For the past few months, calls to our office concerning commercial real estate tenants defaulting on rent payments are at the highest rate we’ve seen since the tech wreck of 2001 and 2002. I will leave it to the economists to explain why this is happening, but here are a few practical tips from a legal perspective for landlords who may be dealing with this situation.
Assess the tenant’s situation
If the rent payment is late, call and ask why. If a credible, satisfactory answer is not forthcoming, ask about the tenant’s financial condition and demand financials as backup. (This is why it’s important to have a lease provision that allows you to demand financials upon any late payment.)
The bottom line is that any late payment in this economy is a signal that you need to have a face-to-face conversation with the tenant. It will help you size up your risk of lost rent down the line.
Have a well-considered position about occupancy and cash flow for your asset
Some landlords refuse to negotiate with a struggling tenant and some will do anything to protect even a reduced cash flow, while others consider each tenant on a case-by-case basis. Most landlords have a position that ties directly to the project’s financing.
Know your approach – don’t just react to the situation.
Size up the situation
Decide whether it is a lost financial situation or one where cooperation with the tenant makes sense. In most cases this will not be a difficult task. Financials, the tenant’s business history and credit and asset searches will tell the story.
Make sure your action is consistent with the desired result
Identify all of your objectives – do you want to get the space back, collect default rent, preserve post-default rights against the tenant, assert a landlord’s lien before the tenant leaves with valuable assets or relet the premises? Having a plan will dictate all future actions.
Know the contract
Know what your lease requires to begin and end enforcement action – timely compliance with its requirements will help minimize losses.
The squeaky wheel gets the grease
Written notice of default is almost always required – follow lease notice requirements precisely. Some leases include cure rights. Make sure these are specified in the default notice and give notice as soon as a default occurs. The party that takes the initiative is more likely to get paid than the party that delays. If there are nonpayment defaults by the tenant in addition to rent defaults, make sure these are specified in the same notice.
If the tenant has not cured the default, be ready to act immediately with the next step of your plan to achieve your desired result.
Know the next steps
• Apply the security deposit if the lease allows it.
• Analyze your remedial alternatives.
• Decide whether to lock the tenant out, but talk to your lawyer first.
• Decide whether to terminate occupancy or terminate the lease altogether. There is a distinction when calculating damages, so be careful.
• Consider litigation to recover damages. The terms of your lease, amount of money due for the lease term and the market for reletting the space will influence this decision.
• Once you gain possession of the space, common law requires you to make reasonable efforts to relet the space even if the lease does not. This obligation is commonly referred to as “mitigation of damages.”
Sometimes a tenant walks away, making the landlord’s decision easy. If this happens, it’s time to apply the security deposit, hope the tenant has cleared the space, order an asset search and decide whether to pursue litigation. If the well is dry, send a default letter terminating the lease. Take possession of the space, make reasonable efforts to relet it and hope the tenant will resurface at some point with assets.
Jeff Bennett is a shareholder at Jordan Schrader Ramis PC. He may be reached at 360-567-3900 or jeff.bennett@jordanschrader.com.
