§ 14.02 Defaults

• Jurisdiction: United States
• Publication year: 2022

§ 14.02 Defaults

[1]—Incurable Defaults

Office lease forms increasingly contain prohibitions or limitations which, once breached, have no grace period or provision enabling the tenant to cure. For instance, if a clause specifies that it is a default if the premises are advertised for subleasing, then once breached, this type of default cannot theoretically be cured. A similar result would occur if there is a breach of a clause prohibiting advertising the premises at rental rates lower than those currently being asked by the landlord for space in the building or a provision requiring tenant to maintain specified insurance coverage.¹ Another example would be a breach of a clause specifying that it is a default if the tenant is late in its payments of rent or additional rentals more than a certain number of times in any twelve month period. For these types of defaults, there is no procedural method of cure.

The tenant should scrutinize the language of the lease carefully to ascertain whether any incurable default provisions exist. Incurable default provisions, whether intentional or not in the language of the lease, carry a substantial probability of forfeiture. If at all possible, the tenant should seek to avoid placing itself under the obligations of a lease containing them.

[2]—Material Defaults

There is a significant difference between defaults of material obligations found within a 200 page lease and insubstantial or nonmaterial defaults, such as forgetting to pay for last week's extra cleaning of a lunchroom in the amount of $25.00. It is the authors' opinion that less serious defaults should be differentiated in the lease from the material defaults. Examples of material defaults are: (1) nonpayment of significant monetary obligations; (2) sensitive nonmonetary defaults, such as default in the performance of the obligations to keep the demised premises safe or in legal compliance; or (3) violations of a use clause that places the landlord's ownership position in jeopardy of criminal or material civil violations.

Notwithstanding whether a default is material or not, when faced with a notice of default, a tenant should take all reasonable steps to address the default in order to avoid forfeiture of the lease. New York law is clear that a tenant's business decision to delay curing defaults precludes Yellowstone relief. The New York Appellate Division has held that when a tenant's action or omission under the terms of a lease "is entirely attributable to a tenant's business judgment rather than to surprise, inadvertence or circumstances beyond its control, equitable relief to extend the time" within which to act "is inappropriate."² In Nobu Next Door, LLC v. Fine Arts Hous., Inc., a tenant operated a restaurant and was served notices to cure defaults under the lease as a result of its failure to replace certain equipment and failure to dispose of food waste. The tenant chose to defer those repairs as a matter of its business judgment. The Appellate Division affirmed that the tenant was not entitled to Yellowstone relief in those circumstances.³

Additionally, the ramifications of defaults are generally more wide-reaching than simply facing the receipt of a notice and the possibility of termination. Many times other rights under the lease, such as receiving utilities or services, exercising options for additional space, renewal of term, first rights of refusal or rights to sublease or assign are conditioned upon the tenant not being in default under the lease.

Clauses that state that an option or another right under the lease is allowed "provided the tenant has faithfully performed its lease throughout the term and has not been in default thereunder" can give rise to an incurable default, however insignificant the act that precipitated it. This, in turn, may permanently block the exercise of a valuable and significant right negotiated by the tenant. Incurable defaults are like the first check in a chess game. The incurable default will continue to prohibit and block exercise of other rights throughout the term of the lease (as well as other leases if cross-defaulted, which may have a very bad continuing and far-reaching operating consequence to a tenant).

Specific written differentiation of materiality and significance of different types of defaults within the lease can avoid the impact of significant loss of rights of the tenant during the term of a lease. These issues should be thoughtfully examined and negotiated prior to executing the office lease.

[3]—Tenant Self-Help When Landlord Defaults

[a]—Operation of Self-Help

All leases have requirements for the landlord and the tenant to perform certain obligations. While all leases have default provisions, penalties and remedies in the event a tenant does not perform its obligations under the lease, not very many standard forms of landlord leases have penalties or remedies in the event a landlord does not perform its obligations. Additionally, most of the standard forms do not allow a tenant to offset or abate rent as a remedy for nonperformance by the landlord of its obligations.

It is not enough to specify that a landlord will operate a building in a first class or high quality manner or provide sufficient air conditioning and heating to the premises for the enjoyment of the tenant during the term. The tenant generally cannot afford the time or the cost to sue the landlord for breach of covenants nor can it depend on mutual covenants or conditions under the lease for terminating the lease in the event the landlord does not perform its obligations or provide its services.

For instance, the frustration of essential purpose doctrine, which would allow a tenant under some circumstances to terminate its lease, is not very helpful in practice when a tenant has worked hard to build its good will at its present location. It would be considerably disruptive to the tenant's clients, customers, and operations to pack up and leave. Withholding rent as a defense mechanism, if prohibited by the lease terms, could cause the tenant to have its lease terminated and leave itself open to other significant landlord remedies as well. None of these are satisfactory solutions for the tenant.

Astute tenants usually negotiate for self-help rights.⁴ Self-help allows the tenant to take the necessary actions to receive the essential services so operations can continue while the issues of rent credits or litigation are sorted out. The tenant can obtain its services from another source or may elect to perform the obligations of the landlord itself. In either case, the self-help clause should be structured to enable the tenant to receive payment back from the landlord or offset its costs against rent.⁵ Self-help rights fall into various categories:

• The right of the tenant to sue the landlord and receive specified liquidated damages, as well as reimbursement for all costs of the litigation should the tenant prevail.

• The right of the tenant to give landlord specific notice of its failure to live up to an obligation and, if the obligation is of the sort that the tenant may be able to provide for itself or retain others to provide, after notice, the tenant is authorized to obtain the necessary service. Further, the tenant has the right either to deduct the same from rent and additional rentals accruing under the lease, together with an interest carry factor applied or to sue the landlord for the costs and obtain judgment and reimbursement of legal and court costs, as well as other professional fees necessary for the litigation.

• If the remediation costs are greater than the tenant is able to bear or to defray by amortization against the future rentals under the lease, the tenant has the right to terminate the lease and collect from the landlord or from the landlord's property, any increase in the costs of renting substitute space, as well as moving costs and other damages resulting from the landlord's failure to perform under the lease.

A self-help provision can also be structured to allow the tenant, after giving notice to the landlord of its intention to do so, to complete any repairs that the landlord fails to complete within the time frame set. The provision would state that the tenant is entitled to reimbursement in the form of repayment or as a rent credit.

[b]—Rights of Superior Interest Holders

Mortgagees, ground lessors, and other holders of superior interests have considerable interests in tenant rights of offset and self-help. They will generally require that the tenant, before exercising such rights, give them notice of the default and an opportunity to cure the landlord's default under the lease.

If the notices and rights to cure of the superior interest holders are granted in the lease or by non-disturbance or recognition agreements, care and attention must be given to the fact that such entity may foreclose the landlord's ownership rights under the lease and step into the landlord's shoes. While superior interest holders may step into the shoes of the landlord, they will not necessarily be bound by or liable for prior defaults of the landlord nor by prior self-help rights of the tenant. If this is the case, a tenant may exercise self-help and replace a half million dollar air conditioning system serving the demised premises only to find that its rights to offset against future rentals or be reimbursed by the successor landlord are cut off by the non-disturbance agreement or other lease provisions.

Careful attention must be given to related documents as well as the language in the lease to see that a tenant self-help rights in the lease are not nullified by the related documents.

[4]—Landlord Leasing Strategies to Address Tenant Defaults

The following are some lease drafting strategies used to ensure either payment of rent and compliance, or a swift eviction" of a defaulting commercial tenant.⁶

[a]—Additional Rent

All required payments over the course of the lease, other...