Commercial Property Herald

When the Tenant Stops Paying Rent - What Do I Consider First

When a commercial landlord or property manager first contacts me and advises me that a tenant is no longer paying rent, I first determine if the lease was terminated or not. Lease termination could occur: 

1. By mutual agreement; 
2. By the terms of the lease; 
3. By the foreclosure; 
4. By the landlord by service of a Notice to Quit, Pay or Quit, Perform Covenant to Quit, or Notice of Belief of Abandonment.

If the lease was terminated before the filing of the suit, the landlord's  claims to rental damages in California, are usually limited to Civil Code 1951.2 damages, if the lease so provides, which include: 

• Rents owing up to the date of termination; 
• Rents owing from the date of termination of the lease until the date of trial, less what the tenant can prove we could have reasonably avoided, (mitigation); and 
• Future rents, which are calculated by determining the present value of future rents owing from the date of trial through the end of the term of the lease, less what the tenant proves we can reasonably avoid, (mitigation).

Notice that of the three measures of damages above, only the second two involve issues of mitigation.

While in this post, I am referencing California law, many other states have similar statutes that allow a landlord to collect rents through the end of the term of a lease although the lease was terminated as a result of some act or failure to act by the tenant.  You should consult your own attorney who is qualified to give legal advice in the state that the premises are located.

If the lease was not terminated prior to the filing of the lawsuit, we have the option of terminating the lease and suing for Civil Code 1951.2 damages or, if the lease so provides, suing for rents as they accrue, in which case we are only entitled to collect rents and other charges owing up through the date of trial. Note, we do not waive rents owing after trial through the end of the term. As to those future rents, we would have to file a new lawsuit to collect those rents. While the requirement of filing a new lawsuit to collect those future rents seems daunting at first glance, based upon my experience litigating these matters, I have often found that the advantages of suing for rents up through the date of the trial far outweigh the disadvantages of getting a partial judgment.  I will explain.

For one thing, when you terminate the lease and seek rents accruing at any time after the date of termination, mitigation is always an issue and proving and disproving this fact is usually the most expensive part of the litigation. I have also found that in the face of a competent lawyer defending the tenant, the landlord's proof and brokers documentation is often very deficient. Some brokers document their files well and follow legal instructions well and some don't. For the most part, brokers participate in the litigation only to the extent that they continue to do work for the landlord but otherwise see little payoff by cooperating and doing a good job in litigation. Even when the landlord can expect cooperation from the broker, brokers, as a whole are not well known for the type of detailed record-keeping that is necessary to be convincing in court. As a consequence, I try to avoid dealing with mitigation issues. A suit for rents as they accrue is far easier and quicker to win, in most cases. There are very few, if any defenses.

When the lease is not terminated, in essence, the tenant is treated as if they continue to have control of the premises and thus, the landlord's efforts to mitigate are unnecessary. This is so, even when the tenant voluntarily abandons the premises and turns over the keys. The tenant usually cannot unilaterally terminate the lease, unless the lease allows for it, so the landlord can refuse to terminate the lease, in which case the lease continues to run and rents continue to accrue. When the tenant abandons the premises and turns over the keys unilaterally, most leases allow for the landlord to take possession only for the purpose of releasing the premises for and on behalf of the tenant, clean up the premises for re-leasing, secure the premises and for the purpose of safety. This usually puts the landlord in a perfect position of mitigating its damages since it is usually the most common sense and practical approach, without giving up any rights.

Other reasons why I tend to favor avoiding terminating a lease and just suing for rents as they accrue, include: 

1. Because there are so few defenses to a suit for rents as they accrue, the landlord has a much better chance of winning a Motion for Summary Judgment (avoiding a trial and just getting judgment by a motion), avoiding the longer process; 
2. Even if you get to trial, the damages are often very substantial, forcing a quicker resolution. For example, if the tenant owes $20,000.00 per month and it takes you 12 months to get your judgment, you will get a judgment for at least $240,000, plus interest, late fees and attorneys fees in addition to any other damages that you can prove. This is nothing to sneeze at in a breach of lease action. That judgment can get entered and you can file a UCC Judgment lien which, if properly perfected and seasoned, can be a secured lien if the tenant files for bankruptcy protection. 
3. In many instances, the landlord can immediately, upon filing of the complaint, obtain a pre-judgment Writ of Attachment whereby the court, if it is convinced that the Landlord will probably win the suit, can allow the landlord to attach any or all of the tenant's assets in an amount equal to what the court anticipates the tenant will owe up to the anticipated date of trial, plus anticipated attorneys fees and costs of suit. This is a very effective way to force a quick settlement; and
4. After you get your first judgment, it is relatively simple to get a judgment for rents accruing after the date of the first judgment and even another pre-judgment Writ of Attachment. That's because in the second suit, you do not have to re-prove anything that you had already proven in the second suit. We lawyers use the latin term for this as "Res Judicata." All of the facts proven and issues resolved in the first suit are taken as admitted and proven in the second suit and a pre-judgment Writ of Attachment is almost guaranteed.

It is important to note that additional factors that I consider are the type of property, i.e. retail vs. office, industrial, warehouse, etc., the financial resources of the tenant, (to what extent we believe they can pay on a judgment) and the state of the economy, (the ease of re-leasing the premises at a rental rate equal to or greater than the rate owed by the tenant in accordance with their lease.

 

Commercial Foreclosure Basics in California - Part 2 An Update

I am often asked by borrowers whether of not a lender can sue the borrower for any amount that is owed on the loan, over and above the sale price received at a private sale.  Well, there are many, "it depends."  The first depend is, "it depends what state the property is located in."  First and foremost, you have to be aware that each state has different rules and procedures and I am not qualified to advise in any state other than Califonia, so this post is limited to property and laws in California.  However, while I am only referening certain laws and rules in California, the are many similarities from state-to-state.

In very short summary, if the lender proceeds with a NJF, (non-judicial foreclosure), a procedure provided by California law and the property is sold as a result, the lender cannot proceed against the borrower if there is any deficiency.  By deficiency, I mean that the property sold for less then what was owing on the secured loan.

In California there are two procedures generally used by lenders and trustees when foreclosing on the collateral given by a defaulting borrower, (1) judicial foreclosure, and (2) non-judicial foreclosure.  In a commercial context, in California both procedures are used.

Often, the lender proceeds with a non-judicial foreclosure to begin the statutory process allowing the lender to foreclose on the property, usually without the involvment of an attorney.  The non-judicial foreclosure process is relatively quick and inexpensive as compared to a judicial foreclosure and is also typically used in residential foreclosures.

Concurrently with or a short time after the commencemnet of the non-judicial foreclosure process, a lender will often file with the court, a judicial foreclosure lawsuit, seeking an immediate appointment by the court of a receiver.  Usually, the main purpose of the receiver is to manage the property and collect rents during the pendency of and until the sale of the property as a result of the non-judicial foreclosure.  This will preserve and protect the lender's collateral, to the extent possible. Usually, the judicial foreclosure lawsuit remains open and active for a period of time beyond the sale of the property at a non-judicial foreclosure in order to allow the receiver to finalize the administration of the property while the receiver was responsible for managing the property and upon the final report of the receiver, the lawsuit is usually dismissed.

However, there are some occassions where the judicial foreclosure lawsuit is not dismissed and the lender can continue to proceed with a lawsuit, seeking damages against the borrower and, in some cases, a guarantor.  A lender will continue to proceed against the borrower and/or the guarantor including instances in which the lender believes that the borrower or its principal was involved in some sort of fraud relating to the loan or missapropriation of rents that part of the lenders collateral.  Continuing actions may also include action against guarantors who fully or partially guaranteed the loans or were otherwise subject to certain carve-out rules.t

Following posts will address The Bird Rule and carve-out exceptions to limited guarantees.

Please take care when using the above information.  As in most cases, the devil is in the details and the exceptions are what keeps lawyers employed.  A thorough analysis by your attorney should be done before you act on any of the advice contained herein.

 

California Appeals Court Rules Oral Promises Are Binding

A recent California appeals court ruling found that an oral promise by a lender to modify a loan is enforceable, by the borrower.
California Appeals Court Rules Oral Promises Are Binding.

To an experienced lawyer, a recent court ruling in California finding that an oral promise to modify a loan can be enforceable even when the loan documents require a writing to modify the loan, is not new or surprising law and is nothing more than what we learned in law school.  What us lawyers would refer to as "Hornbook Law." We know this defense as "Promissory Estoppe and can be raised as a defense in almost any contract dispute, not just loans. The defense arises when one party reasonably relies upon, to their own prejudice or harm, the person making the promise may be bound by their oral promise. 

There are some difficulties in the defense, not the least of which is proving that the promise was actually made, that the promisee reasonably relied upon the promise and that the promise relied upon the promise to their prejudice.

Deficiency Judgments allowed in Arizona

For those living in California, take heed of Arizona's new law allowing deficiency judgments in foreclosure actions.

In July, Arizona passed legislation removing the ban on a lender obtaining a deficiency on a foreclosed home except in instances in which the borrower lived in the residence for more than 6 consecutive months and was able to prove it with a certificate of occupancy. The bankers love it but public criticism has prompted legislators to repeal the July legislation.

Arizona bankers are not taking this sitting down though and are appealing to the Arizona Supreme Court trying to block the repeal on technical grounds.

For more of an explanation of when a lender can obtain a deficiency, see my earlier article Commercial Foreclosure Basics, Part II.

Give it Some Thought First

When meeting a new client or potential new client, I am often asked why they should hire me.  Of course I go through the list of my attributes that I believe the clients will recognize as the kind of attributes that they will want in an attorney.  Primarily, I try to point out how I can help them make money or save money and in any event make them better off after they hire me then before.  What I also try to do is to describe the kind of clients that choose to work with me and are loyal to me for years.  I do this because not all clients are motivated by the same things or are they looking for the same relationship with their attorney. And yes, it is a relationship. One that I believe is based primarily on trust.

The clients that seem to be the most attracted to me are the ones that like to think about what they are going to do before they do it.  They like to strategize and decide if they are better off serving a Notice to Quit or simply sue for rents as they accrue without terminating the lease; which strategy will make them more money in the short or long term or save them more money in the short or long term.  They are the kind of clients that do consider both the long and short term considerations. What is likely to happen if they enforce the continuous operation clause or choose to ignore it?  What will the effect of their decision be on the other tenants in a shopping center or their ability to later obtain a loan or attract new tenants to the shopping center.  Is the penalty provision in a lease enforceable and can the landlord ultimately rely upon that provision as part of its long or short term strategy? What are the costs associated with serving a Notice of Right to Reclaim Abandoned Property and are those costs warranted under the particular circumstances of the case? How can we move a case along faster and what would it cost to do so?  What is the likelihood of success and does success mean collection on a judgment?

I don't think that I am primarily used simply as an enforcer of contracts or a reciter of laws.  I like to believe that I have loyal clients because they use me to help guide them through the myriad of legal issues associated with their business, using not just my legal knowledge, but my practical common sense based upon over 33 years of business and legal experience

I do not think that someone looking for a cheap, thoughtless reaction would be interested in the services that I provide.  I give too much thought to what I say, do and recommend to be considered cheap.  That is not to say that I am expensive, particularly since I charge less than 1/3 of what most typical lawyers charge with similar experience.  I use paralegals and attorneys, not to do my work, but to do the work that doesn't require my gray haired experience and knowledge. I really don't have hair but I have now officially been referred to as a gray hair.  And yes, I was at Woodstock!

The clients who use me for years are the clients that look for an attorney who they can trust.  An attorney who is not afraid of telling them not to waste their money on emotional, non-productive lawsuits, but will also fight for their best interests with a passion.  An attorney who will give them the most bang for the buck.

Secure Rental Deposit with Writ of Attachment

I have previously explained that California Civil Code Section 1950.7 limits a commercial landlords ability to use more than 2 months rent being held as a security deposit, see Commercial Landlord's Obligation to Return Security Deposit, and further explained that a commercial tenant can waive the protections of California Civil Code Section 1950.7 in the lease, see Can Tenant Waive Landlord Restrictions on Use of Security Deposit. But what if the tenant has not waived the civil code section?  Is there any way that the landlord can hold on to the amount of security deposit in excess of two months?  The answer is yes, but it will be more costly than a waiver in the lease and the landlord needs to move pretty quickly after the lease termination.

The landlord can secure the excess security deposit amounts by obtaining a Pre-Judgment Writ of Attachment, see Securing Tenant Rents While in Litigation and Before Judgment and  An Advantage of a Pre-Judgment Writ of Attachment.  However, the landlord must obtain the Writ of Attachment prior to 30 days after the date that the lease terminates, otherwise, the landlord will have to return the excess security deposit.  For example, consider the following facts:

•  Landlord holds six months security deposit equal to $120,000;
• Last months rent is $20,000;
• Tenant is $20,000 in arrears;
• Lease terminated on May 31, 2009 after the service of a 3 Day Notice and the tenant vacation on that date;
• The lease term was 5 years ending on May 31, 2012, with over $760,000 owing over the remainder of the term of the lease;
• Tenant did not waive 1950.7;
• Tenant left the premises in such a way that repair by landlord was not necessary.

Without any other facts, and assuming some other detail that I have not disclosed in this posting, the landlord will have to return $60,000 of the security deposit by July 1, 2009, since the landlord can apply back due rent of $40,000 plus last months rent of $20,000.  However, if the landlord chooses to pursue future rents owing on the lease, in accordance with Section 1951.2 of the California Civil Code, and the landlord obtains a Writ of Attachment prior to July 1, 2009, the Writ wouuld attach to the balance owing of the security deposit that would have otherwise been returned.

The landlord must ask as to whether or not the Writ of Attachment is a good or adequate remedy to secure the security deposit.  My thought is that if the landlord is going to pursue future rents, then it should be moving for a Writ of Attachment anyhow and the fact that the landlord is holding, in its hands, $60,000 is just greater motivation to go for the Writ and to do it early.  It should be noted that the Writ of Attachment could be applied to secure other assets, including but not limited to inventory, real estate, etc.

Can Tenant Waive Landlord Restrictions on use of Security Deposits

In my earlier posting, Commercial Landlord's Obligation to Return Security Deposits addressed the restrictive nature of California Civil Code Section 1950.7, which, generally limits the landlord's ability to use a commercial tenant's security deposit to up to approximately 2 months rent, when the default is the payment of rent.  If you are holding more in the hope of using the balance to pay future rents, forget it, unless, your lease explicitly has the tenant waive the provisions of California Civil Code Section 1950.7, a provision that I don't see in leases often.  Yes children, your first line of defense here, if you are a commercial landlord is to have a provision in the lease, explicitly waiving the landlord's restrictions. It should be noted that the "Standard," American Industrial Real Estate Association lease does not include such a waiver.

Let's go over a practical example, with and without an explicit waiver:

With Waiver:  Landlord is not sure about the tenant's financial ability to pay rent so it requires as part of the lease, a security deposit equal to 6 months rent and CAM charges, which the tenant pays.  13 months into the lease, the tenant stops paying rent and is 2 months in arrears by the time they abandon the premises and terminate the lease.  Assume for the moment that the lease has been terminated, an issue that I will discuss later in more detail.  Landlord may immediately sue for future rents, assuming the lease already allows the landlord to do so and can apply all of the security deposit to the balance of rents owing, both in arrears and prospectively.

Without Waiver: Considering the above facts and if the lease does not provide a waiver of California Civil Code Section 1950.7, the landlord must return 4 of the six months security deposit withing 30 days after the termination of the lease, even though, both the landlord and tenant know that the landlord will ultimately be owed an amount equal to or greater than the 4 months security deposit that has to be returned.

In a strong economy, this issue may not arise that often since the leased premises are often re-leased relatively quickly and a large security deposit usually does not need to be drawn down upon and large security deposits are not as common.  In a weakened economy it becomes a more significant issue since larger security deposits are more common and the need to draw upon the security deposits increases as vacancy rates increase.

There are some alternative remedies, some of which I favor and some, which I do not, all of which will be addressed in later posts.  However, from the landlord's perspective the waiver of California Civil Code Section 1950.7, is clearly the least expensive and most favorable security deposit remedy that the landlord has in its arsenal against defaulting tenants.

An Advantage of a Pre-Judgment Writ of Attachment

When considering pursuing a collection action against a tenant debor and upon filing the complaint, the landlord or Plaintiff should consider filing an Application for Pre-Judgment Writ of Attachment.  If granted by the court, the landlord can attach assets of the tenant, immediately and  prior to obtaining judgment in order to secure payment on the judgment, when the landlord eventually obtains the judgment.  One of the significant advantages of the Pre-judgment Writ of Attachment is that the landlord can, prior to obtaining judgment, do discovery to determine the assets of the tenant, they type of discovery which is not normally relevant until after the landlord obtains judgment.

Securing Tenant Rents While in Litigation and Before Judgment

If suit is brought to collect rents owed by a tenant, there is a court procedure in California that can secure the tenant obligation before the landlord obtains judgment.  It is called a Pre-Judgment Writ of Attachment.  The term "Pre-Judgment," is merely descriptive.

A Writ of Attachment is a court order, obtained upon application by the plaintiff, (landlord), at any time after the filing of the complaint and before judgment or dismissal, which will allow the landlord to take possession of the tenants assets in order insure payment on the judgment once the landlord goes through the litigation process and obtains judgment.  The Writ can be used to obtain funds in a tenants bank accounts or to take possession of cars, boats or any other asset that might secure the judgment.

Obtaining a Writ of Attachment can be a very effective tool in persuading a tenant to settle the lawsuit or of course, will significantly increase the landlord's chances of actually collecting rents rather than just obtaining a worthless judgment.

Actually getting the order, is not a mere matter of right in favor of the landlord, but can be obtained only in situations in which the landlord can convince the court that the landlord will probably prevail in the suit in the amounts that the landlord seeks in the Writ application. This is a significant burden of proof at such an early stage of the litigation and courts are leary of allowing the landlord to take the tenant's assets before judgment unless the court is pretty certain that the landlord will prevail at the time of judgment. 

Cost of pursuing a Writ of Attachment is also a significant consideration and is not likely a recommended procedure unless significant tenant assets have been identified that can be subject to a Writ of Attachment.  In addition to having substantial facts in favor of the landlord, significant attention to detail and argument, including persuasive declarations need to be prepared and submitted to the court.  The landlord also needs to be credit worthy in order to obtain a bond that is required by statute.  The total cost of obtaining and enforcing an effective Writ of Attachment could range from as low as $2,000.00 to as high as $10,000 or more.

Finally, it should be noted that a Writ of Attachment is not enforceable and will have no legal effect in the event that the tenant files for bankruptcy protection.