Beep, Beep. Escalation Clauses and Wile E. Coyote

A shout out to my brother David who sent a link about a road runner cartoon tunnel painted on a wall by a graffiti artist and how someone tried to drive through it.

Just like Wile E. Coyote, that move did not turn out so well for the driver’s car. My favorite comment posted was “He’s lucky, a train could’ve come out of there.”

Please indulge us as we dedicate this issue to that renowned commercial leasing attorney, Wile E. Coyote.

And why not? He has many admirable qualities.

He is, after all, as his business card attests, a “suuuuuper genius”. You also cannot question his loyalty to the Acme Company and all of its fine products. And he is certainly more resilient than most in his ability to bounce back after falling off a cliff or having an anvil fall on his head.

Yes, I admit, he does keep falling for the same tricks. Not since Bugs Bunny regularly got the best of Elmer Fudd, has one of my hapless heroes been so consistently outdone.

Perhaps the same could be said for all commercial tenants and their hapless hero commercial leasing attorneys.

We keep falling for the same tricks, a.k.a. “industry standards” that do not make sense in any other commercial context.

For example? Glad you asked!

For all commercial contracts there is an applicable statute of limitations governing the period of time that a party can bring a legal action to address a wrong. In New York State, the statute of limitations in a standard contract is six years.

In most commercial leases, landlords afford themselves the right to invoice their tenants for operating expenses and taxes that were underbilled with no restriction on how far back they can go in time other than the applicable statute of limitations, but at the same time require that their invoices for operating expenses and taxes be deemed final unless objection is made by the tenant within a relatively short (e.g., 30, 60 or 90 days) period of time after receipt.

Even if an audit of operating expenses shows a huge error in a particular operating year, the lease language often precludes the tenant from correcting that error in prior operating years.

This is the functional equivalent of our suuuuuper genius coyote friend missing his prey and then realizing that he is running in place ten feet from the cliff with a giant chasm below.

Avoid your operating expense and real estate tax escalation clauses from becoming a puff of smoke at the bottom of a cliff by following these six Acme Company approved suggestions:

• Afford yourself ample time. It is unlikely that you will be able to convince a sophisticated landlord to agree to the local statute of limitations time periods with respect to operating expense audits and real estate tax objections. Your landlord has a legitimate interest in closing its books, but you should grant yourself plenty of time in your lease to determine whether to audit operating expenses (180, 270 or more days; not the 30, 60 or 90 days usually offered) and to conduct your audit, and these rights should specifically extend past the expiration date with respect to the final lease year. You should also have 60 or 90 days to review, understand and raise questions regarding any real estate tax escalation invoice (which invoice should include any bill received by your landlord from the municipality).
• Allow time to provide details. Avoid any schedule for your operating expenses audit that requires you to provide specific details at an unreasonably early stage in the process.
• Include Base Year. It does not do you much good to audit a particular operating expense year if you do not have the ability to also audit the base year. Ideally, you should be entitled to audit the base year together with the first operating year that you audit, even if such operating year does not occur until near the end of your lease. At a minimum, try and provide that you can audit the base year together with any of the first three or four operating years.
• Cover prior errors. If you discover during your audit that your landlord has made an egregious error that may have been perpetuated over the years, allow yourself the right to reopen operating expenses from prior operating years even if the time period to do so would have otherwise expired.
• Require maintenance of books and records. You should require your landlord to maintain its books and records (in a uniform system and at an easily accessible location) for a reasonable period of time that coincides with your lease audit rights.
• Limit your landlord’s “look back” period. There is not much worse for a tenant than to receive a large invoice towards the end of its tenancy for sums that its landlord neglected to bill in prior years. You should preclude your landlord from billing you for a particular operating year or tax year for an agreed upon period of time (e.g., two or three years) from the end of the applicable operating year or tax year. In addition, try to limit your landlord’s ability to look back after such two or three year period to invoice you for additional items or to correct underbillings. Make all such time periods “time of the essence”.

In his autobiography, Looney Tunes animation director Chuck Jones indicated that the creators of the Road Runner cartoons carefully followed nine rules for each cartoon (e.g., “no dialogue other than ‘beep beep’”, “no outside force can harm the coyote; only his own ineptitude or the failure of the Acme products.”, etc.). You can be a suuuuper leasing escalations genius and you only have to carefully follow the six rules above when including time limitations in your operating expense and real estate tax escalation clauses.