True Detective and Your Lease Renewal
Okay, I admit it. I watched the second season of the HBO series “True Detective“, about three detectives linked together to solve the same murder case involving endemic corruption in Vinci, California (I like my corruption endemic) and, despite all the panning by the critics, I liked it almost as much as the first more critically acclaimed season.
That is, until the series finale. Spoiler Alert!
Yes, the episodes were contrived and confusing, with too many coincidences, characters and stiff dialogue, but it kept me coming back, if nothing else for the opening Leonard Cohen song “Never mind“.
Not that I understood anything that happened (and I read incomprehensible commercial lease provisions for a living). I could only sort of, kinda, figure out what was going on by hitting the blogosphere.
But that lame ending! Basically, three of the four main protagonists survive shootouts in ridiculously unlikely ways only to die by either taking incredibly stupid risks or at the hands of bit characters that appear out of nowhere. Really?
In the film noir world of commercial real estate, with similar mayhem, mystery, sex and violence, we have our own pressure to come up with a satisfactory ending. One way is to keep the show going by having one or more renewal rights to extend the term.
Such renewal rights usually need to be negotiated up front during the term sheet stage, in particular the rental during the renewal term.
To be equitable, the rental should be a “fair market rental” (or, if the tenant has some leverage, some percentage (e.g., 95%) of the fair market rental).
Some landlords will propose extremely one-sided approaches, such as being entitled to propose its version of a fair market rental and, if the tenant does not accept, then being free to rent to third parties as it pleases.
Tenants must insist on an objective methodology when determining their fair market rental.
One of the most effective and equitable approaches is to provide for an arbitration procedure to determine the renewal term rental.
In fact, commercial leasing attorneys and brokers will tell you that a properly drafted arbitration provision is so equitable that it is hardly ever invoked!
That is because most landlords and tenants come to the conclusion that an arbitration proceeding is not worth the time and expense and that realization forces the two parties to negotiate a fair outcome.
Make sure your renewal rent arbitration provision is equitable by covering the following 10 issues:
- Define “fair market rental”. This should be what a willing lessee would agree to pay and a willing lessor would agree to accept for the renewal premises during the renewal term. Your landlord may try to provide that your rental cannot be less than the “floor” of your then current rental, but this is not fair market and should be resisted.
- Set the deal parameters. The arbitrators will need to reflect in the fair market rental certain aspects of the renewal deal, for example, that your landlord will not be providing any initial work or tenant concessions, that the base years for escalations will be updated, or that there is no rental charged for terrace space.
- Include “all relevant factors”. Many landlords will try to require that the arbitrators take into account only certain factors which, not surprisingly, benefit the landlord. Some of these may be “phantom factors” or value enhancing measures that your landlord is not even providing. The arbitrators should be entitled to make their determination based on “all relevant factors”.
- Objectively determine the arbitrators. Whether selecting one arbitrator or having each party select an arbitrator who then together select a third arbitrator, the parties must either agree on an independent arbitrator or provide for selection by a neutral third party, such as the American Arbitration Association or a court with jurisdiction. A landlord advocacy group is not an independent third-party.
- Set criteria for the arbitrators. The arbitrators should be leasing brokers or attorneys with at least 10 years’ experience in the applicable area, and without any conflict of interest, such as having recently(e.g., past five or ten years) been involved in a litigation with either party.
- Structure for success. The arbitration procedure should encourage voluntary agreement without the need to resort to arbitration.
○ Employ Baseball Arbitration. This is the method (used by Major League Baseball for salary arbitration) where each party selects a rental figure and the arbitrator must select one of proposals, but no other amount. This compels the parties to propose reasonable figures since an outlier is likely to be rejected.
○ Pre-arbitration discussions. Build in a formal time period (e.g., 30 or 45 days) for the parties to meet and discuss options before heading into formal arbitration. Some leases will even provide for a pre-exercise estimate request, where a tenant can request that the parties submit their proposed figures well in advance of the exercise of the renewal right, with the requirement that such figures be the ones submitted to an eventual arbitrator.
○ Split the difference if close. If the parties’ estimates are within some pre-determined amount of each other (e.g., 3% or 5%), require that the parties “split the baby” rather than go to the expense of the arbitration proceeding.
- Agree on the process. Specify whether there will be formal hearings, witnesses or discovery, and provide timetables for the parties to appoint arbitrators and submit proposed rentals, with rights deemed waived if responses are not timely. Timing is important if for no other reason than that your landlord may require that you use its rental determination until final determination by the arbitrator (at which point there should be a “true up”). At a minimum, your lease can tie into an objective set of rules, such as procedures of the American Arbitration Association or a similar independent body.
- No thank you. If you are a very large tenant with sufficient leverage you may be able to obtain the option to reject the fair market rental after it is determined by the arbitrator. Most landlords will not agree and will want you obligated to go forward once the option is exercised; not an unreasonable position.
- Determination should be binding. Any decision rendered in the arbitration should be final and binding with the parties consenting to the entry of any order of judgment in court.
- Specify costs. The parties generally share the costs and fees of a third arbitrator and pay their own costs associated with “their” arbitrator and attorneys.
Most (not all) leases do not require shootouts in order to transition to a successful renewal term. But just to be safe, your lease renewal has a better chance of a happy ending by following our ten suggestions above.