Six questions to ask before filing suit for default on a commercial lease.
When a commercial tenant defaults in rent, the landlord must evaluate the cost efficiency of filing suit and likelihood of collecting damages. The particular lease terms can be critical to the outcome of the landlord’s and counsel’s evaluation. The complexity of any particular lease dispute can vary based on the nature of the circumstances, but there are six fundamental questions any commercial landlord and counsel should consider before filing suit against the non-paying tenant.
Is the Defendant Solvent?
As a starting point, there is no point to filing suit if the landlord ultimately cannot collect. A corporation or other legal entity experiencing a cash flow crisis may not have other assets that can be attached to satisfy a judgment. Before filing suit, it is important for the landlord to evaluate whether there is gold at the end of the rainbow. There are vendors that sell licenses to online databases that can be helpful in evaluating the availability of publicly known assets such as real estate. Alternatively, it may make sense to hire a private investigator to do an asset search.
Is There a Guaranty?
The existence of a guaranty can make a night-and-day difference to the landlord evaluating its options. For instance, a landlord may require the individual principal operating the corporate tenant to personally guaranty the lease obligations. Or if there is a lease assignment, the prior tenant and its principal may be required to remain liable as a condition to the landlord’s consent to assign the lease. If there are any solvent entities standing behind the lease, the landlord’s chances of recovering for unpaid rent increase exponentially.
Is the Guaranty Continuing or Limited?
The language used in the guaranty is important. Generally, a guaranty agreement may be limited or continuing. A limited guaranty may be confined to the lease obligations under the terms in place at the time of execution and may expire as of a certain time period. In contrast, a continuing guaranty may remain in place indefinitely (subject to the right of revocation, which can be waived), and give rise to future liability of the principal under successive transactions. In a longer term lease, a continuing guaranty can be particularly critical where the lease has been assigned more than once, the lease term expanded or the rent obligation increased over time. In such cases, the continuing guarantor will remain liable, even if the guarantor did not know about the expanded scope of its obligations.
What Is Reasonable and Necessary to Mitigate?
Mitigation can be a hotly disputed issue in lease litigation. The landlord must take reasonable steps to re-let the premises to limit the damage from the tenant’s default. Therefore, it is important the landlord act prudently and pursuant to reasonable commercial practices. Among other things, the landlord should evaluate (1) the need to engage a commercial broker (who may be a trial witness on the re-leasing efforts), (2) the types of potential replacement tenants, (3) the reasons for pursuing or rejecting any particular tenant and the reasonableness of doing so, (4) the need for tenant improvements and city permits, and (5) other considerations to expeditiously re-lease the property. Because mitigation is almost always a fact issue, the landlord should expect the tenant to challenge the mitigation efforts undertaken by the landlord.
What Types of Damages Are Available under the Lease?
Commercial leases commonly enumerate the types of damages that the landlord can recover. For example, the lease may provide that in case of default, the landlord can recover late fees and interest. If the lease is a net lease, it may provide for the landlord to recover such things as property taxes, insurance, utilities, maintenance and repairs. The lease may grant the landlord the right to recover the costs of re-leasing the premises, including things such as real estate commissions, and costs of renovation and alteration. All these things may add up and enhance the landlord’s damages claim beyond recovery of rent.
Does the Lease Have an Attorney Fee Clause?
The presence of an attorney fee clause will change the dynamic of the litigation. The landlord’s ability to recover its attorney fees and costs will make it worthwhile to litigate a default under the lease. The tenant exposed to paying the landlord’s legal expenses in addition to its own, on top of paying damages, will be more motivated to settle early versus attempting to litigate and win by a war of attrition.
Jared M. Katz is a partner with Mullen & Henzell L.L.P., in Santa Barbara, California.