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Legal Rights Versus Practical Rights

A well written lease should have a comprehensive and aggressive remedies section in favor of the landlord. The landlord’s rights should include the right to collect both past due and future rents, the right to re-enter the premises and relet it to another tenant, the right to terminate the lease, and the right to collect all damages incurred in connection with the tenant’s default. These rights will put the landlord in a position to recoup its losses and be made whole in the event that the tenant does not live up to its obligations under the lease…if the landlord can exercise its rights. There is a difference between the legal rights granted to the landlord in a legal document, and the practical rights that the landlord will actually have if a dispute arises or if a tenant defaults. The former is worthless if the latter does not exist.

Cost of Litigation

The first, and usually the largest, hurdle to overcome in a dispute with a tenant is the cost of the litigation. The old adage that the only ones who truly win in a legal dispute are the lawyers is true when it comes to lease disputes as the legal costs that the landlord incurs can greatly outweigh the damages that the landlord will receive. If a landlord is lucky, it has included language in its lease that states that the prevailing party can collect its legal fees from the other party. This right, however, is also a double-edged sword as a landlord may lose its case and end up with not only having to pay damages to its tenant, but also both the landlord’s and the tenant’s legal fees. This is a risky proposition.

Let’s consider the actual costs. A landlord’s out of pocket costs for a simple eviction start at $1,000, but this action can easily cost more than $100,000 if the tenant disputes the eviction, brings defenses, makes procedural objections, or delays the trial. Similarly, an action to recover damages will likely cost more than $2,000 just to file the complaint before the lawyer even steps foot into a courtroom or receives any response from the tenant. A landlord would likely pay more than $50,000 for a simple trial. A crafty tenant’s lawyer could cause the landlord to bleed cash and delay an action so that the landlord is compelled to reach an unfavorable settlement with its tenant even if the tenant is to blame.

The Insolvent Tenant

Prevailing in a lawsuit against a tenant is not the end of the landlord’s problems. Even assuming that the landlord evicts its tenant and wins a lawsuit against its tenant, the landlord must still collect on its judgment. Many tenants are shirking their obligations under their leases due to the simple fact that they have no money. If the landlord comes after the tenant, it will simply declare bankruptcy to avoid its obligations to its landlord. A landlord could try going after the guarantors as well, but chances are that they, too, are bankrupt, and the landlord may need to commence another legal action against the guarantors if the landlord has not included the guarantors in the original lawsuit.

Solutions

If the landlord is confident that it will prevail in any litigation brought against the tenant, the lease contains provisions that not only allow the landlord to recoup unpaid rent and damages, but also legal costs, and the tenant has deep pockets, the landlord should by all means commence a lawsuit and seek its damages. For the majority of the landlords in the world, however, this will not be the case. Such landlords should consider negotiating with their defaulting tenants. Although it may be painful, a landlord may have to swallow its pride and simply allow the tenant to vacate its premises. A landlord that offers a tenant a deal that relieves that tenant with most or all of its future obligations under the lease may be the best scenario for all parties as the landlord will be able to lease up the space and avoid mounting legal fees.

The best scenario for landlords is to protect themselves when negotiating the lease. Cash is always king so any security deposit that a landlord can obtain will benefit the landlord greatly, but tenants in today’s market are not willing to pay a security deposit equal to more than a month or two in rent so the security deposit alone will not provide the level of security that most landlords want. Another alternative is to require that the tenant provide a letter of credit, but even this form of security is not fool-proof as many landlords find that the bank that issued the letter of credit is not always willing to honor its obligations under the letter when the tenant’s finances go south. A lien on the tenant’s assets is another viable alternative if the tenant has assets and the tenant’s lender does not already have a lien on the assets. The best form of security is finding both tenants and guarantors with strong balance sheets, regularly checking the financial health of each, adding provisions in the lease that allow the landlord to declare an event of default if the tenant’s or the guarantor’s net worth is in jeopardy, and actually exercising its rights on the lease before other creditors are involved if, in fact, the tenant’s or the guarantor’s net worth deteriorates.

One additional comment should be made. When negotiating with its defaulting tenant, a landlord should be extremely cautious with how it treats the tenant and its property. A landlord can inadvertently accept a surrender of the tenant’s leasehold interest (thus relieving the tenant from any additional obligations), constructively evicting a tenant, or undertaking certain actions that would allow the tenant to bring a claim for damages. A landlord should seriously consider engaging an experienced leasing attorney for each of these steps so that it can avoid potentially harmful and unwanted consequence.

DISCLAIMER: This article is to be used for general information purposes only, not as a substitute for in-person evaluations. The information contained herein is not legal advice and no attorney-client relationship is formed through this article.


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