Empty Spaces – How to Protect Yourself From a Defaulting Tenant

Empty Spaces – How to Protect Yourself from a Defaulting Tenant

Presented By: William R. Meyer, Kelly D. Stohs,

David P. Vallas, Brendan McPherson

Topics to be Covered

Collecting unpaid rent

A landlord's obligation to mitigate its damages

Whether you can sell property left in the premises to cover a tenant’s debt

What to do when a tenant files a bankruptcy

HOW TO COLLECT A/R

Presented By: David P. Vallas

Tools to Collect A/R

Manage expectations

– Evaluate the goal at the outset: recovering possession or A/R or both?

Best tool to collect A/R is to understand the tenant’s business and financial wherewithal.

– Asset reports do not tell you where the money is hidden.

Tools to Collect A/R

Lessons from Al Capone

– “You can get much further with a kind word and a gun than you can with just a kind word.”

• Really just saying, “Create downside risk.”

What is a landlord’s “gun”? How to create leverage?

– Speed: Easier to slow down than to speed up

– Unlawful detainer action

Unlawful Detainer Actions

Unlawful detainer proceeding

– Pros:

Very powerful tool: A landlord can shut down a tenant’s

business for even a slight lease infraction.

Relatively fast process: A matter of months, not years,

from start to finish.

– Cons:

Generally a tenant favored system

Most eviction judges are not accustomed to complicated commercial leases.

Terminating what?

How to tip the scales (further) in the landlord’s favor?

– Terminating the right to possession

The rental obligation may not continue.

– Terminating the lease

Terminating the lease may have unexpected consequences.

Worth at time of award formula

The Remedy Provision

Recovery: Terminating the lease – “Worth at time of award” approach

• Past due rent + future rent – amount tenant proves could be avoided

– “Fair market value” approach

• Past due rent + future rent – fair market rental value of the premises

Concerns?

It is hard to understand

What if Tenant fails to raise a defense?

Courts are reluctant to enter judgment if they believe the Landlord could double dip.

What if fair rental value exceeds the current rental rate?

Contemplates perfect mitigation – No Dark Period!

Must a Landlord seek future rent in unlawful detainer action?

Collateral estoppel and the rule against claim splitting.

The Remedies Provision

A better formula?

– Landlord may accelerate and recover present value of rental due through end of the term.

– Any recovery, whether from tenant or any replacement tenant gets applied:

• First, to the landlord's costs and re-letting expenses;

• Second, to unpaid and accelerated rental; and

• Third, to original tenant.

THE OBLIGATION TO MITIGATE DAMAGES

Presented By:

Kelly D. Stohs

The Duty to Mitigate Damages

Measure of Landlord’s Damages – Affirmative Defense of tenant

– May limit your recovery of damages

Existence of the Duty depends on – Lease

– State law • Common law

• Modern Trend

• Statute

– Landlord’s actions

The Modern Trend

Varies from State to State

– Common Law: No duty to mitigate

• Rationale: property law

– Modern Trend: Imposes duty on Landlord

• Rationale: contract law

The Majority

Majority of States Imposes a Duty – At least 28 States: Arizona, Arkansas, California, Colorado, Delaware,

Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Mass., Michigan, Montana, Nebraska, New Jersey, North Carolina, North Dakota, Ohio, Oregon, South Carolina, Tenn., Texas, Utah, Vermont, Wash., Wisconsin, Wyoming

Statutes – California, Cal. Civ. Code 1951.2(c)

– Delaware, Del. Code Ann. 5507(d)

– Illinois, 735 Ill. Comp. Stat. 5/9-213.1

– Texas, V.T.C.A. Prop. Code 91.006(a)

– Wisconsin, Wis. Stat. 704.29

Variations

State to State Variations – A few states limit the duty to certain circumstances,

such as upon re-entry or termination of the lease (Delaware, D.C., Florida, Massachusetts, Missouri)

– No Duty to Mitigate (common law) (Alabama, Georgia, Minnesota, New York, Penn., Virginia)

– A couple states have not addressed the issue

Best practices: – Be aware of state law when taking back possession or

sending termination letter – Include a lease provision that negates duty, as matter of

contract law, upon termination or return of poss.

Waiver of the Duty

Waiver in the Lease

– Waiver Not Enforceable: Texas, New Jersey

– Waiver Enforced: North Carolina, Ohio

– Factors under Contract Law

• Equal bargaining power, Arm’s length transaction

• Public policy

What is Required to Mitigate

What is required of Landlord? – Only “reasonable” efforts or diligence

– Totality of the circumstances • Listing with reputable broker

• Sign

• Advertising efforts

• Interactions with potential replacement tenants

Best Practice: Document your efforts and communications

• Majority: Burden of Proof on Tenant

– Whether duty was met and the amount

Common Issues

Commonly Litigated – Efforts to advertise

– Negotiations or communications with potential new tenant

– Subdivide

– Listing/Leasing for lesser or higher rent

– Leasing other vacant space first

Best Practices

Define in the Lease what is reasonable, and what “shall not be deemed” unreasonable. – Landlord may re-let whole or part “upon such terms and

conditions acceptable to Landlord in its sole discretion”

– Use by new tenant

– Caliber of new tenant

– Leasing other vacant space first

– No obligation to improve space for new tenant, and LL may offer rent incentives

– May make repairs, alterations, and additions, alter character of space, in sole discretion,

– May re-let for lesser/greater term, re-let all/part premises

DISPOSING OF PERSONAL PROPERTY OF TENANT

Presented By:

Bill Meyer

Personal Property of Tenant

Your tenant is gone…

…but their stuff is not– now what?

Options for Property Left Behind

Four Options:

– Leave it on the curb

– Deem it abandoned

– Enforce a landlord lien

– Get a judgment and execute on the remaining property

… (or self-help)

Dump it on the Curb

After getting an order for possession

you can clean out the space and leave

any leftover property on the curb

Safe harbor

Public policy to protect landlords

Fixtures and Abandonment

Is left over property yours?

– That depends!

– Fixtures

– Abandonment

Landlord Lien

Three kinds of landlord liens

– Common law

– Contractual

– Statutory

Benefits

– Potential for expedited recovery

– Single lawsuit

Get a Judgment

Post-Judgment Collection

– Once you have a judgment, you can

execute on the judgment

– Separate proceeding

– Sheriff’s sale

Conclusion

Consider whether there is any actual value in property left behind

Real value may be retaking possession of the space as quickly as possible

TENANT BANKRUPTCY Presented By:

Brendan McPherson

Be Aware of the Automatic Stay

11 USC § 362

Protects a debtor – i.e., tenant – from virtually every action against them

The stay takes place without any motion or action by the debtor/tenant (it’s automatic)

Serious penalties associated with violating the automatic stay

Violation Examples: Starting or continuing an eviction or other litigation against tenant, calling tenant or sending demands, setting off funds, removing property or changing locks

Stay remains in place for duration of case, unless “lifted”

Automatic Stay – Special Circumstances

Automatic Stay may not apply when: – If term of the lease expired before the bankruptcy date or

expires during bankruptcy proceeding. 11 U.S.C. § 362(b)(10).

– Chronic Filers: Stay terminates 30-days after filing, unless court extends for debtors whose case was dismissed in last year. 11 U.S.C. § 362(c)(3). Or, if debtor had two or more cases pending within one year, no stay goes into effect. 11 U.S.C. § 362(c)(4).

– Special circumstances for residential leases.

Rent Payments During Bankruptcy

Debtor must comply with lease terms until assumption/rejection.

However, debtor may delay performance within the first 60-days for “cause.” 11 U.S.C. § 365(d)(3).

If no performance, must file a motion seeking to require performance.

What Happens to the Lease

Debtor’s Options: Assumption, rejection, or assign.

Debtor has 120-days to decide. 11 U.S.C. § 365(d)(4)(a). – Period can be extended 90-days for “cause,” but no more.

– If no decision in 120-days, debtor deemed to have rejected.

During 120-days, debtor required to pay pursuant to lease.

Assumption = assignment and assumption to third party – Can occur over landlord’s objection.

– Bankruptcy code eliminates the landlord’s discretion or consent rights in an anti-assignment clause.

Getting Paid

Pre-Bankruptcy Amounts Owed: general unsecured claim – may need to file a proof of claim. 11 U.S.C. § 502(b)(6)(B). – Only exception is that landlord will have a secured claim for amount of

security deposit.

Administrative Priority: – Amounts due in bankruptcy, prior to rejection

– Amounts not paid after assumption

Other Rejection Damages: If tenant rejects, landlord has an unsecured claim from amounts that would be due under the terms of the lease if there was no rejection (e.g. future rent), subject to a cap. 11 U.S.C. § 502(b)(6).

Landlord Liability Unique to Bankruptcy

Preference Actions. 11 U.S.C. § 547. – 90-day and 1-year look-back periods for insiders.

– Likely good defenses, but still risk

Fraudulent Transfer Actions – “Fraudulent” a misnomer

– Be aware of the source of rent payments

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