cure period for completing and delivering the Leased Premises to Tenant . . . .
The landlord could not, despite commercially reasonable efforts, obtain the funds required to commence the construction of the building and other improvements. The tenant wants to withdraw from the project and terminate its obligations under the Lease, as delivery of the building lies well ahead, under an uncertain timetable. The landlord discovered a broad Force Majeure clause in the hind-quarters of his form Lease. Can he rely on it to hold his tenant to the lease? Something in the circumstances led me to advise that while reliance on that clause might have "legs," it would not be a position I would be over-confident would prevail. Which, then, led me to this reflection.
Here's a Force Majeure clause of the broadest sort:
“If either party to this contract shall be delayed or prevented from the performance of any obligation through no fault of their own by reason of labor disputes, inability to procure materials, failure of utility service, restrictive governmental laws or regulations, riots, insurrection, war, adverse weather, Acts of God, or other similar causes beyond the control of such party, the performance of such obligation shall be excused for the period of the delay.”
Very well; does not the unavailability of debt financing lie at the root of an inability, shortage of funds, to procure materials or labor, or otherwise constitute a "cause beyond the control" of any landlord whose vertical improvements are incomplete--or not launched? Should not a court acknowledge impossibility or frustration of purpose as excusing a landlord's contractual obligation, in the current financial climate? Here, should force majeure entitle landlord to a delay in performance without permitting tenant to terminate its obligation to occupy the premises upon its completion and perform its other lease obligations?
Force majeure generally encompasses unforeseen events beyond the control of, and not due to the fault of, the party seeking a break (in this case, forgiveness for the delay in premises delivery). But hold on! Should "forgiveness" of the risks arising from a supervening event (fire, flood, riot, disease and the like) include those that are allocated, expressly or implicitly, by contract? Doesn't that allocation of risk trump the landlord's reliance upon scarcity, even if the subject scarcity--money--could not be anticipated? If all allocation of risks is to be ignored, is there any point to writing down the parties' promises? Well, if the answer is that allocation of risks expressed in the contract cannot be dismissed, then re-read the Possession Date clause above; did the tenant here not accept an allocation of risk that the premises would not be ready by years’ end—isn’t that what the parties intended by the expression “except for Force Majeure events?” Maybe yes, maybe no—it depends, I suppose, on how carefully the parties studied the terms of the force majeure paragraph.
We will find out, perhaps soon enough, about the power of the “Force.” The real estate developer, Donald Trump along with companies he controls, seek to delay repayment of obligations for borrowed money to Deutche Bank and a syndicate of other banks. The borrowers want a declaratory judgment that prevailing real estate market conditions are within such a clause and beyond the borrowers' control. Accordingly, they want to lawfully delay repayment of a $40 million installment past due under a $640 million construction loan. Their argument is that sales of condo and hotel units which the construction loan supported have failed to materialize as anticipated. Is this argument sufficient to allow "the Donald" to obtain his performance time-out? In New York, the “Force” seems opposed to these borrowers; here’s why.
In Kel Kim Corp v. Central Markets, 519 N.E. 295 (N.Y. 1987), a lessee sought a declaratory judgment to be excused from an obligation to procure insurance on leased premises in light of the liability insurance crisis of the 1980s that made it essentially impossible to buy such insurance. The New York Court of Appeals, affirming both a trial court and intermediate appellate court, rejected the lessee’s common law impossibility and contractual force majeure arguments.
As to the common law impossibility claim, the general rule is that contracting parties agree to perform or pay damages even if unforeseen events make that burdensome. This stance is relaxed under the impossibility doctrine to excuse performance only to reflect the contractual risk allocation the parties manifestly contemplated. This requires circumstances like destruction of the subject matter of the contract or discovery that the means of performance is “objectively impossible.” It also requires proving that the event could not have been foreseen or guarded against by contract. In Kel Kim, the tenant did not meet these requirements for excuse under the doctrine of impossibility, since an inability to obtain insurance could have been foreseen and guarded against in the lease.
Nor was the tenant’s claim within the scope of the lease’s Force Majeure clause, because only if an event is expressly within such a clause can it be invoked to excuse performance. The Kel Kim lease did not explicitly include the inability to obtain insurance. Instead, the listed events dealt with everyday commercial operations, the court found. The catch-all phrase about "other similar causes" did not, in the opinion of the court, expand that class to include insurance. Staying insured is not about frustrated expectations in daily operations. The court reasoned that it is about the landlord's bargained-for protection of its unrelated economic interest, where the tenant operates a particular business at the landlord’s site that poses certain liability risks.
The doctrines (or defenses) of impossibility (sometimes known as “frustration”) of performance and force majeure are related but are not identical as to outcomes. Frustration leads to the conclusion that the entire contract has been rendered permanently impossible to perform, and so typically results in the contract ending as a matter of law. Force majeure, by contrast, does not involve complete and permanent impossibility of performance—indeed, it may be susceptible to performance in all respects, once the event of force majeure has passed. Capital markets will be righted, like a foundering ship; lending ultimately will resume. So will development.
It’s a tough time for landlords developing new projects. The desiccation in lending markets seems as unanticipated, hazardous and devastating as a period of civil insurrection. In the end, however, there’s no way for the parties to realize their reasonable expectations under their lease (which sounds like the essence of good faith and fair dealing) if the articulated allocation of risks and the fundamental promises that form the basis for an agreement may be excused as to one party, while holding the other party to the bargain. I suspect that in the noted circumstances that the commercial tenant will not obtain any relief from his landlord through the courts except damages, if demonstrable, for delay in the delivery of the Premises. The opposite result will lead to a forfeiture of the bargain made by the landlord, a phenomenon Arizona’s courts claim to abhor.
In the meantime, if force majeure becomes elemental in construing the parties’ rights and obligations, it behooves the drafters of leases and other contracts to consider these things:
a. What events are covered—and what events are excluded from coverage?
b. Are any contractual obligations affected by force majeure? Even the payment of money? If so, that needs to be expressly agreed to.
c. If at all, to what extent does the relied-upon force majeure event have to have been unforeseen? After all, shortage of labor or materials always hypothetically is possible; but it usually still falls in the ambit of a force majeure event.
d. Does a degree of “fault” enter into the equation? What if a party claiming force majeure just didn’t take reasonable care, or wasn’t diligent in pursuit of the item that is now scarce or unavailable? If that failure was intended to preclude one party’s reliance on force majeure, that should be made clear in the agreement.
e. Is “impossibility” of performance the standard for the relying party; or is it enough that its performance has been rendered only impractical, or substantially more difficult or perhaps even just significantly more expensive.
f. Notice—should not the party relying on force majeure be required to give notice of the occurrence of the triggering event as soon as practicable after the relying party becomes aware (or should have become aware) of the event?
g. Should not the party relying on force majeure be required to take steps to mitigate the effect of the delay on the other party, or the ancillary fallout if delay is not the main impact on the other party? But how substantial should the steps be? How about commercially reasonable efforts? Heroic efforts? And what is, in the circumstances of the contract, commercially reasonable?
-MNW
If the Possession Date has not occurred by December 31, 2008 (except for Force Majeure events or in circumstances of affirmative interference by Tenant or its agents), Tenant may terminate this Lease by affording Landlord written notice of its intended termination, and affording Landlord a ten (10) day cure period for completing and delivering the Leased Premises to Tenant . . . .
The landlord could not, despite commercially reasonable efforts, obtain the funds required to commence the construction of the building and other improvements. The tenant wants to withdraw from the project and terminate its obligations under the Lease, as delivery of the building lies well ahead, under an uncertain timetable. The landlord discovered a broad Force Majeure clause in the hind-quarters of his form Lease. Can he rely on it to hold his tenant to the lease? Something in the circumstances led me to advise that while reliance on that clause might have "legs," it would not be a position I would be over-confident would prevail. Which, then, led me to this reflection.
Here's a Force Majeure clause of the broadest sort:
“If either party to this contract shall be delayed or prevented from the performance of any obligation through no fault of their own by reason of labor disputes, inability to procure materials, failure of utility service, restrictive governmental laws or regulations, riots, insurrection, war, adverse weather, Acts of God, or other similar causes beyond the control of such party, the performance of such obligation shall be excused for the period of the delay.”
Very well; does not the unavailability of debt financing lie at the root of an inability, shortage of funds, to procure materials or labor, or otherwise constitute a "cause beyond the control" of any landlord whose vertical improvements are incomplete--or not launched? Should not a court acknowledge impossibility or frustration of purpose as excusing a landlord's contractual obligation, in the current financial climate? Here, should force majeure entitle landlord to a delay in performance without permitting tenant to terminate its obligation to occupy the premises upon its completion and perform its other lease obligations?
Force majeure generally encompasses unforeseen events beyond the control of, and not due to the fault of, the party seeking a break (in this case, forgiveness for the delay in premises delivery). But hold on! Should "forgiveness" of the risks arising from a supervening event (fire, flood, riot, disease and the like) include those that are allocated, expressly or implicitly, by contract? Doesn't that allocation of risk trump the landlord's reliance upon scarcity, even if the subject scarcity--money--could not be anticipated? If all allocation of risks is to be ignored, is there any point to writing down the parties' promises? Well, if the answer is that allocation of risks expressed in the contract cannot be dismissed, then re-read the Possession Date clause above; did the tenant here not accept an allocation of risk that the premises would not be ready by years’ end—isn’t that what the parties intended by the expression “except for Force Majeure events?” Maybe yes, maybe no—it depends, I suppose, on how carefully the parties studied the terms of the force majeure paragraph.
We will find out, perhaps soon enough, about the power of the “Force.” The real estate developer, Donald Trump along with companies he controls, seek to delay repayment of obligations for borrowed money to Deutche Bank and a syndicate of other banks. The borrowers want a declaratory judgment that prevailing real estate market conditions are within such a clause and beyond the borrowers' control. Accordingly, they want to lawfully delay repayment of a $40 million installment past due under a $640 million construction loan. Their argument is that sales of condo and hotel units which the construction loan supported have failed to materialize as anticipated. Is this argument sufficient to allow "the Donald" to obtain his performance time-out? In New York, the “Force” seems opposed to these borrowers; here’s why.
In Kel Kim Corp v. Central Markets, 519 N.E. 295 (N.Y. 1987), a lessee sought a declaratory judgment to be excused from an obligation to procure insurance on leased premises in light of the liability insurance crisis of the 1980s that made it essentially impossible to buy such insurance. The New York Court of Appeals, affirming both a trial court and intermediate appellate court, rejected the lessee’s common law impossibility and contractual force majeure arguments.
As to the common law impossibility claim, the general rule is that contracting parties agree to perform or pay damages even if unforeseen events make that burdensome. This stance is relaxed under the impossibility doctrine to excuse performance only to reflect the contractual risk allocation the parties manifestly contemplated. This requires circumstances like destruction of the subject matter of the contract or discovery that the means of performance is “objectively impossible.” It also requires proving that the event could not have been foreseen or guarded against by contract. In Kel Kim, the tenant did not meet these requirements for excuse under the doctrine of impossibility, since an inability to obtain insurance could have been foreseen and guarded against in the lease.
Nor was the tenant’s claim within the scope of the lease’s Force Majeure clause, because only if an event is expressly within such a clause can it be invoked to excuse performance. The Kel Kim lease did not explicitly include the inability to obtain insurance. Instead, the listed events dealt with everyday commercial operations, the court found. The catch-all phrase about "other similar causes" did not, in the opinion of the court, expand that class to include insurance. Staying insured is not about frustrated expectations in daily operations. The court reasoned that it is about the landlord's bargained-for protection of its unrelated economic interest, where the tenant operates a particular business at the landlord’s site that poses certain liability risks.
The doctrines (or defenses) of impossibility (sometimes known as “frustration”) of performance and force majeure are related but are not identical as to outcomes. Frustration leads to the conclusion that the entire contract has been rendered permanently impossible to perform, and so typically results in the contract ending as a matter of law. Force majeure, by contrast, does not involve complete and permanent impossibility of performance—indeed, it may be susceptible to performance in all respects, once the event of force majeure has passed. Capital markets will be righted, like a foundering ship; lending ultimately will resume. So will development.
It’s a tough time for landlords developing new projects. The desiccation in lending markets seems as unanticipated, hazardous and devastating as a period of civil insurrection. In the end, however, there’s no way for the parties to realize their reasonable expectations under their lease (which sounds like the essence of good faith and fair dealing) if the articulated allocation of risks and the fundamental promises that form the basis for an agreement may be excused as to one party, while holding the other party to the bargain. I suspect that in the noted circumstances that the commercial tenant will not obtain any relief from his landlord through the courts except damages, if demonstrable, for delay in the delivery of the Premises. The opposite result will lead to a forfeiture of the bargain made by the landlord, a phenomenon Arizona’s courts claim to abhor.
In the meantime, if force majeure becomes elemental in construing the parties’ rights and obligations, it behooves the drafters of leases and other contracts to consider these things:
a. What events are covered—and what events are excluded from coverage?
b. Are any contractual obligations affected by force majeure? Even the payment of money? If so, that needs to be expressly agreed to.
c. If at all, to what extent does the relied-upon force majeure event have to have been unforeseen? After all, shortage of labor or materials always hypothetically is possible; but it usually still falls in the ambit of a force majeure event.
d. Does a degree of “fault” enter into the equation? What if a party claiming force majeure just didn’t take reasonable care, or wasn’t diligent in pursuit of the item that is now scarce or unavailable? If that failure was intended to preclude one party’s reliance on force majeure, that should be made clear in the agreement.
e. Is “impossibility” of performance the standard for the relying party; or is it enough that its performance has been rendered only impractical, or substantially more difficult or perhaps even just significantly more expensive.
f. Notice—should not the party relying on force majeure be required to give notice of the occurrence of the triggering event as soon as practicable after the relying party becomes aware (or should have become aware) of the event?
g. Should not the party relying on force majeure be required to take steps to mitigate the effect of the delay on the other party, or the ancillary fallout if delay is not the main impact on the other party? But how substantial should the steps be? How about commercially reasonable efforts? Heroic efforts? And what is, in the circumstances of the contract, commercially reasonable?
-MNW
Saturday, December 27, 2008
Growing Faith in a Community's Future
Today, I'm riding the spanking new, Valley Metro, light rail. I'm not going anywhere specific, particularly. (I'll just feel a brief moment of exhilaration about experiencing a travel modality that is quiet and efficient, and a twinge of modest vindication.) But metropolitan Phoenix surely is.
This is a leap forward in mass transit and in urban planning for America's fifth largest city. It's been a long journey getting here. Here's a bit of history. In 1985, Phoenix had an election for a joint regional freeway RPTA entitled Proposition 300; this was to secure tax funding for the development of a regional Maricopa County freeway system over 20 years (tentative completion by 2005). The initiative also created the Regional Public Transit Authority, whose small percentage of the freeway tax was to be used to plan, design and find a funding source for a regional transit system within 5 years.
By Prop 300 requirements, the RPTA was created to design a transit plan. In 1989, the agency proposed an initiative to secure a one-percent sales tax funding source over 30 years for the following components: A regional Maricopa County-wide bus system (7 day-a-week service on every major street in the county), regional-express rapid-bus transit system, multiple commuter trains which would use freight railroad tracks and a 103-mile, elevated, double track, 60 mph rapid-train system. It was totally ambitious, this VALTRANS plan. It made for a very contentious election, in which many voters felt that the plan was too large, too long, too expensive but, somehow, not detailed enough. Even more voters did not like the idea of transit vehicles travelling overhead above neighborhood backyards and streets. Still more were skeptical, concluding that despite the County’s 1985 freeway tax imposed four years earlier, only 10-15 miles of freeway had been built with the taxes collected—so who was to say this wasn’t another boondoggle for a few vested interests?
Having served on the City of Phoenix's Surface Transportation Advisory Board for 3 or 4 years beginning about 1985-86, I was recruited by the RPTA proponents to become a vocal supporter of the initiative. I felt up to the task, since I had spent years in Naples, Italy and metropolitan Washington, D.C. depending on mass transit, and I particularly was a fan of the Paris Metro and bus system that Peggy and I rode for miles daily during the first year of our marriage. No one prepared me for the public hostility awaiting me at Kiwanis breakfasts and Rotary lunches where panels or debates on the proposition usually spoiled the meals. Many agendas emerged in the opposition to the VALTRANS proposition, but it clearly was doomed--very early in the pre-election process--and no one was shocked that the voters savaged it by a 3-1 margin.
It seemed not so much that the valley was populated by backward-thinking people. Much of the resistance was from folks who weren’t ready to abandon driving their cars, and/or didn’t especially care to emulate the transit-heavy eastern cities from which they had migrated westward (New York/NJ, Chicago). Since much of the in-migration of the 1980s was from California, many newer arrivals weren’t frustrated by habits of spending hours in vehicles commuting daily. Some of the local communities’ entrenched leaders were convinced that freeways alone would address the pressures of sustained growth—and they had waited too long already for the funding with which to lay asphalt.
Well, perhaps that hasn’t changed much. Honestly, it doesn’t matter tremendously whether the over-40 crowd doesn’t ride light rail here. There aren’t going to be that many converts among those with a reserved parking stall (except when they realize they are needlessly paying a premium to sit for 30 minutes in a parking garage downtown after a Suns or Diamondbacks game). It’s enough that parents don’t forbid their children to ride. Those who aren’t predisposed to disregard mass transit as a viable mode for travel will in time create the critical mass to reach the “tipping point,” where light rail becomes, beyond vogue, a behavior pattern. I used to think that it would take about 25 years for that to happen, but I’m going to make an optimistic prediction: 15 years, and the Valley Metro ridership will more than cover the expense of its ongoing maintenance. If I’m crazy, then Denver is collective-crazy. Take a look at the acceptance of rail travel in the business and hospitality sector corridors in that city. There’s no Portland-tree-hugging, chip-on-the-shoulder attitude in Denver. It’s Middle America; and the population there understands that transit solves an urbanization problem. And take a look at the impact of Denver transit on its urban form, too. Perhaps that’s the most exciting potential for Valley Metro—a transit-driven urban form, and the eventual electrification of Phoenix’s downtown that some of us have been waiting patiently for—lo, these many decades.
-MNW
This is a leap forward in mass transit and in urban planning for America's fifth largest city. It's been a long journey getting here. Here's a bit of history. In 1985, Phoenix had an election for a joint regional freeway RPTA entitled Proposition 300; this was to secure tax funding for the development of a regional Maricopa County freeway system over 20 years (tentative completion by 2005). The initiative also created the Regional Public Transit Authority, whose small percentage of the freeway tax was to be used to plan, design and find a funding source for a regional transit system within 5 years.
By Prop 300 requirements, the RPTA was created to design a transit plan. In 1989, the agency proposed an initiative to secure a one-percent sales tax funding source over 30 years for the following components: A regional Maricopa County-wide bus system (7 day-a-week service on every major street in the county), regional-express rapid-bus transit system, multiple commuter trains which would use freight railroad tracks and a 103-mile, elevated, double track, 60 mph rapid-train system. It was totally ambitious, this VALTRANS plan. It made for a very contentious election, in which many voters felt that the plan was too large, too long, too expensive but, somehow, not detailed enough. Even more voters did not like the idea of transit vehicles travelling overhead above neighborhood backyards and streets. Still more were skeptical, concluding that despite the County’s 1985 freeway tax imposed four years earlier, only 10-15 miles of freeway had been built with the taxes collected—so who was to say this wasn’t another boondoggle for a few vested interests?
Having served on the City of Phoenix's Surface Transportation Advisory Board for 3 or 4 years beginning about 1985-86, I was recruited by the RPTA proponents to become a vocal supporter of the initiative. I felt up to the task, since I had spent years in Naples, Italy and metropolitan Washington, D.C. depending on mass transit, and I particularly was a fan of the Paris Metro and bus system that Peggy and I rode for miles daily during the first year of our marriage. No one prepared me for the public hostility awaiting me at Kiwanis breakfasts and Rotary lunches where panels or debates on the proposition usually spoiled the meals. Many agendas emerged in the opposition to the VALTRANS proposition, but it clearly was doomed--very early in the pre-election process--and no one was shocked that the voters savaged it by a 3-1 margin.
It seemed not so much that the valley was populated by backward-thinking people. Much of the resistance was from folks who weren’t ready to abandon driving their cars, and/or didn’t especially care to emulate the transit-heavy eastern cities from which they had migrated westward (New York/NJ, Chicago). Since much of the in-migration of the 1980s was from California, many newer arrivals weren’t frustrated by habits of spending hours in vehicles commuting daily. Some of the local communities’ entrenched leaders were convinced that freeways alone would address the pressures of sustained growth—and they had waited too long already for the funding with which to lay asphalt.
Well, perhaps that hasn’t changed much. Honestly, it doesn’t matter tremendously whether the over-40 crowd doesn’t ride light rail here. There aren’t going to be that many converts among those with a reserved parking stall (except when they realize they are needlessly paying a premium to sit for 30 minutes in a parking garage downtown after a Suns or Diamondbacks game). It’s enough that parents don’t forbid their children to ride. Those who aren’t predisposed to disregard mass transit as a viable mode for travel will in time create the critical mass to reach the “tipping point,” where light rail becomes, beyond vogue, a behavior pattern. I used to think that it would take about 25 years for that to happen, but I’m going to make an optimistic prediction: 15 years, and the Valley Metro ridership will more than cover the expense of its ongoing maintenance. If I’m crazy, then Denver is collective-crazy. Take a look at the acceptance of rail travel in the business and hospitality sector corridors in that city. There’s no Portland-tree-hugging, chip-on-the-shoulder attitude in Denver. It’s Middle America; and the population there understands that transit solves an urbanization problem. And take a look at the impact of Denver transit on its urban form, too. Perhaps that’s the most exciting potential for Valley Metro—a transit-driven urban form, and the eventual electrification of Phoenix’s downtown that some of us have been waiting patiently for—lo, these many decades.
-MNW
Friday, December 26, 2008
Realty Bytes: Episode One--Desperate Times and Desperate Measure[ment]s
In this and the next post, Mike eyeballs two "approaches" to justifying non-performance of landlord-tenant obligations. This first one feels like a recycled theory of justification for tenant to suspend performance or obtain a refund of asserted lease overpayments.
Every time there’s a downturn in the economy, commercial tenants fall like flies, swan-diving into the landlord's windshield. That’s understandable, but sometimes tenant machinations to liberate it from their promises to pay rent get a bit silly. In the last downturn, tenants turned to—as now—the convention of “I got cheated through the incorrect measurement of my space.” This comes about when so-called “lease auditors” or clever attorneys point out that the tenant may have been overcharged for rent or its shares of CAMs in net leases based on “phantom footage”—a landlord's exaggerating the square footage of the premises.
The conventions of usable, rentable, occupy-able and leasable square footage well could occupy a separate posting, and that’s not the purpose of this one. No matter what standard of measurement applied, there’s likely nearly always some basis for discord. The questions, seems to me, are:
a. If the lease doesn’t say what standard of measurement was used in determining footage, who decides which applies? Is that an arbitrable dispute? And who will be found culpable for the "silent standard?"
b. If the lease does say which measurement standard applies, and recites the footage, is that a landlord representation and warranty of size? Is the answer affected if the footage is reported as “approximate” or “more or less”?
c. Suppose b. is that a court would find a landlord obligation here, but the tenant never bothers to verify the footage—shame on whom, in that case? In New York, the courts say that if there’s no protest over the measurement prior to lease commencement, the parties “deem” the footage to be as set forth in the document, regardless of the actual measurement—shame on tenant, I guess. Well, unless the premises are larger than what is set forth in the lease. Then, demerits to the landlord.
d. What if the parties discover some time into the lease that the size was misreported/mis-measured? Does that mistake of fact entitle either of the parties to rescind the lease deal? What happens, in that case, to the doctrine of “course of performance,” since rent and CAMs have been billed and paid on the mutually-erroneous assumption?
e. What if the lease says, without reference to size, that tenant is renting “Suite 185”? Does that mean the tenant has no basis to object to the size of the space, so long as the suite as delivered was the same configuration as the premises visited by the tenant prior to signing the lease? Does the pre-leasing conversation among the parties on the rate per-square foot affect this, if there’s an integration clause in the lease (meaning, one that expressly states that no prior or contemporaneous oral agreements are pertinent)? What about if the landlord says that the tenant's triple nets should average $XXX per month? Does the tenant have, at any point, the right to rely on the landlord's [or broker's] representations about any item of lease cost as a promise of a certain sized premises?
f. Under what dimensions (measured, say, by percentage of space “lost” to the tenant) can a tenant sustain its claim for violation of implied lease covenants of good faith/fair dealing? At what magnitude of mis-measurement of square footage does the difference become unconscionable (point for the distressed party) as a matter of law?
g. How long can the distressed party wait to protest/sue before it can be said that the equitable doctrine of “laches” applies (you sat on your hands for too long)?
h. If "size matters," to either party, why wasn't someone measuring the space? I mean, how hard is it to get a tape measure through the suite doorway? Should there be a general "rule" that there's a "duty to measure" [like the old duty to read]--or forever hold your peace? How many times does the tenant require the last 5% of the square footage promised?
-MNW
Every time there’s a downturn in the economy, commercial tenants fall like flies, swan-diving into the landlord's windshield. That’s understandable, but sometimes tenant machinations to liberate it from their promises to pay rent get a bit silly. In the last downturn, tenants turned to—as now—the convention of “I got cheated through the incorrect measurement of my space.” This comes about when so-called “lease auditors” or clever attorneys point out that the tenant may have been overcharged for rent or its shares of CAMs in net leases based on “phantom footage”—a landlord's exaggerating the square footage of the premises.
The conventions of usable, rentable, occupy-able and leasable square footage well could occupy a separate posting, and that’s not the purpose of this one. No matter what standard of measurement applied, there’s likely nearly always some basis for discord. The questions, seems to me, are:
a. If the lease doesn’t say what standard of measurement was used in determining footage, who decides which applies? Is that an arbitrable dispute? And who will be found culpable for the "silent standard?"
b. If the lease does say which measurement standard applies, and recites the footage, is that a landlord representation and warranty of size? Is the answer affected if the footage is reported as “approximate” or “more or less”?
c. Suppose b. is that a court would find a landlord obligation here, but the tenant never bothers to verify the footage—shame on whom, in that case? In New York, the courts say that if there’s no protest over the measurement prior to lease commencement, the parties “deem” the footage to be as set forth in the document, regardless of the actual measurement—shame on tenant, I guess. Well, unless the premises are larger than what is set forth in the lease. Then, demerits to the landlord.
d. What if the parties discover some time into the lease that the size was misreported/mis-measured? Does that mistake of fact entitle either of the parties to rescind the lease deal? What happens, in that case, to the doctrine of “course of performance,” since rent and CAMs have been billed and paid on the mutually-erroneous assumption?
e. What if the lease says, without reference to size, that tenant is renting “Suite 185”? Does that mean the tenant has no basis to object to the size of the space, so long as the suite as delivered was the same configuration as the premises visited by the tenant prior to signing the lease? Does the pre-leasing conversation among the parties on the rate per-square foot affect this, if there’s an integration clause in the lease (meaning, one that expressly states that no prior or contemporaneous oral agreements are pertinent)? What about if the landlord says that the tenant's triple nets should average $XXX per month? Does the tenant have, at any point, the right to rely on the landlord's [or broker's] representations about any item of lease cost as a promise of a certain sized premises?
f. Under what dimensions (measured, say, by percentage of space “lost” to the tenant) can a tenant sustain its claim for violation of implied lease covenants of good faith/fair dealing? At what magnitude of mis-measurement of square footage does the difference become unconscionable (point for the distressed party) as a matter of law?
g. How long can the distressed party wait to protest/sue before it can be said that the equitable doctrine of “laches” applies (you sat on your hands for too long)?
h. If "size matters," to either party, why wasn't someone measuring the space? I mean, how hard is it to get a tape measure through the suite doorway? Should there be a general "rule" that there's a "duty to measure" [like the old duty to read]--or forever hold your peace? How many times does the tenant require the last 5% of the square footage promised?
-MNW
The Housing Market
Will there EVER be a housing market recovery?
Lots of us want the answer to this question. However, none of us has a crystal ball. But we can examine the various forces affecting the market today.
There are several ideas I have been hearing about which may have helped get us into the current predicament -- everything from Elliot Wave theory about this being a Grand Supercycle Event, to The Fourth Turning's ideas about the population of baby boomers moving through the economy, causing boom and bust as they age, to PayTruthForward.com's ideas about the compound growth of immorality. And really, I think all these things are related -- Elliot Wave theory tracks the psychology of markets; the Fourth Turning is about psychology; and immorality is yet another aspect of the same thing.
However we got here, though, where we are today is a situation of credit no one wants, along with homes no one wants to buy with that credit. The oversupply of homes is enormous and likely to grow as the economy continues to slow. A large majority of home sales in Phoenix today are short sales and other foreclosure related transfers. The banks are accepting substantial discounts to market rates for homes; worse yet, more and more homes are coming into foreclosure.
The next big wave will be option mortgages, where people have a 30 year fixed loan but with an option for interest only for the first 10 years. This is fine except that the fine print on many of these loans indicates that when the home value falls below a certain threshold, full principal and interest payments must be made. Further, for another few years, more and more of the interest only loans will be resetting. At the moment this is not too bad a thing since rates are quite low.
Many of us would have thought that the tighter credit standards would lead to a better rental market, but this has not been the case -- many of the homes listed for sale are also listed for rent; a recent listing I had, both for sale and for rent, finally rented last month after a year, and at a below market rate!
As the economy has slowed, fewer people have contemplated moving to Phoenix; the huge machine that drove our commercial and residential markets has also dramatically slowed, putting even more pressure on the housing market.
So what has to happen for the housing market to return to some semblance of normality? First, foreclosures must slow significantly. As long as there is massive downward pressure on the market from banks dumping non-performing loans, prices will continue to fall, and people will be less likely to buy a home. Second, there must be some loosening of loan standards in terms of a down payment; in weakening economic conditions, people are reluctant to put 10% or 20% down on an asset which is falling in value. Failing that, we must see the rental market pick up, which will encourage investor purchases. [I might note that there are investors in the market now -- but these are the savvy investors, not the ones that drove the market out of sight -- we need a little of each, I think]
I don't see all the conditions coming together anytime soon; my personal expectation is for further weakness for at least 2-3 years, with some semblance of normality returning after that, perhaps in 2013.
In the meantime, if you are interested in buying a home, be sure to look at short sales; a short sale takes more time -- often 120 days to close, 60-90 to even get an answer! but the values are there.
-PLH
Tuesday, December 23, 2008
Sensory Sugarplums - More and Less
Henry L. Menken, that most articulate of curmudgeons, famously labeled Dixie as "almost as sterile, artistically, intellectually, culturally, as the Sahara Desert." While his comments (in The Sahara of the Bozart) have to be appreciated in context (for his scorn was reserved only for the South's then-recent culture), the simile pierced me well into adulthood. I found myself, occasionally, tempted to nominate cultural life in Las Vegas and later Phoenix as the Mojave and Sonoran Desert nominees, respectively, for enshrinement in Menken's Pantheon. Recently I've been struck by two advances that give me great pride in the progress of our arts community that I salute. I'd recommend these venues to visitors and residents alike--and might suggest investing a few visiting hours during the December holidays down-time.
First is the Phoenix Art Museum. It has been in a period of sustained advance and truly has become an excellent place to enjoy the visual arts. Particularly dramatic in its improvement in quality, I think, is the modern art collection. A few of the Museum's Trustees have answered the call of philanthropy and the results are, well, easy to appreciate if you've not lost your vision altogether. Two occurrences are especially salutary for the contemporary art lover. One is the museums capital improvements, and they are capital indeed. improving in leaps and bounds the galleries and other display areas. When I first visited the museum in the 1970s, housed in a bleak spot, I vowed never to return. (Thankfully, I can't recall any of my vows except when my wife kicks me in the shins.) Second is the hiring of a new curator, Sara Cochran, who has already served notice that anyone expressing an interest in improving the collection will be on her radar screen. She's erudite, she has a lilting Scottish accent bespeaking refinement of the pleasantest order, and she knows how to "make the ask." Now they’re cooking!
Second is the Dale Chihuly installations at the Phoenix Botanical Garden. I was there en famille in the driving rain the other night trying not to stomp soggy luminaria bags into a congealed, primal mass of waxed paper. Nothing dampened our spirits; the glass installations are spectacularly contradictory in their simultaneous mass and fragility. They require visiting at night and during daylight hours both, in order to have a full appreciation of the interplay of [natural and artificial] light and color. But if your budget restricts you to one visit, the exhibition is socko any time of day or evening. So hand over your cash to the Garden--which has become a wonderful place in which to appreciate the gifts of the natural desert, whether or not under glass--and enjoy the Chihuly exhibit through sometime in May, I gather. P.S.: You need a reservation for a set visit time, so call in advance to avoid disappointment live at the entrance.
The best evidence of mediocrity on the current Phoenix cultural scene is the unimaginative--and awful-- programming of a few local FM stations during the holiday season. Bulletin to the programming directors: Your 50 great Christmas hits of the "popular music" era, repeated between 3 to 6 times daily for the entire month of December, are not. Not deserving of listenership, I mean. Paul McCartney's A Wonderful Christmas Time lyrics featuring nearly 40 unique words? Dan Fogelberg's whiny Same Auld Lang Syne? Andy Williams' powering through the octaves on It's the Most Wonderful Time of the Year? Honestly! There are a lot more great tunes that you can tape for “sustained” play even if you're trying to conserve a few bucks or give the DJs some extra time off with their families. I'm not anti-icon; I recognize the power of Bing Crosby and Karen Carpenter to evoke the comfort and romance of the season, and their voices (yeah, that Karen Carpenter--just listen to Merry Christmas, Darling and tell me that you're not blown away by her completely effortless key change after the "logs on the fire/ fill me with desire/to see you and to say" phrase; just ignore the juvenile Oh-Ahhh! chorus in the background. Ms. Carpenter had the premier natural American pop vocal talent after Crosby (Bing, not David) and Nat “King” Cole--and had to demonstrate her gifts handicapped by bizarre and cliched arrangements by Richard), like that of Elvis, send them to the top of anybody’s play list. But a lot of your "hits" aren't enduring by dint ofy selling a half-million copies during one holiday season. And everything recorded around a Christmas theme by Sinatra and the Beach Boys isn't a classic only because they tossed another licorice pizza. There are local bell choirs that will give the stations complementary CDs that have seasonal fidelity and genuine musical integrity. Play one of those tunes every 25 minutes. Show some imagination, radio folks. Or poll some locals on the subject of what makes an enduring Christmas pop classic. In fact, maybe the readers here will throw down a few candidates for next year's play list.
In the meantime, readers, revolt. Turn the volume knob to “off.” Make your own play list. Here's a couple of albums that received my attention lately. Los Lonely Boys have put out a CD, Christmas Spirit, this season with two original songs and the remainder covers, but with their own coloration. They are great respecters of Texas Latino dance bands, and Henry Garza can play lead guitar with ferocity and touch. Josh Groban (Noel) has an immense voice. Its massiveness brings me to my knees; finally, though, it feels like chest compressions, and after about 20 minutes I have to move onto something else--but God knows the man has chops. James Taylor’s At Christmas album (2006) that the FM "holiday music" stations play a cut or two from once in a while, but not enough compared to the works of the venerable Gene Autrey and Burl Ives, is worth a re-listen. His voice will calm the noise in your head as well as anything this season. Incidentally, are there any listeners left of the generation of Autrey and Ives who actually tune into--and stayed tuned to--"holiday music" stations?
Enjoy all the holiday assaults on your senses, and make some joyful noise!
--MNW
First is the Phoenix Art Museum. It has been in a period of sustained advance and truly has become an excellent place to enjoy the visual arts. Particularly dramatic in its improvement in quality, I think, is the modern art collection. A few of the Museum's Trustees have answered the call of philanthropy and the results are, well, easy to appreciate if you've not lost your vision altogether. Two occurrences are especially salutary for the contemporary art lover. One is the museums capital improvements, and they are capital indeed. improving in leaps and bounds the galleries and other display areas. When I first visited the museum in the 1970s, housed in a bleak spot, I vowed never to return. (Thankfully, I can't recall any of my vows except when my wife kicks me in the shins.) Second is the hiring of a new curator, Sara Cochran, who has already served notice that anyone expressing an interest in improving the collection will be on her radar screen. She's erudite, she has a lilting Scottish accent bespeaking refinement of the pleasantest order, and she knows how to "make the ask." Now they’re cooking!
Second is the Dale Chihuly installations at the Phoenix Botanical Garden. I was there en famille in the driving rain the other night trying not to stomp soggy luminaria bags into a congealed, primal mass of waxed paper. Nothing dampened our spirits; the glass installations are spectacularly contradictory in their simultaneous mass and fragility. They require visiting at night and during daylight hours both, in order to have a full appreciation of the interplay of [natural and artificial] light and color. But if your budget restricts you to one visit, the exhibition is socko any time of day or evening. So hand over your cash to the Garden--which has become a wonderful place in which to appreciate the gifts of the natural desert, whether or not under glass--and enjoy the Chihuly exhibit through sometime in May, I gather. P.S.: You need a reservation for a set visit time, so call in advance to avoid disappointment live at the entrance.
The best evidence of mediocrity on the current Phoenix cultural scene is the unimaginative--and awful-- programming of a few local FM stations during the holiday season. Bulletin to the programming directors: Your 50 great Christmas hits of the "popular music" era, repeated between 3 to 6 times daily for the entire month of December, are not. Not deserving of listenership, I mean. Paul McCartney's A Wonderful Christmas Time lyrics featuring nearly 40 unique words? Dan Fogelberg's whiny Same Auld Lang Syne? Andy Williams' powering through the octaves on It's the Most Wonderful Time of the Year? Honestly! There are a lot more great tunes that you can tape for “sustained” play even if you're trying to conserve a few bucks or give the DJs some extra time off with their families. I'm not anti-icon; I recognize the power of Bing Crosby and Karen Carpenter to evoke the comfort and romance of the season, and their voices (yeah, that Karen Carpenter--just listen to Merry Christmas, Darling and tell me that you're not blown away by her completely effortless key change after the "logs on the fire/ fill me with desire/to see you and to say" phrase; just ignore the juvenile Oh-Ahhh! chorus in the background. Ms. Carpenter had the premier natural American pop vocal talent after Crosby (Bing, not David) and Nat “King” Cole--and had to demonstrate her gifts handicapped by bizarre and cliched arrangements by Richard), like that of Elvis, send them to the top of anybody’s play list. But a lot of your "hits" aren't enduring by dint ofy selling a half-million copies during one holiday season. And everything recorded around a Christmas theme by Sinatra and the Beach Boys isn't a classic only because they tossed another licorice pizza. There are local bell choirs that will give the stations complementary CDs that have seasonal fidelity and genuine musical integrity. Play one of those tunes every 25 minutes. Show some imagination, radio folks. Or poll some locals on the subject of what makes an enduring Christmas pop classic. In fact, maybe the readers here will throw down a few candidates for next year's play list.
In the meantime, readers, revolt. Turn the volume knob to “off.” Make your own play list. Here's a couple of albums that received my attention lately. Los Lonely Boys have put out a CD, Christmas Spirit, this season with two original songs and the remainder covers, but with their own coloration. They are great respecters of Texas Latino dance bands, and Henry Garza can play lead guitar with ferocity and touch. Josh Groban (Noel) has an immense voice. Its massiveness brings me to my knees; finally, though, it feels like chest compressions, and after about 20 minutes I have to move onto something else--but God knows the man has chops. James Taylor’s At Christmas album (2006) that the FM "holiday music" stations play a cut or two from once in a while, but not enough compared to the works of the venerable Gene Autrey and Burl Ives, is worth a re-listen. His voice will calm the noise in your head as well as anything this season. Incidentally, are there any listeners left of the generation of Autrey and Ives who actually tune into--and stayed tuned to--"holiday music" stations?
Enjoy all the holiday assaults on your senses, and make some joyful noise!
--MNW
Monday, December 22, 2008
China Syndrome
Lately I’m reminded of the Chinese curse wishing the listener “interesting times,” and the dynamic between desperate tenants with credit lines and inventory/equipment financiers, and frantic landlords with mortgages, has indeed been interesting of late. Seems like tenant inability to perform its commercial lease obligations is a recurring theme. So, what do the parties have to take into account?
If a tenant cannot persuade its landlord to release it from its lease obligations in difficult economic times, then it may shortly face the unenviable path of bankruptcy. Consequently, landlords and tenants need to review the documentation to recall the status of guarantees. If the tenant principals signed no guaranty, or if only one spouse in a marital community signed, there may be no reason to file for bankruptcy relief.
Recall that a guaranty signed by a single spouse is binding only on the separate property of the signing spouse, not upon the separate property of the spouse not signing, nor on that (unsigned) spouse’s undivided interest in the community property of the Arizona-based guarantor. (The same applies if the guarantor principal is a resident of California, Washington and several other western states.) Many marital communities have little separate property that is reachable by execution on a judgment.
If there’s no effective guaranty the tenant may have little incentive to file bankruptcy, but if the tenant wants to protect significant equipment or inventory from execution or seizure and sale under a landlord’s lien (or liens or interests of other parties [see below]), then a bankruptcy may be in order.
What should the landlord do if it has a reasonable certainty that bankruptcy is forthcoming? Before answering that question, how best will the landlord read the tenant who asserts it intends to do so? There are a few behaviors that signal a bankruptcy is forthcoming. Closing the premises (“going dark”) or failing to communicate with the landlord after it has changed the locks after a tenant monetary default usually a good sign that bankruptcy looms, except in the case where a tenant has moved all its wares and operates from more than one location—in that instance, closure may be only an indication of consolidation of inventory or services. Handing the landlord’s representative a business card from the office of a bankruptcy attorney may be another indication of imminent action. The seizure of a tenant’s inventory, equipment or trade fixtures by a secured lender or equipment lessor is a sign that filing is highly probable. Another is the tenant’s announcement of severe curtailment of operating hours, or reduction in staff to levels well below the usual complement of personnel at the premises.
While tenant lockouts (when available as a landlord remedy) without termination of the lease are effective to get the tenant to make up back rent, CAMs or other lease sums when money is available, they are pointless when the tenant can’t catch up the delinquency(ies) in performing the lease and a bankruptcy seems inevitable. If there’s no reasonable hope for the tenant catching up on its obligations, review carefully the landlord’s remedies section of the lease. If termination is an option without notice to the tenant, the landlord has to consider the option of ending the lease by notice to the tenant of summary termination.
The automatic stay of bankruptcy under Section 361 of the Code does not apply when a landlord’s asset is not property of the bankruptcy estate. If the landlord cancels the lease properly, prior to the date of the bankruptcy filing, this ends landlord’s risk that the tenant will consume up to 120 days—with no compensation to landlord in the meantime--to assume (or assume and assign) or reject the lease in the bankruptcy where the tenant seeks to reorganize under Chapter 11. (Of course, in a Chapter 7, the bankruptcy trustee will have control of the premises until it makes a determination whether the lease has any liquidation value, an unlikely circumstance in the significant majority of bankruptcy filings. Also, in the present financial environment, it would be rare indeed for a Chapter 11 debtor to be able to find an assignee for the lease obligations, unless it was in connection with sale of its operating business.)
So, should the landlord fire the bankruptcy-beating termination “silver bullet” when it appears likely that the tenant will soon be in federal court, to defeat the imposition of the automatic stay? Well, not always. The landlord has to calculate several things in the decision matrix. How long can the tenant hold on before filing bankruptcy? After all, from the date of termination forward, the landlord cannot recover future rent through the scheduled expiration date of the lease, so is limited in recovery to the delinquent rent and other charges amounts prior to the date of the tenant’s filing. Terminating the lease too soon costs the landlord potential rent payments for some period.
Another consideration is who has competing claims to the non-leasehold assets of the tenant. There may be equipment lessors; or conventional lenders with perfected security interests in certain assets (or the FDIC, if the lender has itself faced insolvency); or the SBA who guaranteed a business loan and took a security interest; or a franchisor or analogous asset-provider. Another factor is this: Did the tenant remove all its personal property out of the landlord’s premises—or does a lot of it remain parked inside the premises, even if the tenant has “gone dark?” In addition, there has to be a review of the lease file to see if landlord has signed a subordination of its statutory lien position against the personal property. Or—wait—does that even matter, if the lease had been terminated by the landlord? Recall that when the lease is terminated, there is no landlord-tenant relationship; and in that case, how can there be a “landlord” lien prescribed by statute? If a former landlord forgoes its landlord status, there goes the lien.
The last situation becomes a dilemma for the landlord. If it has canceled the lease before the property of the tenant is finally removed, the automatic stay impacts the landlord’s options with respect to those trade fixtures. While there may be an available landlord administrative claim in Chapter 11 for the property’s ongoing premises occupancy after the filing, for storage costs, that will not do much to position the premises for re-letting.
So did the landlord’s lease happily recite that (a) upon termination of the lease, any property of the tenant remaining within the premises is deemed to have been abandoned by the tenant and (b) that this “convention” would survive termination of the lease? If the landlord is not so well-positioned, then the landlord will want to consider the following course of conduct:
Research whether there are other parties with a status of owner, lessor or secured party with respect to the personal property;
Decide whether to terminate the lease prior to a bankruptcy filing;
With a high-quality still or motion camera, take a photographic inventory of all tenant property within the premises (this avoids liability in the face of future allegations of theft, destruction or damage to tenant’s property or personal effects of employees of tenant);
If the landlord has decided to terminate the lease and there’s more strategic space available to the landlord, move the personal property of the terminated tenant to that more salutary location, carefully, minimizing damage or loss to the property. Re-video the personal property after the move is completed, documenting the condition of the inventory of goods.
My clients gripe about this responsibility for remaining tenant personal property more frequently than any other aspect of bankruptcy (except that tenants should not be allowed to use it in the first place to re-order their business lives). First, they believe that the ipso facto principle is “just wrong,” so they should not be responsible for any dimension of the tenant’s future, because the lease provides that a bankruptcy is a material default and the tenant and its principals deserves everything they get from the moment of filing forward. Second, there’s a major disconnect between the idea that landlord had the right to terminate the lease before the bankruptcy filing date but not to throw the tenant’s property into the nearest dumpster or on the sidewalk with a “free stuff-help yourself” sign on the top of the heap. Of course, that ignores the possibility that there are other stakeholders in the property’s ownership, in addition to the fact that there may be some recovery to the landlord via an administrative claim. And, most of all, it ignores the reality that the termination of the real property right of tenant does not give the landlord license to ignore the automatic stay of the Code with respect to other debtor assets contained within the leased premises.
--MNW
If a tenant cannot persuade its landlord to release it from its lease obligations in difficult economic times, then it may shortly face the unenviable path of bankruptcy. Consequently, landlords and tenants need to review the documentation to recall the status of guarantees. If the tenant principals signed no guaranty, or if only one spouse in a marital community signed, there may be no reason to file for bankruptcy relief.
Recall that a guaranty signed by a single spouse is binding only on the separate property of the signing spouse, not upon the separate property of the spouse not signing, nor on that (unsigned) spouse’s undivided interest in the community property of the Arizona-based guarantor. (The same applies if the guarantor principal is a resident of California, Washington and several other western states.) Many marital communities have little separate property that is reachable by execution on a judgment.
If there’s no effective guaranty the tenant may have little incentive to file bankruptcy, but if the tenant wants to protect significant equipment or inventory from execution or seizure and sale under a landlord’s lien (or liens or interests of other parties [see below]), then a bankruptcy may be in order.
What should the landlord do if it has a reasonable certainty that bankruptcy is forthcoming? Before answering that question, how best will the landlord read the tenant who asserts it intends to do so? There are a few behaviors that signal a bankruptcy is forthcoming. Closing the premises (“going dark”) or failing to communicate with the landlord after it has changed the locks after a tenant monetary default usually a good sign that bankruptcy looms, except in the case where a tenant has moved all its wares and operates from more than one location—in that instance, closure may be only an indication of consolidation of inventory or services. Handing the landlord’s representative a business card from the office of a bankruptcy attorney may be another indication of imminent action. The seizure of a tenant’s inventory, equipment or trade fixtures by a secured lender or equipment lessor is a sign that filing is highly probable. Another is the tenant’s announcement of severe curtailment of operating hours, or reduction in staff to levels well below the usual complement of personnel at the premises.
While tenant lockouts (when available as a landlord remedy) without termination of the lease are effective to get the tenant to make up back rent, CAMs or other lease sums when money is available, they are pointless when the tenant can’t catch up the delinquency(ies) in performing the lease and a bankruptcy seems inevitable. If there’s no reasonable hope for the tenant catching up on its obligations, review carefully the landlord’s remedies section of the lease. If termination is an option without notice to the tenant, the landlord has to consider the option of ending the lease by notice to the tenant of summary termination.
The automatic stay of bankruptcy under Section 361 of the Code does not apply when a landlord’s asset is not property of the bankruptcy estate. If the landlord cancels the lease properly, prior to the date of the bankruptcy filing, this ends landlord’s risk that the tenant will consume up to 120 days—with no compensation to landlord in the meantime--to assume (or assume and assign) or reject the lease in the bankruptcy where the tenant seeks to reorganize under Chapter 11. (Of course, in a Chapter 7, the bankruptcy trustee will have control of the premises until it makes a determination whether the lease has any liquidation value, an unlikely circumstance in the significant majority of bankruptcy filings. Also, in the present financial environment, it would be rare indeed for a Chapter 11 debtor to be able to find an assignee for the lease obligations, unless it was in connection with sale of its operating business.)
So, should the landlord fire the bankruptcy-beating termination “silver bullet” when it appears likely that the tenant will soon be in federal court, to defeat the imposition of the automatic stay? Well, not always. The landlord has to calculate several things in the decision matrix. How long can the tenant hold on before filing bankruptcy? After all, from the date of termination forward, the landlord cannot recover future rent through the scheduled expiration date of the lease, so is limited in recovery to the delinquent rent and other charges amounts prior to the date of the tenant’s filing. Terminating the lease too soon costs the landlord potential rent payments for some period.
Another consideration is who has competing claims to the non-leasehold assets of the tenant. There may be equipment lessors; or conventional lenders with perfected security interests in certain assets (or the FDIC, if the lender has itself faced insolvency); or the SBA who guaranteed a business loan and took a security interest; or a franchisor or analogous asset-provider. Another factor is this: Did the tenant remove all its personal property out of the landlord’s premises—or does a lot of it remain parked inside the premises, even if the tenant has “gone dark?” In addition, there has to be a review of the lease file to see if landlord has signed a subordination of its statutory lien position against the personal property. Or—wait—does that even matter, if the lease had been terminated by the landlord? Recall that when the lease is terminated, there is no landlord-tenant relationship; and in that case, how can there be a “landlord” lien prescribed by statute? If a former landlord forgoes its landlord status, there goes the lien.
The last situation becomes a dilemma for the landlord. If it has canceled the lease before the property of the tenant is finally removed, the automatic stay impacts the landlord’s options with respect to those trade fixtures. While there may be an available landlord administrative claim in Chapter 11 for the property’s ongoing premises occupancy after the filing, for storage costs, that will not do much to position the premises for re-letting.
So did the landlord’s lease happily recite that (a) upon termination of the lease, any property of the tenant remaining within the premises is deemed to have been abandoned by the tenant and (b) that this “convention” would survive termination of the lease? If the landlord is not so well-positioned, then the landlord will want to consider the following course of conduct:
Research whether there are other parties with a status of owner, lessor or secured party with respect to the personal property;
Decide whether to terminate the lease prior to a bankruptcy filing;
With a high-quality still or motion camera, take a photographic inventory of all tenant property within the premises (this avoids liability in the face of future allegations of theft, destruction or damage to tenant’s property or personal effects of employees of tenant);
If the landlord has decided to terminate the lease and there’s more strategic space available to the landlord, move the personal property of the terminated tenant to that more salutary location, carefully, minimizing damage or loss to the property. Re-video the personal property after the move is completed, documenting the condition of the inventory of goods.
My clients gripe about this responsibility for remaining tenant personal property more frequently than any other aspect of bankruptcy (except that tenants should not be allowed to use it in the first place to re-order their business lives). First, they believe that the ipso facto principle is “just wrong,” so they should not be responsible for any dimension of the tenant’s future, because the lease provides that a bankruptcy is a material default and the tenant and its principals deserves everything they get from the moment of filing forward. Second, there’s a major disconnect between the idea that landlord had the right to terminate the lease before the bankruptcy filing date but not to throw the tenant’s property into the nearest dumpster or on the sidewalk with a “free stuff-help yourself” sign on the top of the heap. Of course, that ignores the possibility that there are other stakeholders in the property’s ownership, in addition to the fact that there may be some recovery to the landlord via an administrative claim. And, most of all, it ignores the reality that the termination of the real property right of tenant does not give the landlord license to ignore the automatic stay of the Code with respect to other debtor assets contained within the leased premises.
--MNW
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