Beware of Defenses to Commercial FEDs: War Stories

The typical reason to evict a tenant is the tenant's failure to pay rent. Although there may be other, technically, material reasons to evict a tenant, many commercial landlords will overlook those reasons if there is an ongoing stream of payments. If an HVAC unit goes out over warehouse space, the landlord is unlikely to initiate to notice the eviction of the tenant if it doesn't immediately replace the unit. On the other hand, if that same tenant fails to make its monthly rent payment within ten days of the date it is due, patience will not be one of the landlord's virtues. Nonetheless, a landlord typically has the right to evict any tenant that is in default of the terms of a rental agreement.

I. Generally

The good news for landlords is, commercial tenants do not receive protection from the legislature like residential tenants. The bad news is there are creative attorneys willing to represent tenants. It is good to know the scope and nature of the few defenses of commercial tenants to an FED action. The first step towards preventing wayward defenses is to recognize the existence of the defense. The next step is to eliminate the potential defense by snuffing out its source.

The purpose of this article is to illustrate the nightmare of two defenses through two war stories. The first defense was based upon equitable principles. The other defense was a fluke that, in reality, could occur more often.

II. The Case of Equity Gone Awry

1. Background
   
   Our client, the new owner of a multi-use commercial building in a large metropolitan area, entered into a lease with the owner of a progressive, flamboyant, business who had been moved out of his previous location by demolition of the building. The specific space that the tenant wanted to occupy had some deferred maintenance needs and, in addition, needed significant improvements to accommodate the glitzy business ambiance of the tenant.
   
   The parties entered into a lease agreement that, among other things, provided the following:

   Unless otherwise specified in any Rider or Exhibit to this Lease, Tenant shall pay for all Tenant improvements, whether the work is performed by Landlord or by Tenant. . . . All improvements, alterations and other work performed on the Premises by either Landlord or Tenant shall be the property of Landlord when installed. . . . Notwithstanding Landlord's consent to improvements or alterations by Tenant, all such improvements, alterations or other work to be performed by Tenant shall be at the sole cost and expense of Tenant.

   The lease term was 10 years.
   
   Immediately after taking possession, the Tenant expended approximately $100,000 in improvements of the electrical, plumbing, and acoustical elements of the lease space. It conducted the improvements with the blessing of the landlord and began conducting its business from the premises. Unfortunately, customers didn't beat a path to the door of the premises. The tenant fell behind in the payment of rent and utilities within 1-1/2 years of executing the lease and the landlord called us.
2. The Defense
   
   We commenced a Forcible Entry & Detainer ("FED") action to have a court enter a judgment forcing the tenant to vacate the premises. The tenant admitted owing "rent" but argued that the landlord would be unjustly enriched if it were allowed to evict the tenant. The tenant's theory was that the landlord was getting something for nothing if the tenant was not either allowed to realize the full term of the lease (and therefore, the useful life of the improvements) or be reimbursed by the landlord for the reasonable value of the improvements notwithstanding the language in the lease.
   
   At first, the judge was sympathetic to the tenant's plight. The tenant had, undeniably, improved the landlord's premises; the premises could be sublet by the tenant for another use, but the landlord refused; both parties believed at the outset of the lease that it would be long-term; and the business had been a fixture in this metropolitan area for several years at its former location. An eviction would likely cause a bankruptcy of the business and the unemployment of several people. If the "benefit" to the landlord could be translated into rent, the tenant would be current and could remain current with the impending resurgence of its business.
3. The Ruling
   
   The judge ultimately agreed with us that, in the absence of fraud or duress by the landlord, a tenant must accept the legal consequences of entering into a commercial lease agreement no matter how unfavorable the agreement may turn out to be.
4. Lessons Learned
1. Invest in a form of lease agreement that specifically sets forth the landlord's construction obligations (or absence thereof). The lease should reflect the parties' agreement pre-construction and construction obligations, tenant improvement allowance (if any), payment method, change order process and treatment of tenant delays.
2. Don't orally modify the terms of the lease; and
3. The anti-waiver clause in the lease is not just window-dressing. If drafted carefully and adhered to by the landlord, it will allow the landlord some flexibility in the treatment of tenant defaults without creating an equitable defense for the tenant.

III. Looks Like a Duck; Quacks Like a Duck. . .

1. Background
   
   Our client leased storefront, retail space to a tenant who used it to operate a rental/sale business. The former owner of the building and the tenant had executed a lease agreement which contained a bare-minimum of terms, but clearly identified the tenancy as a commercial lease. The tenant faithfully paid rent each month for several years, but began to fall behind in timely payment and finally defaulted. The space contained, in addition to the retail space, a bathroom, as well as an office and a "break room" (sink and microwave oven). The retail space was separated from the rest of the premises by a door which could not be unlocked without a key from the retail space. Both sides of the premises had exterior doors.
   
   We undertook to lock out the tenant and to seize the inventory. We had determined the inventory and shelving was unencumbered and if we didn't do a lockout there was a strong probability that the inventory would disappear during an FED proceeding. We contacted the police to let them know what we were doing and we met our locksmith at the building after business hours. We entered the building through the retail space and began to inventory the contents when the tenant burst through the interior door brandishing a club.
   
   After we calmed the tenant, he explained that he had been living in the "office" for a long period of time. It was his "residence." Worse yet, we discovered our client was aware of the arrangement, but didn't think it mattered.
2. The Problem
   
   Residential tenancies are dramatically different from commercial tenancies in several respects, not the least of which is the fact that there is no lockout rights in residential tenancies. The law frowns on entering residential premises in the middle of the night and changing locks.
3. The Remedy
   
   We opted to treat the premises as separated by the interior door into a commercial tenancy on the retail side and a residential tenancy on the "office" side. We locked the internal door from the retail side and paid for the installation of a new lock on the office side for the tenant. We gave a notice as if the entire lease were a residential lease, but we posted notices of the lockout on the retail side as if it were a commercial lease. Our client was paid in full by a purchaser of the business and the tenant moved out before the commercial/residential lease issue went to court. A determination that the tenancy was residential regardless of the lease would have resulted in significant exposure to the landlord, including statutory damages.
4. Moral for Landlords
1. Get to know the tenant;
2. Visit the property every once in awhile;

3. Tell your attorney everything that may be relevant (no matter how remote you may believe it is) to the task at hand.

This article is intended to inform the reader of general legal principles applicable to the subject area. It is not intended to provide legal advice regarding specific problems or circumstances. Readers should consult with competent counsel with regard to specific situations.

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